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Fiduciary Out
Practical Law Glossary Item 5-382-3460 (Approx. 3 pages)
Glossary
Fiduciary Out
An exception to the no-shop covenant in a merger agreement. Generally, when the board of directors of a public company agrees to sell the company in a cash deal, the board becomes subject to a heightened duty of care, or "Revlon duty." This duty requires the board to obtain the highest value reasonably available to the company's stockholders (see Practice Note, Fiduciary Duties of the Board of Directors: Sale of Control). Consequently, even though the directors may negotiate several deal-protection mechanisms (such as a no-shop), they still need to be able to accept a better deal for the stockholders without being fully locked up by the terms of the merger agreement. A fiduciary out permits the board to change its recommendation for the signed deal and terminate the merger agreement if failing to do so would breach its fiduciary duties.
There are three common forms of fiduciary outs:
- A right for the board to consider superior third-party offers and accept one to replace the current, signed agreement. This is the most common, and unobjectionable, form of fiduciary out.
- A right for the board to change its recommendation and terminate the agreement because of an intervening event, unknown to the directors at signing, that causes the target company to become worth substantially more than its valuation at signing. This is colloquially referred to as a finding of gold in the backyard.
- A general right of the board to change its recommendation and terminate the agreement because of a good-faith finding, on the advice of counsel, that not doing so would violate the board's fiduciary duties. In the absence of a specific reason like a superior offer or intervening event, this fiduciary out is the least common form.
In most public merger agreements, the buyer can use its matching right to improve its offer before the board of the target company exercises its fiduciary out and terminates the agreement.
Although a board may need a fiduciary out to comply with is fiduciary duties, there are no "inherent" fiduciary outs under Delaware law in negotiated agreements. A fiduciary out must be explicitly drafted in the contract.
Typically, it is the target company's board that requires a fiduciary out. However, the buyer's board may also request a fiduciary out if the buyer is paying the consideration with stock and requires a vote of its own stockholders. In this scenario, the buyer's board often has the same concerns about its fiduciary duties and therefore requires a reciprocal fiduciary out.
For details of fiduciary-out provisions in public merger agreements, see Practice Note, What's Market: Fiduciary Out.