Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The M&A Termination Fee Trap That Cost a Buyer $22 Million
Transcript
- Lucas: So there's a paragraph in almost every letter of intent that most buyers treat as boilerplate. It's the termination fee clause. And in early 2022, a mid-sized private equity firm in Chicago learned exactly how expensive ignoring it can be. Luna: How expensive? Lucas: Twenty-two million dollars. They signed an LOI to acquire a specialty manufacturing company — let's call it Midwest Precision — for $180 million. The LOI included a $22 million termination fee if the buyer walked or failed to close, subject to certain conditions. Standard stuff. Luna: Right, a break fee. Usually three to five percent of deal value. That's in line. Lucas: Exactly. $22 million is about 12.2 percent, which is actually high, but the target had multiple suitors. The seller wanted protection. The buyer agreed, thinking they'd close in sixty days. They didn't. Luna: What happened? Lucas: A larger strategic buyer came in during exclusive due diligence — offered $230 million. The seller's board had a fiduciary duty to consider it. They triggered the no-shop clause's fiduciary out, terminated the deal, and took the higher offer. The original buyer demanded their $22 million. Luna: Wait, the buyer triggered the termination? I thought the seller triggered it. Lucas: The seller terminated, but the fee provision was written asymmetrically — it only applied if the buyer walked. The buyer's argument was that the seller's termination constituted a breach of the exclusivity covenant. The seller countered that the fiduciary out allowed it. Luna: So the buyer ended up paying the fee? Lucas: They didn't pay it — they sued. And after eighteen months of litigation, the court ruled that the termination fee was enforceable only if the buyer walked. Since the seller terminated, no fee was owed. But here's the kicker — the buyer had already spent $3 million on due diligence and legal fees. They got nothing. Luna: And the $22 million was never paid. That's brutal. Lucas: It gets worse. The court also found that the buyer's LOI had a flawed definition of 'termination event.' It didn't explicitly cover a seller's fiduciary-out termination. So the buyer had no contractual basis to recover. Luna: So the lesson is: if you're a buyer, make sure the termination fee is mutual — trigger it on a seller's fiduciary out too. Lucas: Exactly. And if you're a seller, you want it one-sided in your favor. But either way, the critical thing is that the definition of 'termination event' is airtight. This case hinged on three words that should have been there and weren't. Luna: What were those three words? Lucas: 'Or seller's termination.' Sounds obvious in retrospect, but in the rush to sign the LOI, the buyer's counsel used a template that said 'buyer's termination or mutual agreement.' They never updated it for the fiduciary-out scenario. Luna: Template language. That's how deals blow up — not because of some exotic legal theory, but because someone didn't read the fine print. Lucas: Exactly. And I think this is a good moment to mention something. These episodes take time to research, and we keep the show ad-free deliberately. We think that makes the conversations more useful. If this kind of detail has helped you think about a deal differently, you can support the show at buy me a coffee dot com slash fexingo. It's a small way to keep these episodes free and independent. Luna: Yeah, I agree. No ads means we can go deep without anyone telling us to speed up. It's a good trade-off. Lucas: So let's go deeper. The other nuance here is the no-shop clause itself. The buyer's LOI had a typical 45-day exclusivity period. But the clause allowed the seller to terminate if they received a superior proposal — standard fiduciary out. The buyer thought that was fine because they planned to close fast. Luna: But the due diligence hit a snag? Lucas: Yes. They found an environmental issue on one of the manufacturing sites. Soil contamination from a solvent used in the 1990s. The buyer wanted a $5 million escrow for remediation. The seller pushed back, saying it was pre-existing and should be excluded. That negotiation took three weeks. Luna: And during those three weeks, the larger buyer came in. Lucas: Exactly. The seller's banker quietly ran a mini-auction. By day 40 of exclusivity, they had a signed topping bid at $230 million. The original buyer's only recourse was the termination fee — which, as we said, wasn't triggered. Luna: So the $22 million was essentially a paper tiger. It only worked if the buyer walked. But the buyer didn't walk — they were ready to close. The seller walked. Lucas: Right. And courts generally interpret termination fees strictly. They're liquidated damages. So if the contract doesn't say the fee applies in that specific scenario, it doesn't. Luna: What about the buyer's argument that the seller breached exclusivity? That seems like a straightforward breach of contract. Lucas: The court ruled that the fiduciary out was an express exception to the exclusivity clause. So the seller didn't breach. The buyer's claim was essentially that the seller shouldn't have considered the higher offer — but Delaware law, where most of these deals are governed, says boards have a duty to consider superior proposals. Luna: So the buyer had no case. And they lost $3 million in sunk costs. Lucas: Plus the opportunity cost. They spent 18 months in litigation. Their fund's IRR took a hit. The managing partner later said in a deposition that the termination fee was 'an afterthought' when they signed the LOI. Luna: An afterthought that cost them the deal and millions in legal fees. Lucas: Yes. And this is surprisingly common. I've seen data from the American Bar Association's M&A committee — about 40 percent of LOIs have at least one ambiguity in the termination fee provision. Usually it's around the definition of 'termination event' or the trigger conditions. Luna: So what's the fix? If I'm a buyer, what do I insist on? Lucas: Three things. First, make the termination fee mutual — it should apply if either party terminates for a reason that isn't a material breach by the other side. Second, define 'termination event' to explicitly include a seller's acceptance of a superior proposal. Third, tie the fee to specific dollar amounts, not just a percentage — because percentage can be ambiguous if the deal value changes. Luna: And as a seller? I'd want it one-sided, but I'd also want a clause that says the fee is the buyer's sole remedy if the seller takes a better offer. Lucas: Exactly. That's called a 'sole remedy' provision. It prevents the buyer from suing for damages beyond the fee. Many sellers push for that, especially in competitive processes. Luna: So the termination fee is really a price tag on the seller's flexibility. The buyer pays for exclusivity. Lucas: That's exactly how to think about it. A break fee is the cost of the seller's option to walk. If you're a buyer, you want that option to be expensive enough that the seller thinks twice. But you also want to make sure you actually collect if they do walk. Luna: Which brings us back to the drafting. The fee itself is useless if the trigger is wrong. Lucas: Right. And there's one more trap I want to flag. Some LOIs include a 'reverse termination fee' — where the buyer pays the seller if the buyer can't get financing or fails to close. Those are common in larger deals. But if the fee is structured as a reverse break fee, the buyer might be tempted to walk if they find a better opportunity — because the cost is known. Luna: So it becomes a walk-away price rather than a deterrent. Lucas: Exactly. In the deal we're discussing, there was no reverse termination fee. The buyer could walk for any reason and owe nothing. That's actually unusual — most sellers would insist on a reverse fee to ensure the buyer is serious. But because the seller had multiple bidders, they didn't push. Luna: And that lack of a reverse fee gave the buyer false comfort. They thought they had no downside. Lucas: Right. But the downside was the $3 million in sunk costs — plus the reputational hit. Their LPs were not happy. Luna: So what's the right percentage? You said 12 percent is high. What's typical? Lucas: For a deal under $500 million, you usually see three to four percent. Over a billion, it can drop to two or three. Twenty-two million on 180 is 12 percent — that's more typical of a hostile takeover defense than a negotiated deal. It signals that the seller was worried about the buyer lowballing. Luna: Or that the seller knew they might get a higher bid and wanted compensation. Lucas: Exactly. And the buyer agreed to it because they thought they were the only serious bidder. They were wrong. Luna: So the negotiation of the termination fee is really a negotiation about how serious both sides are. Lucas: Yes, and about how likely a topping bid is. If you're a buyer going into a competitive process, you want the lowest possible break fee. If you're a seller, you want it high enough to deter the buyer from fishing for a better deal elsewhere. Luna: There's also the timing. In this case, the buyer had 45 days. That's actually short for a manufacturing company with environmental issues. Lucas: Very short. Sixty to ninety days is more common for a deal of that complexity. The buyer was overly confident. They waived the environmental condition precedent, thinking they could negotiate the escrow post-signing. That was a mistake. Luna: So multiple mistakes compounded. First, the LOI language. Second, the due diligence timeline. Third, the waiver of conditions. Lucas: Yes. And the fourth mistake: not including a matching right. Some LOIs give the buyer the right to match any superior proposal. This buyer didn't ask for one. If they had, they could have matched the $230 million and kept the deal. Luna: But they would have had to pay $22 million extra anyway, because the termination fee wouldn't apply. Lucas: Right, but they could have matched. Instead, they lost the deal entirely. The $22 million was never paid, but the buyer ended up with nothing. The seller got $230 million from the strategic buyer. Luna: So the real cost to the buyer wasn't the fee — it was losing the acquisition. Lucas: Exactly. And that's the hidden trap. Buyers focus on the fee amount, but the real risk is losing the deal. The termination fee is just the consolation prize. But if you don't draft it right, you don't even get that. Luna: So next time I'm reviewing an LOI, I'm going to spend an extra fifteen minutes on the termination fee paragraph. Lucas: It's the most expensive page in the document. And the one most people skim. Luna: Thanks, Lucas. Good stuff. Lucas: Thanks, Luna. Let's do it again soon.