The strange nature of 'fiduciary outs'.

• Author: KABACK, HOFFER
• Position: Brief Article

Forget traditional notions of contract law when it comes to merger agreements.

A "FIDUCIARY OUT" in merger agreements permits a seller to negotiate with a new bidder that tops the price of the buyer with which that seller has already contracted. Three interrelated provisions are involved: the "no-shop" that prevents the seller from soliciting, providing confidential information to, or negotiating with, new bidders; the "fiduciary out" that lets the seller out of the "no-shop" restriction, if the seller's lawyers have advised its board that it cannot ignore the new bidder without violating its fiduciary duties; and the "break-up fee" that compensates the jilted buyer if the seller makes a deal with that new bidder.

These provisions are standard nowadays. Yet their tripartite existence is a little strange under general principles of contract law. If X Corp contracts to supply widgets to Y Corp and then breaches, Y has a right to recover damages from X measured by the benefit to Y of the supply contract to which it was entitled. That contract wouldn't contain clauses saying that if, post-signing, X makes a better deal (for itself) to supply Z Corp (a competitor of Y's) instead of Y, X's board is free to do so and Y is simply relegated to a break-up fee.

Similarly, if Smith contracts in writing to sell real estate to Brown, it's just tough on old Smith if, a week later, Newman offers Smith more money fort that parcel. If Newman wants to own the property, he has to try to make a deal with Brown post closing, not with Smith in order to induce him to breach the contract with Brown. Nor should this result be different if the owner of the property is not Smith individually but instead Smith Inc., a Delaware (public or private) corporation.

So, whence our trio of provisions? Well, in the bad old days of the early 1980s, some sellers employed "lock-up" devices to (a) favor the initial bidder (often an LBO entity in which the seller's management had an equity participation) and (b) preclude other bidders from having a fair shot at a level playing field. In response, courts clamped down. Fiduciary-out clauses were one result.

However, there are two ends to the spectrum. At one end: the board has made a sweetheart deal with a favored bidder before canvassing the universe of potential buyers. Here, even absent an explicit fiduciary-out clause, the courts would imply one upon suit by a higher bidder. At the other end, though: after a comprehensive search...