Fiduciary Out

What is a fiduciary out?

Fiduciary out (an exception based on fiduciary duty, also called a fiduciary out clause) is a clause in acquisition agreements under US practice that allows the governing body of the target company to respond to an unsolicited, better offer despite a no-shop obligation. The target company is the company that is to be acquired; the no-shop obligation prohibits it from looking for other buyers. The governing body may then change its recommendation to the shareholders and, where appropriate, terminate the agreement against payment of a fee. The reason is the fiduciary duty its members owe to the company and its shareholders.

The fiduciary out is one of the protective mechanisms that buyer and target company agree between signing and closing, together with the no-shop clause, the break-up fee and the buyer's matching right. It matters in takeovers of listed US companies whose shareholders still have to approve the transaction. German law has no direct equivalent. It is not needed in the sale of GmbH shares or in funding rounds, because there the shareholders themselves decide.

Background in US corporate law

The members of the governing body of a US company (board of directors) owe duties of care and loyalty. The courts in Delaware, where many US companies are incorporated, examine protective clauses in acquisition agreements to see whether they effectively rule out a better offer or push the shareholders towards approval. Arrangements that take away any possibility for the governing body to respond to a superior offer have been criticised. A frequently cited case combined voting commitments of the majority shareholders with an obligation to put the agreement to a vote in every case, and dispensed with a fiduciary out. The outcome was thus fixed before a better offer could even arrive.

Acquisition agreements with a no-shop clause therefore regularly contain a fiduciary out. The target company then may not approach other buyers, but may respond to offers that arrive without its involvement. This combination is also called a window shop. Actively looking for buyers, by contrast, is permitted only by a go-shop provision.

Process in the case of a superior offer

1. Unsolicited offer: A third party submits an offer without the target company having breached the no-shop obligation.
2. Review: The governing body determines whether the offer is or may become superior (superior proposal). Agreements usually require a written, serious offer that is financially more favourable and, including its financing, is likely to be completed. The usual contractual language requires a good-faith determination after consulting external legal and financial advisers.
3. Discussions and information: Only then may the company negotiate with the third party and give it documents, as a rule under a confidentiality agreement that is no more favourable than the buyer's.
4. Notice and matching right: The buyer is informed of the identity and terms and can improve its offer within a period (matching right), often three to five working days.
5. Change of recommendation or termination: If the buyer does not improve its offer sufficiently, the governing body examines whether continuing with the agreement would be incompatible with its fiduciary duties. If so, it may change its recommendation to the shareholders or terminate the agreement in order to conclude with the third party. Payment of the break-up fee is often a condition of termination.

Some agreements also permit a change of recommendation without a third-party offer if an unforeseen, material event occurs after signing (intervening event). Conversely, some agreements oblige the company to put the transaction to the shareholders for a vote despite a changed recommendation.

Position under German law

GmbH and the venture context

In the sale of GmbH (German limited liability company) shares, the shareholders are themselves party to the contract and decide on the sale. The management is bound by shareholder resolutions (Section 37(1) of the German Limited Liability Companies Act, GmbHG). There is therefore no organ duty that would force an exception to the no-shop clause, and the sellers can bind themselves even without such an exception. In funding rounds, too, in which the company, shareholders and investors take part, the fiduciary out is of no significance.

Stock corporation and takeover law

The management board of a stock corporation (Aktiengesellschaft, AG) manages the company on its own responsibility (Section 76(1) of the German Stock Corporation Act, AktG) and is committed to the interest of the company. German stock corporation law does not recognise a duty to maximise the shareholders' proceeds alone in this form. The law measures its decisions against the care of a prudent and conscientious manager (Section 93(1) AktG).

In public takeovers, the management board and the supervisory board must give a reasoned statement on every offer and every amendment (Section 27 of the German Securities Acquisition and Takeover Act, WpÜG). An obligation to recommend an offer regardless of better alternatives would be hard to reconcile with this duty. In agreements with the bidder, often called a business combination agreement in practice, the boards therefore frequently reserve the right to withdraw their support if their duties so require. Economically, these reservations serve a similar purpose to the fiduciary out.

Practical example: a fiduciary out in a US takeover

A listed US company with 40 million issued shares signs an acquisition agreement with buyer A at USD 30 per share, i.e. USD 1.2 billion. The agreement contains a no-shop clause with a fiduciary out, a matching right of four working days and a break-up fee of 3%, i.e. USD 36 million.

• Three weeks after signing, bidder B submits an unsolicited, written, financed offer at USD 32 per share, USD 1.28 billion in total.
• After consulting advisers, the governing body determines that the offer may be superior, opens discussions and informs buyer A.
• Buyer A improves its offer within the period to USD 32.50, USD 1.3 billion in total.
• Bidder B raises its offer to USD 34, USD 1.36 billion in total. Buyer A waives a further adjustment.
• The company terminates the agreement, pays buyer A the fee of USD 36 million and signs with bidder B.

For the shareholders, the price is USD 4 per share, or USD 160 million, above the original agreement. The fee corresponds to USD 0.90 per share and falls economically on bidder B, because it reduces the value of the acquired company. Buyer A receives the agreed fee for its efforts.

Distinction: fiduciary out, no-shop, go-shop and MAC clause

• No-shop clause: establishes the prohibition on approaching other interested parties and negotiating with them. The fiduciary out is the exception to it.
• Go-shop provision: permits the active search for buyers for a period after signing. The fiduciary out only permits a response to incoming offers.
• Break-up fee: the payment that regularly falls to the original buyer when the fiduciary out is exercised.
• Material adverse change: concerns the buyer's exit in the event of a material adverse change, whereas the fiduciary out concerns the target company's exit.

Common mistakes

• Adopting it in GmbH agreements without reason. In a share purchase agreement there is no organ duty that requires such an exception. An adopted clause creates uncertainty about whether and when the sellers may withdraw.
• Vague definition of the superior offer. If there are no criteria on financing, conditions and prospects of completion, a merely higher price can be presented as superior.
• Endless matching rounds. Without a rule for repeated improvements, the original buyer can narrowly outbid every third-party offer and drag out the competition.
• Fee as a de facto barrier. If the break-up fee is so high that switching is hardly worthwhile, the fiduciary out is economically empty.
• Confusing change of recommendation with termination. A change of recommendation does not end the agreement. The agreement must regulate separately what rights both parties have afterwards.

Frequently asked questions

Is there a fiduciary out in German law?

Not as a figure regulated by statute. In public takeovers of German stock corporations, comparable room for manoeuvre arises from the duty to give a reasoned statement and from reservations in the agreements with the bidder.

May a target company with a fiduciary out actively look for buyers?

No. It may only respond to offers that arrive unsolicited. Actively searching after signing requires a go-shop provision.

What does the original buyer receive if the fiduciary out is exercised?

As a rule, the agreed break-up fee. Many acquisition agreements provide that this settles its claims arising from the termination.

Do founders need a fiduciary out when selling their GmbH?

No. As shareholders, they decide on the sale themselves and are not subject to an organ duty that requires such an exception. They secure their price through competition before signing.

The Roemer Capital view

We encounter a fiduciary out mainly in contract drafts from international buyers who work with US templates. To shareholders selling their GmbH shares, we explain that the clause gives them no additional legal position and that its follow-on rules on matching rights and fees can prolong the negotiation.

The question the clause answers matters more to us: whether the agreed price stands up to a comparison with the market. We answer this question before signing through an orderly competition among several interested parties, for example in an auction process. The legal assessment of individual clauses is handled by the client's law firm.