What Is a Break Fee?

A break fee is a fee paid to a party as compensation for a broken deal or contract failure. Two common situations where a break fee could apply is if a mergers and acquisitions (M&A) deal proposal is terminated for pre-specified reasons and if a contract is terminated before its expiration.

How Break Fees Work

In a merger or acquisition transaction, a break fee is invariably negotiated and set to provide some incentive for a target company to complete a deal and to promise monetary compensation to the acquirer if it is not completed. The amount of the break fee is connected to an estimate of due diligence costs, and management and director time to review and negotiate the deal.

A break fee will apply if there is a breach in a no-shop clause or if the target company accepts a bid from another party. An external reason may even trigger a break fee—for instance, failure to receive regulatory approval, which may crop up in industries with relatively high degrees of concentration. Break fees (and what specifically would cause them) are disclosed in Form S-4, a filing with the Securities and Exchange Commission (SEC) for matters related to a merger or acquisition.

Common in lease agreements, break fees are penalties charged against parties who vacate premises or return equipment before lease expiration dates. This is to protect lessors from losses they would incur from the early termination of leases. Break fees may also be written into other types of business transaction contracts to deter non-performance and compensate a party if in fact there is non-performance.

In certain derivatives contracts, such as swap agreements, a break fee may be included in the form of a termination clause that describes the procedures and remedies for one of the counterparties if the other counterparty defaults or otherwise ends the contract. This includes, but is not necessarily limited to, the payment of damages to the injured counterparty. When a swap terminates early, both parties will cease making the contractually agreed upon payments and the at-fault party will be required to remediate.

Key Takeaways

  • A break fee is a penalty paid by a party who breaks a deal or agreement to the other party involved.
  • Break fees are commonly included in mergers and acquisitions deals but may also be found in common lease agreements and may be written into derivatives like swap contracts.
  • The amount of the break fee is connected to an estimate of due diligence costs, management and director time to review and negotiate the deal, and any economic loss that may be incurred due to the deal-breaking.

Deal Break Fee Example

Rockwell Collins Inc. filed a Form S-4 in conjunction with a proxy filing dated December 11, 2017, to describe in detail the proposed takeover of the company by United Technologies Corporation (UTC). The break fee clause in the filing stipulates that Rockwell Collins will pay to UTC $695 million if one of the following events occur:

  1. UTC terminates the merger agreement pursuant to the breach termination right on the basis of a breach of a covenant or agreement contained in the merger agreement.
  2. Either party terminates the agreement pursuant to the end date termination right or failure of Rockwell Collins to obtain shareholder approval.
  3. Rockwell Collins completes an [alternative] acquisition proposal or enters into a definitive agreement with respect to an [alternative] proposal.