1. practicallaw.com / September 2014 / PLC Magazine 19
M&ASERIES
M&A SERIES
Threats to certainty of completion are a risk
that sellers will always take into consideration
in mergers and acquisitions (M&A). The
degree of concern will depend on a number
of factors and will necessarily vary from case
to case. One category of deals where the level
of concern is generally fairly high is that of
sales of commercial banks during periods of
uncertainty in financial markets.
Completion risk exists in the period between
the start of a sales process and the signing
of a binding sale and purchase agreement
(SPA), and in the period between signing of
the SPA and completion.
This article, the first of a three-part series on
M&A in banking, looks at not only the steps
that a seller of any business may try to take
to mitigate completion risk (subject to its
commercial bargaining position enabling it
to do so), but also the specific concerns that
a seller of a commercial bank in a period
of uncertainty in financial markets should
consider.
Before signing
The ability of a seller to mitigate the risk of
a deal failing to get to the stage of a signed
SPA will largely depend on its commercial
bargaining power and, in particular, whether
it is able to generate competitive tension
among a group of bidders. Frequently, the
seller’s comfort is limited to reassurance that,
if a bidder is expending significant time and
cost working towards an acquisition, it is
unlikely it will walk away unless a material
problem arises.
A seller in a strong position may, however,
be able to take one or more of the following
steps to mitigate the risk:
• Record key deal terms in a letter of intent
before committing to negotiations with
a bidder.
• Require bidders to pay a non-refundable
deposit to be included in the process (as
a demonstration of intent).
• Require a preferred bidder to make a
payment to secure a period of exclusivity.
• Require a bidder to enter into a reverse
break fee/cost coverage arrangement (see
box “Reverse break fee”).
Between signing and completion
Where there is to be a gap between signing
an SPA and completion of the sale, inevitably
there will be some degree of completion
risk. In a sale process, the seller will seek to
mitigate this, including by trying to:
• Minimise the length of time between
signing and completion.
• Minimise the number of conditions to be
satisfied for completion to take place.
• Ensure that any conditions are restricted
to those required for regulatory purposes.
• Avoid a general material adverse change
condition or, if unavoidable, ensure that
it is tightly drafted.
• Exclude termination rights in respect of
any disclosures that the seller may make
against warranties at completion or in
respect of warranty breaches that emerge
after signing.
• Minimise credit risk by seeking to:
- ensure that the buyer has sufficient
resources to pay the consideration and
to fund any other amounts required to
support the business;
- have such an entity guarantee the buyer’s
payment obligations; or
- have some of the consideration amount
paid into an escrow account at signing.
Regulatory approvals
Where the target is a commercial bank,
the key determinant of the period between
signing and completion is liable to be
the number and nature of the regulatory
approvals required for the transaction to
proceed.These are liable to comprise: merger
approval (if relevant thresholds are met);
financial regulator approval in the target
bank’s territory; and, possibly, financial
regulator approval in the buyer’s home
territory.
In some territories, there is no block
exemption under antitrust laws for M&A
ancillary protection provisions, such as
restrictive covenants, meaning that these
provisions may require a separate approval
from the competition authorities. It is highly
likely that some approval processes cannot
be run in parallel as some regulators will
await sign off from another regulator before
starting their review.
To minimise the delay caused by this process
a seller should:
• Identify which approvals procedures may/
may not run in parallel.
• Specify a timeline for submission of
relevant filings with the regulators with
deadlines calculated based on the receipt
of approvals from other regulators where
consecutive processes are required;
suitable consequences should be attached
Reverse break fee
A reverse break fee arrangement
means that if that party withdraws or
fails to sign a contract by a deadline,
it must pay the seller a fee for the
purpose of covering the seller’s costs
incurred in relation to the sale process.
Protection of this nature is likely to
be subject to caveats appropriate to
the stage that the sale process has
reached; for examples, the seller
providing reasonable access to due
diligence and, potentially, acting
in good faith in trying to reach a
negotiated agreement. These are
liable to be unavoidable, but will
create grounds for potential dispute
as to whether the obligation to pay the
break fee has in fact been triggered.
This type of arrangement is likely to be
achievable in limited circumstances,
given bidders’ resistance to negotiating
under this type of restraint.
M&A in banking: managing completion risk

2. PLC Magazine / September 2014 / practicallaw.com20
to a failure to meet these deadlines in
order to incentivise compliance.
• Ensure that sufficient information is
exchanged (to the extent compatible
with legal restrictions and commercial
confidentiality requirements) during the
latter stages of negotiations to enable a
filing to be made as promptly as possible
after signing the SPA.
• If ancillary restrictions require separate
regulatory approval, ensure that these
do not hold up completion (for example,
by suspending the operation of the
restrictions until the related approval is
received).
• Seek to bind the buyer to complying with
any conditions a regulator may place on
the grant of its approval.
In some cases, regulators may accept filings
before the SPA is signed, which can save time.
Careful consideration should be put into
managing the relationship with the local
financial regulator.The seller will benefit from
ensuring that the regulator is not surprised
by the announcement of the transaction,
and that the regulator’s views on the relative
acceptability of bidders are sounded out, so
reducing the risk of a refusal of consent to
the transaction with the successful bidder
(particularly relevant since the onset of the
global financial crisis).
Ensuring that the lines of communication with
the regulator are established and maintained
during the approvals process is likely to be a
buyer responsibility. This may be supported
by various contractual obligations on the
buyer to involve the seller in the process,
including:
• An obligation on the buyer to use best
endeavours to obtain the regulatory
clearance (as a back up to specific
deadlines for submission of documents).
• A seller’s right to review and comment on
the content of any application and to be
informed of its progress.
• If possible, prohibiting the buyer from
contact with the regulator unless that
contact involves the seller (or is notified
to the seller).
• An undertaking that the buyer will not take
any action that would adversely affect any
regulatory approval process.
The risk posed by the regulatory process to
certainty of completion can be exacerbated
if the seller perceives that the relevant
institutions are insufficiently secure from
external interference in their decision-making
process, but the above steps may mitigate
the concern that such pressures might be
applied by a buyer that has had a change of
heart regarding a transaction.
The seller may also want to consider
requiring the buyer to pay a break fee/
liquidated damages in the event that the
regulatory approval is not obtained (and
potentially also in other circumstances
where failure to complete is not due to the
fault of the seller). Alternatively, the buyer
can be asked to pay a deposit on signing
of SPA, or that such deposit be placed in
escrow and to be payable to the seller if
the regulatory approval is not obtained
(and, again, potentially also in other
circumstances where failure to complete is
not due to the fault of the seller).
It is important, at least under English law, to
structure the break fee/deposit and/or the
triggers for payment so that the clause is
not construed as an unenforceable penalty.
Where the seller is particularly concerned
about repayment of parent funding that has
been supporting the target’s loan book, it
can seek to tie the buyer in by requiring it
to commit at or shortly after signing of the
SPA to some level of funding of the target
business (which may be by deposit or some
other instrument) on terms that would count
towards the target’s regulatory capital
requirements (see box “Capital adequacy
regime”).
While this would not necessarily mean that
the buyer would be disadvantaged if the
sale does not complete, it would at least
demonstrate a further level of commitment
on the buyer’s part and may have a genuine
(though possibly temporary) benefit to the
seller in enabling the seller to withdraw
some or all of the regulatory funding
it is providing even if the sale does not
complete.
Gordon Low, Baker & McKenzie LLP.
Capital adequacy regime
The capital adequacy regime for banks is designed to ensure that banks have, and are
seen to have, an amount of capital that is commensurate with the type of business they
undertake and the commercial risks that they present. The purpose of bank capital
is not just to fund the activities of the bank, it is also needed to enable the bank to
absorb unexpected losses and continue in operation without causing disruption and
loss to its customers.
The amount of capital that banks must hold is calculated as a percentage of their risk-
weighted assets. Some types of capital are inherently of better quality than others: tier
1 capital is the highest quality, and should be capable of absorbing losses on a going
concern basis. Tier 1 capital includes ordinary shares and reserves. Lower quality tier
2 and 3 capital can only generally absorb losses on a “gone concern” basis.
The amount of regulatory capital that banks should hold is a complicated accounting
and, increasingly, political issue. Many believe that under-capitalised banks were the
root cause of the credit crunch and subsequent global financial crisis. Others suggest
that the key failure was overly-stringent capital requirements that caused the creation
of risk-bearing vehicles that were off banks’ balance sheets and undertook maturity
transformation activities without being regulated as banks should be. This debate
continues. What is certain is that the assessments of a bank’s capital requirement, and
whether it has sufficient capital to meet that requirement, is likely to be a key issue
when considering the acquisition of a bank.