Sizing a Break Fee So It Deterred Without Trapping Anyone

The situation

The number on the table was modest by merger standards: a combined transaction valued at roughly $5 million, split between Ngozi's refrigerated trucking business and the smaller competing operation Tesfay had built over the previous decade. Neither company employed more than a dozen people. Neither owner had ever done anything close to a merger before. But for both of them, the money at stake represented most of what they had built in their working lives, and neither wanted to get it wrong.

Ngozi had started out as a farm worker in the fields around Alliston before saving enough to buy a single refrigerated truck and start hauling produce for local growers during harvest season. Over twelve years, with her business partner Abena, that single truck became a fleet of eight, serving farms and distributors across the region. Tesfay had taken a different path into the same business, spending years as a long-haul truck driver before buying his first truck and building a smaller competing operation that focused on the same seasonal produce routes. The two companies had competed for the same handful of large contracts every season, occasionally undercutting each other on price to win a route, and both had noticed that a combined fleet would be large enough to bid on contracts neither could win alone.

Tesfay had decided, for reasons that were mostly practical, that he wanted to reduce his own administrative load and Ngozi's company had the back-office capacity his did not, not to hire a lawyer for the negotiation. He and Ngozi had been talking business to business for months, working out roughly what each company was worth and how ownership of the merged entity would be split, before either side brought in outside help. Ngozi and Abena came to us once the broad terms were largely agreed, wanting the deal actually documented and closed, and it quickly became clear that negotiating directly with a self-represented counterparty who trusted Ngozi personally, but had no lawyer checking what he was agreeing to, created its own set of problems neither side had anticipated.

Abena, who handled most of the paperwork for their own company, had reviewed the draft terms Ngozi and Tesfay produced together and thought they looked reasonable on their face. Nothing in the document was obviously unfair to either side, and both owners had signed off on every term in it before bringing it to us to be finalized. What none of the three of them had done was work through what would actually happen if circumstances changed for either company between signing and closing, which is precisely the situation a merger agreement between two small, trusting competitors is most likely to run into.

The gap nobody had noticed

The draft agreement Ngozi and Tesfay had worked out between themselves, before either side had legal help, included something Tesfay had proposed and Ngozi had agreed to without either of them fully understanding its implications: a clause saying that if either side backed out of the deal after signing, they would owe the other a payment of $750,000, a break fee in effect, though neither of them had used that term. A number like that, agreed without advice and never tested against what a walk-away could realistically cost, is exactly the kind of fixed sum Ontario courts will refuse to enforce as written, treating it as a penalty rather than a genuine estimate of damages — so the $750,000 was not simply owed the moment either side backed out. Tesfay had suggested the number because it sounded serious enough to make both of them take the deal seriously. Neither of them had thought through what the clause actually meant for a $5 million transaction, or what would happen if a better offer showed up for either company before closing.

The gap nobody had noticed was that the fee, as drafted, applied no matter why a party walked away, including if either company received a genuinely superior offer from a third party before the deal closed. On a $5 million deal, a $750,000 break fee is not a modest deterrent against a change of heart. It is close to fifteen percent of the transaction value, large enough to trap a party into completing a deal that had stopped making sense, even if a better opportunity came along through no fault of their own. For Ngozi and Abena in particular, whose company was the larger of the two and more likely to attract outside interest given its existing fleet size, that clause as written could have meant giving up a genuinely better opportunity simply because walking away from Tesfay's deal would have cost them more than the better deal was worth.

There was a second, smaller gap connected to the first: because Tesfay had negotiated the number himself without legal advice, there was no mechanism in the draft for either side to walk away and pay nothing if the other side's business turned out, during due diligence, to have a problem serious enough to justify walking. The fee applied even to a legitimate discovery of a material issue, not just a simple change of mind. That put both parties at real risk of being financially punished for backing out of a bad deal for good reason, which is the opposite of what a break fee is supposed to do.

What we did

1. Explained the break fee's actual effect in plain terms to both sides. Because Tesfay was negotiating without a lawyer, we made sure he understood, not just Ngozi and Abena, what the $750,000 figure actually meant in proportion to the deal size and what circumstances it would apply to, since a deal protection mechanism only works fairly if both sides understand it the same way.
2. Recommended Tesfay obtain independent legal advice on the revised terms. Rather than simply redrafting the clause and asking him to sign, we advised Ngozi and Abena that Tesfay should have his own lawyer review any changes, both to protect the deal from being challenged later as one-sided and because a self-represented counterparty who later feels outmanoeuvred is more likely to walk away or dispute the deal after signing.
3. Rebuilt the break fee around a genuine fiduciary-out structure. We redrafted the termination provisions so the fee applied only if a party walked away for a change of heart or to pursue a deal that was not meaningfully better, while allowing either side to walk away and pay nothing, or a much smaller fee, if a genuinely superior offer emerged before closing and the other side was given a fair chance to match it.
4. Resized the fee to deter without trapping either party. We lowered the fee from $750,000 to an amount closer to three percent of the deal's value, a figure large enough to discourage a casual change of mind but small enough that it would not force either company into completing a deal that had stopped making commercial sense. Fifteen percent had been a punishment; three percent was a genuine deterrent, and that distinction was the entire point of the exercise.
5. Added a due diligence carve-out for material problems discovered in good faith. We built in a right for either side to walk away without owing the fee if due diligence turned up a problem serious enough to justify it, so the clause punished bad faith and cold feet, not the legitimate discovery of a real issue with the other company's business.
6. Documented the negotiation history to protect against a later dispute. Because so much of the deal had already been agreed informally before either side had legal advice, we created a clear written record of what changed, why, and that Tesfay had been advised to seek independent counsel, reducing the risk that he could later claim he had not understood what he signed.
7. Closed on a revised timeline that gave Tesfay's new lawyer time to review. We pushed the closing date back by several weeks once Tesfay retained counsel, rather than rushing to the original date the two owners had picked without legal advice, because a deal renegotiated fairly needs enough time for the newly involved lawyer to actually do the review properly.

The outcome

The merger closed about two months later than Ngozi and Tesfay had originally planned, once Tesfay's own lawyer had reviewed and signed off on the revised terms. The break fee came down from $750,000 to roughly $150,000, structured so it applied only to a genuine change of heart rather than to either a superior offer or a legitimate due diligence problem. Tesfay, once he understood what the original number would have meant in practice, was relieved rather than resistant to the change. He had proposed the figure to sound serious, not because he had thought through what it would cost him if his own circumstances changed.

The compromise was not free for either side. Ngozi and Abena had wanted a higher fee to protect against Tesfay getting cold feet given how much of the due diligence burden fell on their side of the deal, and they settled for a lower number than they would have preferred in exchange for the fairness of a genuine fiduciary-out. The delay for Tesfay to retain and work with his own lawyer also pushed the closing past the start of the next produce season, meaning the merged company missed the chance to bid jointly on one seasonal contract both companies had hoped to win together as a combined fleet.

The deal that closed was smaller in ambition than the one the two owners had first shaken hands on, and later than either wanted, but it was a deal built on terms both sides actually understood, rather than a number Tesfay had picked because it sounded serious. A year later, the combined company had grown its fleet further and won two of the larger regional contracts neither business could have bid on alone. Tesfay, looking back on the negotiation, said the biggest change was not the number itself but understanding what it meant, something he had never had a chance to work out on his own before a lawyer walked him through it line by line.

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