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. It is used to discourage the seller from 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 are a provision in a sales agreement. They are used to motivate the seller to close a pending acquisition deal. 

Breakup fees are meant to discourage sellers from backing out of the sales arrangement. A company might have to 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.

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
• A seller opens the investment opportunity to the public instead of the private investor named in the agreement
• 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.

The Bottom Line

A breakup fee is used in takeover agreements and agreed on by the parties in advance. It is a payment that a seller must make to the buyer if the seller backs out of the sale. A breakup fee serves two purposes: it discourages the seller from backing out of the agreement, and it compensates the buyer for the time and resources they invested in the deal.

Breakup fees are used in both public and private sales; in a public offering, they can be added during the bidding process. The situations that would trigger the breakup fee must be agreed on and outlined in the contract in advance. A breakup fee could be triggered by the break-up of negotiations, by the seller choosing a different buyer, or by the discovery of a defect in the target company that had not previously been disclosed.