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Part Two - Introduction to Fee-Tails. What are they?
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By: David Brown, EMDA Director and Founding President and Partner at WeirFoulds LLP

In the last edition of Exempt Market Update, in the article Engagement Letter Best Practices - Part One, I focused on the importance of specifically delineating whether the mandate is exclusive or non-exclusive in an EMD’s Engagement Letter. Having discussed the critical reasons for that delineation, there is another important reason to discuss: what is commonly known in North America as the "fee-tail” and in Europe as the "tail gunner”.

The fee-tail or tail gunner is, in our experience, one of the least understood provisions of the EMD’s Engagement Letter and deserves to be understood in order to have a proper understanding (and optimal drafting) of the EMD’s Engagement Letter.The fee-tail or tail gunner, let’s stick to "fee-tail” for now, is a provision in the EMDs Engagement Letter relating to termination provisions. Commonly, if an EMD’s Engagement Letter is terminated by either the EMD or the Issuer, and a transaction is consummated within the designated "tail period” after termination (typically 12 to 24 months) with a party whom has been "introduced” (more on that later) by the EMD to the Issuer then the EMD will remain entitled to its full fees. In essence the fee tail triggers payment to the EMD as if the EMDs Engagement Letter was never terminated.

Why We Have Them

An optimally drafted fee-tail clause will take into account the term of the Engagement Letter and the exclusive or non-exclusive nature of the EMD’s mandate. Industry standards and market practices usually see EMD Engagement Letters applying for a fixed duration, usually not less than 1 year with automatic renewal rights thereafter. An allowance is often made for either the EMD or Issuer to terminate the mandate early without cause on 30 days prior written notice. The practical consequence of this is that the EMD’s Engagement Letter is in eff ect a short-term arrangement between the Issuer and the EMD because it can typically be terminated by either party for any reason, or no reason at all, on 30 days prior written notice. The stated reason for this de facto short-term arrangement is that Issuers should not be required of entering into a long-term mandate and tie themselves into a relationship with an EMD that may have uncertain results. Put another way, if the relationship is going badly with the EMD, the Issuer usually wants the ability to unilaterally get out of that bad relationship, and relatively quickly. The converse is also true if the relationship with the Issuer is going badly, and fairness dictates that the EMD should possess the same unilateral ability to exit a bad relationship quickly. So far so good, and fair enough. But there remains one important caveat addressed by an optimally drafted fee-tail, which deals with a potential unfairness to the EMD in scenarios where the EMD does its job, expends time and expense in identifying investors and then the mandate is terminated by the Issuer without cause. If the closing occurs and includes investors brought to the offering by the EMD, the Issuer would benefit from the EMDs efforts but not pay the EMD as they terminated the engagement. In the absence of the protective fee-tail provision, the EMD would be denied its hard earned fees and a manifestly unfair result would ensue.

Best Practices for Drafting Them

Drafting the fee-tail provision requires consideration of whether there is an exclusive or non-exclusive mandate contained within the EMD’s Engagement Letter. In an exclusive mandate, the courts have consistently held that the EMD is entitled to its fees regardless of whether it sourced the investment or not. That is the hallmark of an exclusive engagement: if an investor invests within the term, then the EMD is entitled to its success fee however the investor happened to have found its way to the investment opportunity. That is a very powerful right in favour of the EMD. But not so in a non-exclusive mandate, where the courts have consistently held that in order for the EMD to earn its fee, it must be shown to be the procuring cause of the investment. That is to say, the EMD must have some meaningful involvement in terms of sourcing, identifying or introducing the investor to the Issuer.

Whether an EMD’s mandate is exclusive or non-exclusive has a signifi cant bearing on the optimal drafting of the fee tail provision in the EMD’s Engagement Letter. In an exclusive mandate, the EMD should be entitled to compensation for a closing during the tail period for any investor with whom the Issuer has contact during the term of the EMD’s Engagement Letter, regardless of how said contact is initiated. This would accompany the section in an the Engagement Letter that requires the Issuer to notify the EMD in writing of all potential investors it comes into contact with during the term. Alternatively, in a non-exclusive mandate scenario, the EMD should only be entitled to compensation for any closing that takes place during the tail period with investors who were sourced, identified or introduced by the EMD during the term. The drafting trap for the unwary EMD is this: in many instances we see fee-tail provisions in exclusive mandates that are too narrowly drafted and only entitle the EMD to compensation for closings which occur during the tail period with investors who have been sourced, introduced or identified by the EMD. This is sub-optimal drafting which denies the EMD its rightful compensation in a situation where the EMD did not introduce, source or identify the investor during the term, but the Issuer did have contact with the investor during the term. To a lesser extent, we also sometimes see fee-tails drafted in non-exclusive mandates which entitle the EMD to its fees for a closing which occurs during the tail period for all subscribers with whom which the Issuer has had contact during the term. While beneficial to the EMD, such drafting is too broad owing to the fact it is inconsistent with the underpinnings of the proper compensatory scheme during the term of non-exclusive mandates.

So the key thing to remember is this: fee-tails in exclusive mandates should be drafted in a different fashion than those in non-exclusive mandates - and we find this rarely to be the case in practice.

Other Drafting Considerations

In my experience, fee-tail provisions are often inserted into the EMD’s Engagement Letter based on whatever precedents are readily at hand, and without much thought about theoretical underpinnings or evidence of careful analysis and drafting. Market practices also suggest fee-tail provisions are not heavily negotiated by either Issuers or EMD’s, and in the rare instances when they are, consideration may be given to the following:

1. Reducing the tail period to less than the standard 12-24 months which is an Issuer-friendly change that should be resisted by the EMD. Conversely, in the writer’s experience, anything longer is excessive and should be resisted by the Issuer.

2. Ensuring that the EMD will not be compensated during the tail period if the mandate is terminated by the Issuer with cause (i.e. fault by the EMD) and the EMD will not be compensated for termination of the mandate by the EMD other than with cause (i.e. fault by the Issuer). The Issuer friendly changes may well be fair if the EMD is at fault or if the EMD terminates without cause too quickly, for example: before a certain date, or within 60 days of signing the EMD’s Engagement Letter.

3. Reducing the fee pro-rata as the tail period expires which is an Issuer friendly change rarely seen, and it should be resisted by an EMD on the basis that the entire fee-tail should be earned regardless of the timing of closing during the tail period.

4. Attempts by the EMD to be compensated for any transaction which occurs during the tail period, whether the investor had contact with the Issuer during the term, whether the EMD was the procuring cause of the investor during the term or otherwise. This is an EMD friendly change which should be resisted, as it is a de facto extension of the term of the EMD’s Engagement Letter and converts the fee tail into an exclusive engagement for the tail period, regardless of whether the mandate was exclusive or non-exclusive during the original term. This is a common insertion, wrongly it is contended, in investment banking Engagement Letters.

5. Specifying that the triggering event in the tail period is not a closing, but either a closing or an announcement of a proposed closing whether or not closing after announcement occurs during the tail period or outside of the tail period. This EMD friendly change is fair if a deal (where a public announcement is required) is announced during the tail period yet closes after the expiration of the tail period, the EMD should be compensated regardless of the timing of the closing and provided the other pre-conditions to the EMD’s compensation have been met (i.e. a procuring cause in a non-exclusive mandate or contact with Issuer in an exclusive mandate during the term).

6. Drafting what specifically constitutes the EMD being the ‘procuring cause’ of an investment or ‘sourcing, introducing or identifying’ an investor. Examples may include specifying that a procuring cause includes someone who received the solicitation information or ‘teaser’ from the EMD, expressed an interest to the EMD in the offering, signed a confidentiality/non-disclosure agreement or received a confidential information memorandum. Another Issuer friendly approach would be to require that the investor not only be someone who signed a confidentiality/non-disclosure agreement but also must have actually engaged in negotiations respecting the offering during the term. This is significantly more restrictive from the EMD’s point of view as it narrows the universe of subscribers who would entitle the EMD to its fee-tail. If the specificity in the drafting is inclusive or illustrative and not exhaustive, then those types of amendments to the fee-tail provision will benefit the EMD.

Next Issue - Part Three: Real Estate Licensing Considerations for EMD’s. (yes, you’re reading that right)

For more information contact: David Brown

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