Through many merger cycles, the basic template for M&A deals in the banking sector hasn’t changed very much. Provisions governing the regulatory process included fairly conventional cooperation undertakings, including rights to review. Time periods and drop-dead dates were matched to the regulatory requirements and expectations. The level of effort required on the part of the buyer and the target to obtain regulatory approvals was limited: Neither party would be required to take steps that would have a material adverse effect, typically measured relative to the size of the target. Reverse termination fees, payable by buyers if regulatory approvals were not forthcoming, were rare. Covenants governing the target’s operations between signing and closing were conventional and not unduly controversial.
Deals continue to get done on this basis but in the post-Dodd-Frank era, the regulatory climate is creating new forces that could reshape some of these basic M&A terms. These changes arise for several reasons. First, regulators increasingly see mergers as an occasion to scrutinize the buyer—its compliance record, systems, capacity to integrate and general good standing. In its September 2015 approval of M&T Corp.’s acquisition of Hudson City Bancorp, the Federal Reserve starkly warned that if an examiner identifies a material weakness in an acquiring bank, it will expect the bank to withdraw its application and resolve the issue before proceeding with the transaction.
The specter that the buyer’s challenges or standing can cause the target to be left at the altar has not yet fully worked its way through our M&A contract provisions. This is quite a different sort of regulatory risk, from the target’s point of view, than concerns about potential liabilities of the target or concerns about the competitive effects of the combination, which both parties can evaluate. Already, this regulatory focus has led targets to perform regulatory diligence on buyers, even in cash deals. As the M&A process continues to evolve, targets may try to distinguish between different kinds of regulatory risk and seek explicit protection where the sins of a buyer spoil the ceremony. Alternatively, it may prove too difficult to determine with certainty the cause of a regulatory obstacle, which could lead targets to seek greater protection for any regulatory failure. In either event, the result could be more requests for regulatory break-up fees—targeted or broad-based.
A number of other M&A provisions could be affected as well. For example, as the pendency of agreements becomes longer to allow time for an uncertain regulatory process, the market and intervening events that could change the value of the target or the buyer’s currency become more important, which in turn will increase the importance of material adverse effect conditions, interim covenants, the structure of “fiduciary outs” enabling a target board no longer to recommend an agreed deal, the size of break-up fees, the timing of shareholder votes, and the consequences of a no vote. In stock-for-stock deals between companies of comparable size, there is often a helpful symmetry to the parties’ situations and incentives, which could result in both parties wanting to limit the conditions under which they can back out of a deal—or, conceivably, the reverse. In cash deals or other true acquisitions, that symmetry is absent and each side can be expected to push for protection from the other’s problems. For the buyer, this may mean seeking greater conditionality in the event of adverse developments as well as tougher interim covenants. For the target, it may mean more regulatory protection and greater flexibility to respond to intervening events.
Longer delays and greater volatility also impact techniques for determining the merger consideration in stock deals. A fixed exchange ratio in which the buyer offers an agreed number of its shares in exchange for each share of the target, long a staple, implicitly presumes that the value of the two companies will likely move in sync. As the prospect of asymmetrical changes in value increases—which can be a result of an increasingly vigorous regulatory environment—there is some urge to fix the value of the buyer’s consideration, rather than the number of buyer shares. More fixed value deals will lead to negotiation over “collars” that create minimum and maximum numbers of shares the buyer is obligated to issue in the transaction, and, perhaps, walk-away rights that enable one party or the other to terminate the deal if the buyer’s stock price becomes too high or too low.
It’s too early to assess the impact of the changing regulatory climate on the M&A craft, but there are many reasons to think the current template will evolve, perhaps quite rapidly. That, of course, will put a premium on thoughtful lawyering and creative, practical solutions.