Breakup Fee: What it is, How it Works, Example

What Is a Breakup Fee?

A breakup fee is used in takeover agreements as leverage on the seller against backing out of the deal to sell to the purchaser. A breakup fee, or termination fee, is required to compensate the prospective purchaser for the time and resources used to facilitate the deal. Breakup fees are normally 1% to 3% of a deal's value.

Understanding Breakup Fees

Breakup fees as a contract provision provide motivation to the seller to close a pending acquisition deal. A company might pay a breakup fee if it decides not to sell to the original purchaser and instead sells to a competing bidder with a more attractive offer. Sometimes a breakup fee can discourage other companies from bidding on the company because they would have to bid a price that covers the breakup fee. Usually, a breakup fee provision also limits uncertainty associated with damages if a deal terminates during negotiations.

How Breakup Fee Provisions Are Used

Breakup fee provisions are often found in letters of intent, preliminary agreements, and option agreements, which are agreements to buy a company at a preset price. Breakup fees first became part of public takeovers, particularly in the agreements where shareholders of a targeted company get the final word on approving a deal by voting to tender their shares to the buyer company. 

Breakup fee provisions are now applied more widely and are also found in agreements related to private companies and in industrial agreements or construction projects. The breakup fee provision is generally added to a deal as early as possible. In a public offering, it may be added during the bidding process.

With growing competition in public offerings, the entity making the offer occasionally has to pay the breakup fees. The fees are then called reverse breakup fees. Mutual breakup fees are also a possibility, but they are rare.

Parties to an agreement usually need to agree on the events that can trigger the payment of a breakup fee. Theses events typically include:

• Break-up of the negotiations by one of the parties
• A seller choosing a different buyer than the one named in the preliminary agreement
• When a seller opts to open the investment opportunity to the public instead of the private investor named in the agreement
• If a defect is discovered in the target company during discovery that had not been previously disclosed
• Breakup fees do not require parties to close a deal under any circumstances

Real World Example of Breakup Fees

In 2011, AT&T was looking to acquire cellular provider T-Mobile. However, regulators opposed and blocked the $39 billion deal from getting done citing possible antitrust violations. As a result, AT&T had to pay breakup fees that totaled $4 billion. Specifically, AT&T had to pay a reverse breakup fee of $3 billion in cash and $1 billion worth of AT&T's wireless spectrum as reported by CNN/Money. Wireless spectrum are frequency bands that travel over the airwaves, and each wireless carrier transmits their wireless signals over their own specific frequency.