412 12 Acquisition of Shares in a Privately-owned Company for Cash
Best efforts clauses. A best efforts clause requires both parties to use their “best
efforts” to consummate the transaction. The purpose of a best efforts clause is to
impose a minimum duty to act in good faith toward the party to whom the best ef-
forts obligation is owed.^21
Recommendation clauses. Where the transaction must be authorised by the
vendor’s shareholders, the prospective acquirer may wish to secure from the direc-
tors of the target company a legally binding undertaking to recommend the offer
to the shareholders of the target and not to encourage or co-operate with any
“white knight” (section 18.7) which may emerge as a rival.^22
Cancellation fees, break-up fees. Cancellation fees (also known as break-up
fees) are a common way to protect the prospective acquirer in particular where the
transaction requires approval by the target’s general meeting and/or board of di-
rectors, and the target has not yet taken necessary corporate action.
Cancellation fees are essentially liquidated damages payable if the acquirer
fails to receive the expected benefits of the agreement. In effect, the target is re-
quired to pay a specified amount to the acquirer in the event that the transaction is
not consummated, reimbursing the acquirer for out-of-pocket costs associated with
making the offer and perhaps also including an increment reflecting the acquirer’s
lost time and opportunities.^23
Engagement fees are a variation of the same theme. White knights proposing a
leveraged buyout of the target in response to a hostile takeover bid frequently re-
quire an engagement fee, requiring the target to pay a relatively small fee as con-
sideration for the white knight’s preparation and submission of the bid.^24
Lock-ups. Exclusivity clauses might not prevent competing offers, because ex-
clusivity clauses are not binding on third parties and may not even be enforceable
against the target company or its organs. The prospective buyer may therefore
want to make exclusivity clauses more effective as a deterrent.
In this context, a lock-up is any arrangement or transaction by which the ac-
quirer obtains a competitive advantage over other acquirers in order to deter third-
party interest. So defined, the term includes such tactics as an unusually large can-
cellation fee or an agreement by the target to use takeover defenses to protect the
favoured offer from competition. It can include both shareholder lock-ups and as-
set lock-ups.^25
(^21) Ibid.
(^22) See Davies PL, Gower and Davies’ Principles of Modern Company Law, Seventh Edi-
tion. Sweet & Maxwell, London (2003) p 720: “Indeed, the initial bidder may not be
willing to make a bid for the target unless such assurances are forthcoming. This situa-
tion has given rise to discussion of a second proposition, namely that directors may not
effectively limit their discretion to act in whatever way seems to them at any given time
to be in the best interests of the company, and so cannot give legally binding undertak-
ings of the type sought by the initial bidder ... It is true that the courts exhibit some re-
luctance to regard undertakings of this sort, given by the incumbent management, as in-
tended by the parties to have contractual force.”
(^23) Bainbridge SM, op cit, pp 180–181. See also Cole J Jr, Kirman I, op cit, p 72.
(^24) Bainbridge SM, op cit, pp 180–181.
(^25) Cole J Jr, Kirman I, op cit, p 72; Bainbridge SM, op cit, pp 191–192.