Break fee: Overview, definition and example
What is a break fee?
A break fee is a financial penalty one party agrees to pay if they decide to back out of a deal before it’s completed. Typically, this fee is included in contracts to compensate the other party for the time, resources, or potential opportunities lost due to the cancellation. A break fee can apply in various situations, such as mergers, acquisitions, or partnerships, where one party backs out or fails to meet certain conditions.
Why is a break fee important?
A break fee is important because it provides security and protection for the party that might be left in a disadvantageous position if the deal falls through. It discourages one side from casually walking away from an agreement and ensures that there’s compensation for the disruption caused by the cancellation. For businesses, having a break fee clause can help manage risks and maintain a level of commitment in high-stakes negotiations.
Understanding break fees is also crucial in assessing the costs of backing out of an agreement and ensuring that there’s a clear understanding of the consequences if a deal doesn’t go through.
Understanding break fees through an example
Imagine Company A is negotiating a merger with Company B. As part of the merger agreement, Company A agrees to a break fee clause, which states that if they decide to cancel the deal for any reason before completion, they must pay Company B a $5 million break fee.
In this case, if Company A decides to back out of the merger, they would be financially liable to pay the $5 million to Company B. The break fee protects Company B from the potential costs and disruptions caused by the failed merger and incentivizes both parties to proceed with the deal seriously.
An example of a break fee clause
Here’s how a break fee clause might appear in a contract:
"In the event that either party decides to terminate this agreement prior to closing, the terminating party shall pay a break fee of $5,000,000 to the non-terminating party, to cover costs and losses incurred due to the termination."
Conclusion
A break fee serves as a safeguard in contracts, especially in high-stakes agreements like mergers and acquisitions. It provides a financial deterrent against backing out of a deal and compensates the other party for any disruption or loss of opportunity. By understanding break fees, businesses can ensure they’re protected from potential deal cancellations and can factor this cost into their decision-making process.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.