The transaction between Stone and the founders of Linx includes a stipulation for a break-up fee of 10% of the value of the deal. This percentage is higher than the average for both Brazil and the United States.

Data from the consultancy Dealogic show that in merger and acquisition transactions in the USA, these penalties amount to 3.8% of the value of the deal (based on a sample of 4,697 transactions since 2013), while the average in Brazil is 7.4% (based on only 13 transactions).

The purpose of a break-up fee is to enable one party to obtain defrayal from the other party of the costs of legal and financial advisers if the deal falls apart due to regulatory changes, vetoes of competition authorities or change of mind before closing.

The deal between Linx and Stone is valued at R$ 6 billion, with a break-up fee of R$ 605 million, paid by Linx to Stone if the transaction is concluded with a third party. On the other hand, if CADE does not approve the transaction, Stone will have to pay this amount to Linx. The term sheet also calls for a fine of R$ 151 million (25% of the R$ 605 million, or 2.5% of the value of the deal) payable by Linx if the shareholders of the company (which has dispersed ownership) reject the deal. Finally, if after this rejection, Linx completes a sale to a third party within 12 months, it will have to pay R$ 454 million to Stone, completing the R$ 605 million.

Lawyers say that break-up fees are common, but can be a problem if they are too high. The independent directors of Linx questioned the amounts stipulated, as expressed in the minutes of the board of directors meeting that examined the transaction. The document indicates that the advisers retained for the transaction gave examples (not publicly disclosed) that the amounts are in line with market practice. However, if the amount of the fee is too high and the board accepts it, the consenting directors can be accused of conduct against the interests of the company and shareholders. “The reason is that the board has the duty of accepting the best proposal, but if this does not occur, the cost to the company will be very large,” according to a lawyer.

Fines for failure of approval by the shareholders are uncommon in Brazil, since the majority of companies have a controlling shareholder or group of shareholders. But in the case of companies with dispersed ownership like Linx, lawyers say that when management accepts this type of penalty, the discussion comes to involve whether or not this is equivalent to the board usurping the power of the shareholders, who should have freedom to make the decision.

“When the directors agree on such a high amount if the deal fails to be concluded, they are to a certain extent restricting the leeway for the shareholders to reject the deal,” states João Pedro Barroso do Nascimento, a partner with Freitas Leite Advogados. He further says that in Brazil, the power/duty to approve a transaction like this legally rests with the shareholders. “In the United States, the power of the board of directors is greater.”

In general, the directors and officers in the USA have more power, for two reasons. First, since the ownership of most companies is widely dispersed, they have a more relevant role. Second, the governance models do not emerge from the law, as happens in Brazil. Instead, the governance competencies and capital structure are based on practice and evolve with time.

Claudio Miranda, a partner with CGV Advogados, says that a way for the directors to protect themselves would be to open space for other proposals before recommending a prospective deal to the shareholders. “But they should negotiate the elimination or reduction of the penalty to give the shareholders more freedom to decide. I don’t know if this would be possible in this case in light of the peculiarities of the transaction,” according to Miranda. In his opinion, negotiating the amount of the penalty is very difficult. “If the penalty is applied, the matter might lead to a judicial or arbitral dispute, for resolution of the fairness of the break-up fee and the bases for its fixation or proportionality.” Totvs, which presented a competing offer to that of Stone, has already stated it will contest the fee. Penalties related to decisions of the shareholders at general meetings were stipulated in the transaction between Avon and Natura, directed at the shareholders of Avon, listed abroad. The value was R$ 78.6 million, and the deal was worth US$ 10 billion. In the case of Boeing and Embraer, a penalty was stipulated of US$ 75 million if the shareholders of Embraer did not approve the deal after the company’s board changed its recommendation.

Several transactions in Brazil have involved break-up fees under other conditions. The mergers between Fibria and Suzano (US$ 14.5 billion) and Cetip and BM&FBovespa (US$ 13 billion) called for penalties of R$ 750 million – not paid because both deals were approved. In 2018, Ultra paid R$ 280 million to Petrobras after CADE vetoed the purchase of Liquigas.