A look at deal protection mechanisms
Article first published in Law 360, February 2016
Bermuda companies, like companies in other jurisdictions competing in the international business sphere, are under continued pressure to succeed and grow so as to succeed on a greater scale. Brian Schneider, senior director at Fitch Ratings, commented in its report titled "Bermuda 2016 Market Update" that "organic growth options are limited and scale and diversification are driving a rapid pace of mergers and acquisitions (M&A) activity for Bermuda insurers and Fitch expects industry consolidation to continue."
The high costs and reputational risks of failed business acquisitions or combinations (business combinations) have increased the need for bidders, target companies and their respective advisers to ensure that the deal is successful, or that they are adequately protected if they fail.
Upon deciding the appropriate type of business combination, care should to be taken to ensure that the interests of the company are adequately protected during any negotiation period and between signing and closing. The company should also acknowledge and address the concerns of any counterparty with respect to any costs associated with a failed transaction. Consequently, deal protection mechanisms are often pleaded and tend to be some of the most heavily negotiated provisions. In negotiating deal protection mechanisms, each director must give due consideration to his/her fiduciary duties and continue to do so during the process — the core duty being to act honestly and in good faith with a view to the best interests of the company.
Deal protection mechanisms are principally covenants or arrangements between a bidder and target company boards that are intended to discourage alternative and/or superior proposals with a view to protecting a bidder’s transaction if such a proposal materializes. From a bidder’s perspective, the need for deal protection provisions principally arises because, among other things, they do not want to be a stalking horse as it were and they wish to realize synergies and projected benefits from the business combination and minimize competition. Also, a considerable amount of time and cost is spent resulting from both negotiating business combinations and anticipated future opportunities. For these reasons, bidders are typically reluctant to enter into a business combination without protecting the deal to the best extent possible.