Beware of the Tail Fee: Avoiding the Common Pitfalls of Investment Banking Agreements

By Harry C. Beatty and Alex T. Paradiso

June 23, 2023

Beware of the Tail Fee: Avoiding the Common Pitfalls of Investment Banking Agreements


By Harry C. Beatty and Alex T. Paradiso

Many businesses looking to raise capital are understandably eager to engage a good investment banker to assist them in what can be an exciting endeavor. In the process of engaging an investment banker, however, they might overlook a key provision of the agreement – the tail fee. The tail fee provision is intended to protect investment bankers from clients who would terminate or wait for the expiration of the engagement agreement and then proceed with the very sort of transaction that would have yielded the banker a fee. The tail fee provision typically provides that the investment banker will remain entitled to its fee (often a percentage of the funds raised) if a covered transaction occurs during a specified time period after termination of the engagement agreement (i.e., the “tail period”).

Thus, while the tail fee provision is not inherently unfair, it often can seem so in its application for several reasons. First, engagement agreements often remain in effect indefinitely or, if they have a stated initial term, often automatically renew until affirmatively terminated at the end of the initial or a subsequent renewal term. Clients often revisit engagement agreements only when they wish to change their bankers and can be surprised and frustrated to learn that the tail fee period will not begin until they affirmatively terminate the agreement. And the frustration will be directly proportional to the specified length of the tail period.

Second, the transactions that entitle the investment banker to compensation typically are broadly defined in the engagement agreement to bring as many conceivable transactions within their scope as possible. And the tail fee provision itself often specifically provides that the investment banker is entitled to compensation if a covered transaction occurs, whether or not the investment banker worked on the transaction at issue, and regardless of who the counter party is and whether they were introduced to the client by – or even known to – the investment banker. Any of these and other tail fee factors have the potential to come back to haunt an unwitting company.

This article will focus on termination provisions and the scope of covered transactions by providing an overview of three of the key New York cases that exemplify the strict application of tail fee provisions. At the close of the article, we will provide some practitioners’ advice concerning negotiating, drafting and implementing tail fee tail provisions to avoid some common pitfalls.

Strict Application of Defined “Transaction” and Indifference to “Quality of Service”

The recent First Department case of Moelis & Co. LLC v. Ocwen Fin. Corp.[1] is one of many cases where the tail period and the terms of engagement were strictly applied, even when the investment bank performed no work on the subject transaction or when the work it did perform was alleged to be inadequate.

Moelis was engaged by Ocwen Financial Corporation in January 2015 as a nonexclusive financial and capital markets advisor and investment banker. The engagement agreement included a 12-month tail period. On July 1, 2015, by supplemental agreement, the parties terminated Moelis’s engagement, except with respect to a potential transaction with New Residential Investment Corp., a strategic investor. On Aug. 1, 2016, the parties terminated the engagement as to any New Residential transaction, effective immediately.

Ocwen and New Residential entered into two agreements on July 23, 2017, just over a week before the tail period would have expired (one wonders why they didn’t wait). One of these involved, among other things, a complicated sale by Ocwen of mortgage servicing rights to New Residential and the continuing engagement of Ocwen to subservice the mortgages for a reduced fee, together with a lump sum payment related to the future subservicing fees avoided. Moelis thereafter invoiced Ocwen $2.52 million for a “sales transaction fee” for the totality of this mortgage servicing transaction.

When Ocwen refused to pay the fee, Moelis commenced an action against Ocwen, ultimately winning a motion for summary judgment. In affirming the Supreme Court’s granting of summary judgment, the First Department held that, notwithstanding a convoluted deal structure, the subject transaction fell within the definition of “sales transaction” in the amended engagement letter. The court further noted that it “is irrelevant that Moelis did not work on [the transaction] because it occurred during the Tail Period and involved New Residential.”[2]

The First Department also upheld the Supreme Court’s dismissal of Ocwen’s counterclaims for breach of contract and unjust enrichment. Such counterclaims were premised on Ocwen’s argument that Moelis did not provide the quality of service it required and that Ocwen had sought the return of fees it previously had paid. The court noted that the engagement agreement “does not have any provisions governing quality of services” and that, furthermore, the engagement agreement clearly stated that Ocwen’s obligation to pay fees was “not subject to any reduction by way of setoff, recoupment or counterclaim.”[3]

Strict Application of Termination Provisions and Indifference to Non-Performance

A 2016 case from the U.S. District Court for the Southern District of New York, Peter J. Solomon Co., L.P. v. ADC Prods. (UK),[4] is an illustrative example of New York courts’ strict application of engagement letters’ termination provisions, as well as their reluctance to accept nonperformance by a bank as a defense to the bank’s claim for a fee. In that case, Spirogen, a biotechnology company based in the United Kingdom, engaged the services of Peter J. Solomon Co., L.P. (PJSC) in December 2010 “on an exclusive basis as financial and strategic advisor to the Company, including without limitation in connection with a possible transaction or series or combination of transactions” involving a purchase, sale or licensing of Spirogen property.[5]

According to Spirogen, it had specifically engaged PJSC in order to obtain the services of Frederick Frank, a preeminent investment banker in the life sciences space who had joined the company to create and develop its life sciences practice.[6] Accordingly, Spirogen requested that PJSC include a “key man” provision in the agreement, which provided that “PJSC agrees that Frederick Frank will be substantially involved in providing, or supervising the provision of, financial advisory services to the Company throughout the term of this agreement.” The agreement further provided that

[t]he term of PJSC’s engagement shall extend from the date hereof and shall continue thereafter until (a) three months after such time as the Company or PJSC shall have notified the other party in writing of the termination of this agreement or (b) if PJSC shall be in breach of [the Key Man Provision], 30 days after such time as the Company shall have notified PJSC in writing of such breach unless PJSC shall sooner cure such breach.[7]

The “term” section of the agreement also contained the tail period, which provided, “PJSC shall be entitled to its full fees [a percentage of the aggregate consideration for the transaction] . . . in the event that a Transaction is consummated with an Eligible Party (as defined below) at any time prior to the expiration of one year after such termination.”[8] The agreement defined “eligible party” as “any potential Buyer or Counterparty as to which PJSC advised the Company hereunder or identified to the Company by PJSC or with which the Company had discussions regarding a Transaction, in each case, during the term of PJSC’s engagement.”[9]

PJSC did not provide any investment banking services to Spirogen after the beginning of 2011 (i.e., only a few months after the agreement was entered), and Frank left PJSC in January 2013. Then, in April 2013, Spirogen retained another investment banking firm, Lazard, to identify a potential buyer of the company.[10] However, Spirogen never sent PJSC a notice terminating the agreement.[11] In October 2013, AstraZeneca (AZ) acquired Spirogen. PJSC had not introduced AZ to Spirogen and did not provide any services whatsoever to Spirogen relating to the AZ transaction, but it filed suit in May 2014 to enforce the tail fee provision of the agreement and seeking to recover its fee (a percentage of the transaction) of $3.75 million.[12]

Spirogen raised various defenses to the breach of contract claim, including that the departure of Frank from PJSC constituted a material breach of the “key man” provision of the agreement and a repudiation of the agreement as a whole and that PJSC had abandoned the agreement by failing to provide any services to Spirogen for well over three years before the AZ transaction.[13] Judge Swain of the Southern District rejected Spirogen’s arguments and granted summary judgment to PJSC. Specifically, Judge Swain held that the “provisions for termination notice, opportunity to cure and payment of tail fees negate any inference of repudiation based solely on Frank’s departure.”[14] Likewise, Judge Swain found that “the lack of activity between the parties after the beginning of 2011 falls short of ‘clear, affirmative conduct’ that indicates an ‘unequivocal’ intention by either or both of the parties to abandon the contract.”[15] Finally, Judge Swain noted that AZ clearly constituted an “eligible party” simply because Spirogen had discussions with it concerning a transaction during the term of the agreement and “that PJSC may be paid for a transaction that it never worked on is no reason for the Court to ignore the plain terms of the Agreement, which were negotiated by two sophisticated parties.”[16] The court ultimately entered a $3.75 million judgment in favor of PJSC, together with an additional $1.2 million in pre-judgment interest.[17]

Thus, PJSC collected nearly $5 million for a transaction that it did not do any work on and which Spirogen could have avoided if it had simply sent PJSC timely written notice of the agreement’s termination.

Strict Application of Plain Meaning and Reluctance To Elevate Technical Distinctions Over Substance

A 2015 case from the Supreme Court, New York County, Stormharbour Sec. LP v. IIG Trade Opportunities Fund, N.V.,[18] is another example of a court’s strict application of the terms of an engagement letter and its reluctance to disavow those terms based on technical distinctions in the capacity and role of a counterparty. In that case, the parties entered a July 2011 engagement letter whereby defendant IIG Trade Opportunities engaged the investment bank, StormHarbour, to serve as the exclusive arranger and placement agent for the placement with institutional investors of up to $150 million of first-lien and second-lien financing secured by trade finance instruments for the benefit of IIG.[19]

The engagement letter contained a tail fee provision that applied to “a substantially similar transaction” closed within 12 months of the agreement’s termination with a “prospective investor” introduced by Stormharbour prior to termination.[20] Deutsche Bank, BlueMountain Capital Management and KKR & Co. were all prospective investors who were approached by StormHarbour and rejected its proposals. In connection with its rejection, Deutsche Bank indicated that it would consider being engaged by IIG to structure and place the entire offering. Less than two months after the term of the Stormharbour engagement expired, the fund entered into an agreement with Deutsche Bank to act as a “structuring and placement agent” with respect to certain of IIG’s assets.[21] IIG then formed an issuer and Deutsche Bank, in turn, then purchased finance instruments from the issuer and sold them to BlueMountain and KKR.[22]

One could easily conclude that IIG might have been attempting an end-run around the tail period by engaging Deutsche Bank as an underwriter instead of dealing with it as an investor. Indeed, Stormharbour evidently feared just this and unsuccessfully proposed an amendment to its engagement letter with IIG – just two weeks after Deutsche Bank declined to participate in a transaction, making it clear that Stormharbour would be entitled to a full fee if a similar transaction closed in which Deutsche Bank acted as a placement agent.[23]

Upon learning of the Deutsche Bank transaction, Stormharbour demanded to be paid its $3.41 million fee pursuant to the tail provision. IIG refused, and Stormharbour commenced an action in New York County asserting a single claim for breach of contract on the grounds that a transaction was consummated with a prospective investor (Deutsche Bank) within the tail period.[24] In opposition, IIG argued that Deutsche Bank acted as a placement agent or underwriter for the subject instruments and was not a prospective investor as that term was defined in the engagement letter.[25]

The trial court rejected IIG’s position and granted Stormharbour’s motion for summary judgment. Specifically, the court found that the “Tail Fee Provision makes no exception for a Prospective Investor that changes its role in the Transaction” and that “whatever its ultimate role, [Deutsche Bank] purchased assets in a transaction that was at least ‘substantially similar’ to the Transaction.”[26]

In affirming the trial court, the First Department subsequently held that: (1) the “broad definition [of the transaction triggering the tail fee provision] contemplated that the precise structure of the deal was to be determined,” and (2) “nothing in the Engagement Letter exclude[d] the application of the tail fee provision to Deutsche Bank simply because Deutsche Bank purchased the instruments initially as an underwriter for later sale to end investors.”[27]

Thus, while the transaction at issue in Stormharbour might have initially appeared on paper to be different from the transaction contemplated by the engagement, this case shows that New York courts will examine the practical realities of a transaction to determine if it does, in fact, fall within the purview of the tail fee period. Implicit in this decision is a weariness on the part of courts to a company’s attempt to try to creatively structure a transaction around a tail fee and a willingness to look beyond the labels affixed by a party to a transaction to discern to the substantive reality.

Avoiding Pitfalls

Careful negotiation/drafting and diligence with respect to strict compliance with an agreement’s termination provisions should serve companies well in avoiding the common pitfalls of tail fees. At the outset, companies engaging an investment bank should take care to construe eligible transactions as narrowly as possible. If, for example, there is a specific purpose for the engagement (i.e., to sell certain assets or a certain amount of equity), or a specific targeted counterparty for the transaction, then those details should be set forth with specificity. Likewise, if possible, companies should try to limit eligible transactions to those with parties to whom the investment bank at least facilitated the introduction. That way, companies can avoid having to pay a fee in connection with a transaction with a counterparty with which an investment bank never worked.

With regard to terminating the agreement, companies should try to avoid agreeing to automatic renewal terms. This may be a tall order, as many investment banks will insist upon automatic renewal. At the very least, however, companies should strive to provide that the agreement is terminable at will with a reasonable amount of notice. Along the same lines, if there is a specific professional at the investment bank that is being retained, companies should attempt to make continuation of the engagement strictly contingent upon that professional’s continued association with the bank and provide that the agreement automatically terminates or is terminable upon their departure. In all cases, companies should make sure that they are aware of the exact operation of the termination provisions and take care to ensure that stale engagements are promptly terminated in strict compliance with the agreement’s provisions.

In other words, companies should always be conscious of the tail provision (and for some time thereafter) during the engagement of an investment banker.

Harry C. Beatty is a founding partner of Kent, Beatty & Gordon, where he also heads the firm’s corporate practice.

Alex T. Paradiso is a partner in the firm’s litigation and arbitration practice group.

This article appears in a forthcoming issue of NY Business Law Journal, the publication of the Business Law Section. For more information, please see NYSBA.ORG/BUSINESS.

[1] Moelis & Co. LLC v. Ocwen Fin. Corp., 203. A.D.3d 469 (1st Dep’t 2022).

[2] Id. at 471–72.

[3] Id. at 473.

[4] Peter J. Solomon Co., L.P. v. ADC Prod. (UK) Ltd., No. 14CV4086-LTS, 2016 U.S. Dist. LEXIS 42537 (S.D.N.Y. Mar. 30, 2016).

[5] Id. at *14.

[6] Id. at *3.

[7] Id. at *4.

[8] Id.

[9] Id. at *4–5.

[10] Id. at *6.

[11] Id. at *7.

[12] Id..

[13] Id. at *9–10.

[14] Id. at *13.

[15] Id. at *14–15.

[16] Id. at *16.

[17] See id. at *7 (setting judgment in favor of PJSC at $4,954,828.77).

[18] Stormharbour Securities LP v. IIG Trade Opportunities Fund, N.V., No. 650285/2014, 2015 N.Y. Misc. LEXIS 3555, at *1 (Sup. Ct., N.Y. Co. Sept. 23, 2015).

[19] Id. at *1–2.

[20] Id. at *2–3.

[21] Id. at *4.

[22] Id..

[23] *10–11.

[24] Id. at *6.

[25] Id. at *7.

[26] Id. at *12.

[27] StormHarbour Sec. LP v. IIG Trade Opportunities Fund N.V., 145 A.D.3d 497, 498 (1st Dep’t 2016).



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