Fiduciary Out

A Fiduciary Out is essentially a pre-negotiated “escape hatch” in a merger agreement. Imagine a company’s board agrees to sell the business to a suitor. But before the ink is truly dry, a second, more attractive suitor appears with a much better offer. The Fiduciary Out clause gives the board a legal and ethical pathway to terminate the first deal and accept the second, superior one. This is crucial because a company's board of directors has a fundamental legal obligation, its fiduciary duty, to act in the best financial interests of its shareholders. Without this clause, the board would be trapped, forced to proceed with the inferior deal or risk being sued for breach of contract by the original buyer. In short, the Fiduciary Out allows the board to uphold its duty to shareholders by ensuring they get the best possible price for their company, even if it means walking away from a previously accepted offer.

The process usually unfolds like a high-stakes drama.

1. Step 1: The Initial Deal: Company A's board agrees to be acquired by Company B for $50 per share. They sign a definitive merger agreement that includes a Fiduciary Out clause.
2. Step 2: The Party Crasher: Before the deal closes, Company C, a “white knight,” publicly offers to buy Company A for $60 per share—a clearly better deal, often called a superior proposal.
3. Step 3: The Board Deliberates: Thanks to the Fiduciary Out, Company A's board can legally engage with Company C to evaluate its offer. They are not locked into the deal with Company B.
4. Step 4: The Escape: If the board determines Company C's offer is indeed superior, they can exercise the Fiduciary Out. This means they formally terminate the agreement with Company B. However, this freedom comes at a cost. Company A will almost certainly have to pay Company B a pre-negotiated break-up fee (or termination fee) as compensation for their time, due diligence, and the failed bid.

For a value investor, understanding the Fiduciary Out is vital, whether you're a shareholder in a company being sold or an acquirer yourself.

This clause is your best friend. It acts as a safety net, ensuring the board isn't strong-armed into accepting a lowball offer. It creates the potential for a bidding war, which can dramatically increase the ultimate sale price of your shares. A core tenet of value investing is realizing the full intrinsic value of your holdings. The Fiduciary Out is a powerful tool that helps achieve exactly that in a takeover situation, preventing your investment from being sold on the cheap.

If you, as a potential acquirer, spot an undervalued company that has already agreed to a merger, the Fiduciary Out in their existing agreement is your invitation to the dance. It means the company isn't completely off-limits. If you believe you can make a genuinely superior offer that better reflects the target's true worth, this clause gives the board the legal cover it needs to consider your bid.

Not all Fiduciary Out clauses are created equal. The specific wording is heavily negotiated by lawyers, but they typically revolve around a few key concepts.

The clause strictly defines what counts as a superior offer. It's not just a few cents more per share. It's an unsolicited, bona fide written offer that the board, after consulting its financial and legal advisors, deems to be significantly more favorable to shareholders from a financial point of view. Factors include not just price but also the certainty of financing and the likelihood of the deal closing.

This is the price of walking away. It's designed to compensate the jilted original bidder for their efforts. The fee must be carefully calibrated.

• Too low, and it might not adequately compensate the original bidder.
• Too high, and it can scare off any other potential bidders. A prohibitively high fee, sometimes called a “poison pill,” effectively locks in the first deal and works against shareholder interests, undermining the very purpose of the Fiduciary Out. These fees typically range from 1% to 4% of the deal's total value.

The original bidder is rarely left completely helpless. Most agreements give them “matching rights.” This means that before the target board can terminate the deal, it must notify the original bidder of the superior proposal and give them a short period (e.g., 3-5 business days) to match or improve upon the new offer. This gives the first suitor a final chance to save their deal.