In a typical M&A transaction, the buyer invests substantial time and resources in due diligence—sometimes spanning months. An exclusivity agreement (often called a “lock-out” clause) provides the buyer with a measure of certainty: the seller will not solicit or entertain competing offers during a defined period. While this shields the buyer’s investment of time and diligence costs, it can also limit the seller’s ability to capture the best possible price. Below, we explore the purpose of exclusivity, key legal considerations, and strategies to balance risk for both parties.
Purpose of Exclusivity
- Protecting the Buyer’s Investment
- Due Diligence Costs: Buyers often incur significant fees for lawyers, accountants, and sector-specific advisors. Exclusive negotiation means the buyer can investigate thoroughly without fear of being undercut by a rival bidder.
- Negotiation Focus: Exclusivity fosters more in-depth discussions, encouraging both sides to align on valuation and deal structure without the distraction of competing offers.
- Seller’s Perspective
- Commitment from Buyer: By offering exclusivity, the seller obtains an early gauge of the buyer’s seriousness and willingness to move toward completion.
- Risk of Underpricing: If market conditions change or a strategic acquirer emerges, exclusivity may prevent the seller from exploring a potentially higher offer.
Practical Insight: A time-limited exclusivity period can benefit both parties by focusing negotiations while preserving the seller’s ability to pursue alternatives if the deal stalls.
Legal Considerations
- Duration & Scope
- Typical Timeframes: Ranges from 4 to 12 weeks, depending on the complexity of due diligence.
- Scope Limitations: Some exclusivity clauses only prevent active solicitation by the seller, while others prohibit the seller from responding to unsolicited offers.
- Remedies for Breach
- Injunctions: If a breach is discovered, a court order may force the seller to halt negotiations with third parties.
- Damages: The buyer could claim compensation for wasted due diligence costs if the seller willfully breached exclusivity.
- Practical Barriers: Courts typically require proof of direct monetary loss or irreparable harm, which can be difficult to quantify.
- Carve-Outs & Fiduciary Duties
- Public Company Context: Directors may be legally obliged to consider superior offers under fiduciary duties, limiting exclusivity’s enforceability.
- Regulatory Approval Requirements: Some deals require regulatory clearance, which may temporarily suspend certain exclusivity obligations if mandated by law.
Tip: To avoid unenforceable provisions, specify the scope, duration, and all relevant exceptions clearly. Overly broad exclusivity can run into legal challenges, especially under corporate governance norms.
Negotiation Tips
- Strike a Balance
- Buyer’s Certainty: The buyer wants enough time to complete due diligence without fear of competition.
- Seller’s Price Discovery: The seller may seek a shorter timeframe or carve-outs that allow them to review legitimate unsolicited bids.
- Milestones & Extensions
- Structured Periods: Consider setting incremental checkpoints (e.g., a 4-week initial phase, potentially extended by 2 weeks upon buyer’s milestone completion).
- Automatic Extensions: Some deals provide for automatic renewal if substantial progress is made, preventing the seller from pulling out prematurely.
- Financial Assurance
- Deposit or Break Fee: The buyer may offer a deposit that’s refundable if the seller breaches exclusivity, incentivizing the seller’s compliance.
- Escrow Arrangements: Funds in escrow can protect both parties if either side unilaterally withdraws or breaches.
- Communication Protocol
- Seller Updates: The seller should regularly update the buyer on any incoming offers to demonstrate good faith.
- Buyer Progress Reporting: The buyer’s team should periodically confirm due diligence status to show they are actively pursuing the transaction.
Consequences of Breach
- Damaged Trust
- Resentment & Litigation: The non-breaching party may feel betrayed, leading to immediate termination or even legal claims.
- Ripple Effect on Future Deals: Sellers who repeatedly violate exclusivity risk reputational harm in the M&A community.
- Potential Renegotiation
- Revised Terms: A seller that breaches exclusivity might offer reduced price concessions to placate the jilted buyer.
- Refusal to Proceed: The buyer, feeling aggrieved, may walk away entirely, leaving the seller without any viable deal.
- Derailing the Transaction
- Lost Momentum: The deal can stall, incurring greater costs for both sides, or fail altogether if trust erodes.
- Public Perception (Public Companies): News of a breach can depress share prices and create turmoil among shareholders.
Example: In a scenario where a seller discreetly negotiates with a second bidder, the original buyer might discover the breach, demand compensation for due diligence expenses, and terminate negotiations. Such disputes can end in court, adding further delays and costs.
Conclusion
Exclusivity clauses serve as a cornerstone for serious dealmaking by preventing parallel negotiations and fostering focused dialogue. Yet, they also limit the seller’s ability to solicit competing bids, which can be risky in a dynamic market. Properly drafted exclusivity agreements carefully address duration, remedies, and justifiable carve-outs (such as fiduciary obligations in public company contexts). By balancing these interests—through time-limited exclusivity, milestone-driven extensions, and structured remedies—both buyers and sellers can enhance their commitment to a successful transaction while retaining enough flexibility to adapt if market conditions or corporate duties demand it.
