Hell, high water or handshakes

Ahead of the Deal - Australian M&A Briefing

The current deal environment includes heightened global and domestic regulatory scrutiny. Merger reforms will shortly impact the Australian M&A market. In that context, it has become critical that parties to M&A deals, both public and private, thoughtfully calibrate the obligations of buyers with respect to regulatory approvals. Where the parties land on the spectrum of possibilities can determine whether a deal proceeds. 

The recent Delaware decision of Desktop Metal, Inc (Desktop) v Nano Dimension Ltd et al (Nano) illustrates these issues, where a reluctant buyer unsuccessfully sought to leverage a CFIUS approval to get out of the deal. 

Charting the course of regulatory risk in M&A deals

The allocation of completion risk related to regulatory approval conditions precedent in M&A transactions is typically managed through a range of contractual "efforts" or "endeavours" obligations. These obligations impose standards of conduct, outlining the extent to which each party must act to obtain regulatory approval. The varying degrees of contractual commitment and risk allocation (from least to most onerous) can be seen in the diagram below in the nature of common formulations of "endeavours" obligations.

The uncertainty inherent in exactly what is meant by any form of "endeavours" obligation can be mitigated by specific direction in the agreement. The parties can state that it requires certain things to be done (such as filing regulatory applications by a set date), or that it does not (such as not having to appeal a ruling beyond a first instance review).

A "hell or high water" provision seeks to provide the strongest form of commitment. It obligates the buyer to take all actions necessary, regardless of the cost or difficulty, to ensure that a particular outcome is achieved, come what may. The end outcome may result in the buyer being obligated to commit to matters which at the time of signing may have been an unlikely or even unforeseeable outcome – for example divesting assets, accepting restrictions on conduct by way of behavioural undertakings, or making other concessions demanded by regulators in order to obtain the necessary approvals. There can be limits to the application of the clause by setting parameters beyond which it will not apply.

A US deal that was on the rocks: Desktop v Nano

The recent decision in Desktop v Nano shows that Delaware courts are willing to strictly enforce "hell or high water" clauses. The role of carve-outs to the obligations were also relevant. 

The Merger Agreement in question was conditional on approval from the Committee of Foreign Investment in the US (CFIUS), which was needed due to Desktop's work in sensitive defence related areas. The parties anticipated that CFIUS approval would be complex and would likely require the buyer, Nano, to enter into a National Security Agreement (NSA) to agree to mitigation measures to address national security risks. 

The negotiations were shaped by Desktop's precarious financial position – it was suffering from high cash burn and slow inventory turnover – and therefore its primary goals were to secure deal certainty and to expedite closing. Desktop extracted, amongst other things, the following commitments from Nano:

1. a "hell or high water" commitment to take "all action necessary" to obtain CFIUS approval, including entering into an NSA (negotiated in place of a reverse break fee); and
2. to use "reasonable best efforts" to close as soon as reasonably possible, and to use "reasonable best efforts" to secure regulatory approval.

The Delaware Court noted that reasonable best efforts provisions have been interpreted to require each party to take appropriate actions to keep the deal on track, including to engage in forthright discussions with the counterparty. Good faith is relevant, and a party cannot simply go looking for a way out of its deal. In making its remarks, the Court observed that: 

The "hell or high water" provision was subject to a "10% carve-out". Nano would not be obliged to accept conditions if it was forced to relinquish control of 10% of Desktop, measured by revenue. However, the parties also agreed a list of "required terms" being commonly imposed mitigation remedies that Nano was contractually obligated to accept in the NSA, and which overrode the application of the 10% carve-out.  

Despite the parties initially embarking on a collaborative journey towards closing, an activist shareholder-led campaign (which had hoped to buy Desktop out of insolvency) and a subsequent Nano board shake-up resulted in a newly constituted Nano board that hoped to use the CFIUS approval as a means to "sabotage the merger". 

The Court found that the 10% carve-out did not apply (a narrow construction to the exception was preferred, and none of the proposed NSA conditions would have resulted in a 10% revenue impact), and despite Nano arguing that the imposition of certain conditions would be "problematic" from a "business perspective", the Court expressly noted that the Merger Agreement did not contain an exception for such matters, nor for things that Nano might have viewed as "unfair". The Court also found that even if the 10% carve-out did apply, Nano was obliged to agree to the proposed terms because they were contemplated in the list of "required terms" (which terms themselves were broadly formulated). 

While using a revenue or financial metric can, at times, be an effective means to limit the reach of a hell or high water covenant, the debate around the application and scope of the 10% carve-out in this case highlights the challenges of such a base-line where undertakings may be behavioural rather than structural and their impact is not readily quantifiable in financial terms. They may also be undermined where there are broad "carve-outs" to the "carve-out" – here, the "required terms" ultimately overrode the 10% exception.

Additionally, Nano argued that Desktop was otherwise in breach of the Merger Agreement, including by breaching the "no-bankruptcy" covenant (Nano was not obliged to complete unless Desktop had complied with this covenant (amongst others) in "all material respects"). The language of this covenant was "quite specific" – the test required Desktop to have actually suffered an inability to pay its debts as they matured (a likelihood was not sufficient) and then "admit this much in writing". 

The Merger Agreement also included a cap on transaction expenses (which included legal counsel and advisor fees and expenses) of US$15 million in connection with the Merger Agreement and completion. Nano argued that this was breached by virtue of the legal fees and expenses incurred by Desktop in enforcing the Merger Agreement. The Court found that this interpretation would effectively preclude Desktop from seeking specific performance in the event of breach – a remedy that was expressly contemplated by the agreement, and that Nano's reading would effectively mean that only Nano had a right to enforce the agreement due to the asserted cap on litigation fees. The Court stated:

Nano was ultimately ordered to execute the NSA in the form proposed by CFIUS, which included operational undertakings that dealt with regulator board observer rights, restrictions on manufacturing locations and use of software, within 48 hours of the judgment and to pay the full merger consideration in completing the transaction.

The deal then closed. 

Wading through Australia's "less high" waters

By comparison to the US market, "hell or high water" clauses in their purest form, or anything approaching that, are relatively rare in Australian M&A market practice. There is limited case law addressing the enforcement of these provisions. The exercise in risk allocation will ultimately depend on the relative bargaining power between the parties. In the Australian market where "efforts" or "endeavours" clauses do appear, they are usually heavily negotiated. The framework for required conduct in dealing with regulators is often stipulated in detail, to mitigate any debate as to what is “reasonable” in the context of the deal. Careful thought is required in deals with complex competition issues, as discussed below.

Formulations in Australian public M&A deals (which do get used in private M&A deals as well) have included bidders being obliged to accept conditions that are:

• reasonable and customary;
• ones that the bidder considers to be reasonable (acting reasonably);
• consistent with the regulatory application, or with conditions previously accepted by the bidder; or
• specifically set out in the agreement.

Sometimes, these have been subject to the conditions not having a "material impact" (on value, conduct or operations, or the bidder's decision to pursue the transaction), or tied to a material adverse qualifier or similar, or not being commercially onerous. 

While the Desktop v Nano case might, on the face of it, show the robustness of a hell-or-high-water provision, the Court was primarily focussed on the clear obstructive behaviour of the bidder through a "pattern of delay and backtracking" in negotiations with CFIUS and the form of the NSA. In circumstances where the fact pattern is more nuanced and the "endeavours" obligation is more balanced, the outcome may be more challenging to predict. 

So how do these issues play out with the key Australian regulators?

Deals with complex competition issues give rise to a wide range of important questions for the parties. Is there a threshold divestment package that should be offered? Or one that would be acceptable if required? To what extent should the parties pursue the deal after an unfavourable ruling?

The ACCC's new mandatory merger regime set to commence 1 January 2026 will alter the competition regulator's powers. Like FIRB, the ACCC will then have the power to impose conditions. Under the current informal regime, the onus has always been on the bidder to offer undertakings to the regulator, noting in practice, there would be interaction with the ACCC to ensure what was being offered was headed in the right direction and then agreed.

Historically, there have usually been obligations on the buyer to accept certain FIRB conditions or undertakings, such as the "standard tax conditions", or other conditions "acting reasonably" (which may include a list of pre-agreed commonly imposed conditions likely to be requested by FIRB). The recent changes in approach by FIRB through the removal of their long-standing "standard" tax conditions in favour of tailored tax conditions and their adoption of new private equity specific conditions, may result in greater buyer resistance to "hard" commitments and a likely greater push for broader carve-outs. 

Parties to public M&A deals in Australia also regulate what to do in the event the Court rejects the booklet in, or approval of, a scheme. In the vast majority of deals these are uncontroversial provisions.

Japanese company Nippon Steel recently had its US$14.9 billion acquisition of U.S. Steel approved by President Trump - a reversal of President Biden's prior decision to block the deal on national security grounds. This was on the basis that a CFIUS NSA was entered into which gave the US Government a non-economic “golden share" that conferred broad governance and veto rights on certain matters that impacted national security. While the mechanic of the "golden share" is unknown in Australia, regulators routinely impose conditions on deals (perhaps not as broad as those in U.S. Steel) to achieve similar results. 

Reverse break fees and ticking fees

Reverse break fees are not uncommon in Australian public M&A deals. The most common triggers for a reverse break fee are around a breach of the agreement by the bidder leading to termination by the target. Sometimes, triggers can be based on failing to obtain regulatory approvals. The idea is that a reverse break fee provides an incentive to ensure bidders put their best foot forward to obtain regulatory approvals, as well as compensation to the target for a failed deal. Bidders will point out they will of course be pursuing approvals anyway and will themselves incur significant costs if a deal does not complete, along with the fact that regulatory success or failure may well depend on the target's contribution to the effort. Reverse break fees are not subject to the Takeovers Panel's 1% limit for target break fees. 

Ticking fees see sellers and target shareholders being entitled to an extra payment if the deal goes beyond a particular timing milestone. They have been used in both public and private M&A deals. They do not compensate the seller or target for a transaction failing, but rather for a delayed timeframe.

The appropriateness and quantum of a reverse break fee or ticking fee will depend on a range of factors. Some recent examples of reverse break fees and ticking fees tied to regulatory triggers include those in the following table:

In the US, we will also be keeping our eyes peeled on Google’s proposed US$32 billion acquisition of cybersecurity company Wiz, which is currently the subject of an anti-trust review by the Department of Justice and which contains a reported US$3.2 billion reverse break fee (10% of deal value) if the transaction fails to complete. 

Conclusion

At the end of the day, the message is clear for dealmakers – draft for the worst, drive to achieve the best, and be deeply thoughtful about where on the spectrum of hell, high water, and handshakes you land.

Special thanks to John McKellar for his contribution to this article, and his valuable insight into the new ACCC mandatory notification regime.

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