chair
Ryan Done Miller Thomson LLP
March 8, 2017
Buying or Selling A BUSINESS
*CLE17-0030201-a-puB*
DISCLAIMER: This work appears as part of The Law Society of Upper Canada’s initiatives in Continuing Professional Development (CPD). It provides information and various opinions to help legal professionals maintain and enhance their competence. It does not, however, represent or embody any official position of, or statement by, the Society, except where specifically indicated; nor does it attempt to set forth definitive practice standards or to provide legal advice. Precedents and other material contained herein should be used prudently, as nothing in the work relieves readers of their responsibility to assess the material in light of their own professional experience. No warranty is made with regards to this work. The Society can accept no responsibility for any errors or omissions, and expressly disclaims any such responsibility.
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Library and Archives Canada Cataloguing in Publication
Buying or Selling a Business
ISBN 978-1-77094-231-9 (Hardcopy)ISBN 978-1-77094-232-6 (PDF)
1
Chair: Ryan Done, Miller Thomson LLP
March 8, 2017 1:00 p.m. – 4:00 p.m.
Total CPD Hours = 2 h 30 m Substantive + 0 h 30 m Professionalism
Donald Lamont Learning Centre
The Law Society of Upper Canada 130 Queen, Street West
Toronto, ON
SKU CLE17-00302
Agenda 1:00 p.m. – 1:05 p.m. Welcome and Opening Remarks from the Chair
Ryan Done, Miller Thomson LLP
1:05 p.m. – 1:30 p.m. Getting Ready for the Deal
Diane Brooks, Blaney McMurtry LLP Sundeep Sandhu, Blaney McMurtry LLP
BUYING OR SELLING A BUSINESS
2
1:30 p.m. – 1:55 p.m. Representations and Warranties: Mitigating Liability Maxwell Spearn, Miller Thomson LLP 1:55 p.m. – 2:15 p.m. Non-Competition Agreements Adrian Ishak, Rubin Thomlinson LLP 2:15 p.m. – 2:30 p.m. Question and Answer Session 2:30 p.m. – 2:45 p.m. Coffee and Networking Break 2:45 p.m. – 3:15 p.m. Professionalism Session: Who is Your Client?
(30 minutes) Ian Palm, Gowling WLG (Canada) LLP Jeffrey Simpson, Torkin Manes LLP 3:15 p.m. – 3:35 p.m. Bridging Valuation Gaps in M & A Transactions
Brad Ross, Goodmans LLP
3:35 p.m. – 3:55 p.m. From LOI to Definitive Agreement Ryan Done, Miller Thomson LLP A. Paul Mahaffy, C.S., Bennett Best Burn LLP
3:55 p.m. – 4:00 p.m. Question and Answer Session 4:00 p.m. Program Ends
March 8, 2017
SKU CLE17-00302
Table of Contents TAB 1 Getting Ready for the Deal…………………………………………..…… 1 – 1 to 1 – 5
Diane Brooks, Blaney McMurtry LLP Sundeep Sandhu, Blaney McMurtry LLP
TAB 2 Restrictive Covenants in Commercial and Employment
Contexts: Key Cases and Considerations…………………….………2 – 1 to 2 – 8 Adrian Ishak, Rubin Thomlinson LLP Parisa Nikfarjam, Rubin Thomlinson LLP
TAB 3 Who’s Your Client?..............................................................3 – 1 to 3 – 3
Ian Palm, Gowling WLG (Canada) LLP Jeffrey Simpson, Torkin Manes LLP
TAB 4 Annotated Sample Earn-Out Provisions……………………………4 – 1 to 4 – 5 Brad Ross, Goodmans LLP
BUYING OR SELLING A BUSINESS
TAB 5 From LOI to Definitive Agreement……………………………………5 – 1 to 5 – 2
Ryan Done, Miller Thomson LLP
TAB 6 Letters of Intent……………………………………………………………….6 – 1 to 6 – 25 A. Paul Mahaffy, C.S., Bennett Best Burn LLP
TAB 1
Getting Ready for the Deal
Diane Brooks, Blaney McMurtry LLP
Sundeep Sandhu, Blaney McMurtry LLP
March 8, 2017
Buying or Selling a Business
GETTING READY FOR THE DEAL
Diane Brooks, Blaney McMurtry LLP Sundeep Sandhu, Blaney McMurtry LLP
Prior to making any binding commitment for a significant acquisition, a Seller and Purchaser will engage in due diligence to properly ascertain what is being sold and bought. The Purchaser’s risk tolerance, time constraints and costs will all govern the extent of the due diligence that will be undertaken. Typically, a letter of intent (LOI) (discussed in greater detail below) will afford the Purchaser a period of time to conduct its due diligence before drafting and/or fully executing the definitive purchase and closing agreements. During this time period, more often than not, the Seller must refrain from shopping the offer around.
The Purchaser will use the information obtained during due diligence to decide whether to proceed with the acquisition and on what basis or, if instead it should abandon the transaction altogether.
Due Diligence information is also used by either side to inform negotiations and what contractual provisions and protections will be needed for the definitive purchase agreement, including things like:
Structure of the transaction
Purchase price and valuation
Representations and warranties
Indemnification
Disclosure schedules
Pre-closing and Post-closing covenants
The Confidentiality Agreement
The confidentiality agreement is needed before the parties commence their discussions and due diligence to protect a Seller’s confidential and proprietary information. The agreement should have the following key elements:
Definition of confidential and proprietary information along with stipulating any exceptions
Limitations on use and distribution of confidential information
Circumstances under which the recipient may or must disclose confidential information
Outline who has access to confidential information
Outline the return or destruction of confidential Information
Restrictions against soliciting or hiring the Seller’s employees, suppliers and/or customers
Specific issues with respect to confidently to address during due diligence include the following:
Seller’s Perspective Purchaser’s Perspective
In terms of Buyer’s access to management, suppliers and customers, the Seller may not want these parties to be aware of the transaction as it may result in the loss of a competitive advantage or generally cause a disruption in the daily operation of the business
Should the Confidentiality Agreement be mutual? Will the Purchaser share information?
The Purchaser may want to speak to management, suppliers and/or customers of the target business to help inform its decision and asses transition issues.
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Develop a system to organize due diligence materials at the beginning (i.e. online data site). Determine what documents can be printed or downloaded.
A document index should be used to keep track of what materials have been received.
Due Diligence
Parameters of Due Diligence
Determine with your client the parameters of the due diligence to be engaged. Consider the following:
Scope
o In a share transaction, the Purchaser is purchasing the entire business of the target,
including all of its risks, obligations and liabilities so the Purchaser’s due diligence should
try to cover everything about the target.
o In an asset transaction, the Purchaser is only purchasing certain assets of the target
business and to that extent it gets to choose which liabilities it will assume. Its due
diligence will focus on matters relating to those specific assets.
o What should the depth of review be?
Team
o How many people are needed to assist in the due diligence? What subject matter experts
are needed?
o A due diligence team can include legal, business, accounting, HR and tax specialists.
o The legal team itself may include business lawyers and other specific experts like
environmental, employment, real estate and intellectual property lawyers.
Time
o How much time is required to complete the due diligence (i.e. tax search request with
CRA can take weeks) and how much time do you actually have?
Due Diligence Request
It is typical for a Purchaser to make a request for due diligence information via a due diligence
request list. The request should be industry specific and arranged by topic areas.
The initial due diligence request may be supplemented by additional requests as negotiations
proceed and as a Purchaser learns more about the target business.
Data sites can be set up to assist with sharing information with multiple parties and to deal with
diligence that will result in a large volume of information.
Why do the Due Diligence?
Seller’s Perspective Purchaser’s Perspective
Identify business issues that may affect
value
Confirm the structure of the transaction
and if any pre-closing reorganization is
required to facilitate the desired structure
Identify any hurdles to complete the
transaction
Confirm the value of the transaction
Learn more about the business
Confirm the structure of the transaction
Determine what legal documentation is
needed to complete the transaction
Confirm title to shares and assets of the
business
Identify potential liabilities and risks
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Identify third-party consents and
restrictions on transfer of shares and
assets
Assist the Seller when the time comes to
prepare the disclosure schedules for the
definitive purchase agreement
Assist counsel and Seller to identify
qualifications and exceptions to be made
to representations and warranties
Identify if materials can be disclosed to
the Purchaser without third party consent
Assist with identifying transition and
integration issues
Legal Due Diligence
The areas that legal counsel can be expected to be involved in include the following, which is not intended to be exhaustive list.
Minute Book Review (applicable to a share transaction)
o Organizational Documents (Articles, by-laws, and Shareholders Agreement, if any).
o Authorized Capital and Share Ownership
o Dividends and Identifying Unusual Transactions
Public Searches
o Execution (by jurisdiction or Province wide)
o Business Names
o Security (PPSA and Bank Act)
o Litigation (by jurisdiction).
o Bankruptcy Search
o Bulk Sales filings (by jurisdiction)
o Registered trademark and patent searches
o Real Estate Title Searches and Off Title Searches
o Environmental Searches
o Employment Searches
Contracts Review
o Who are the Parties?
o Assignment - In an asset purchase transaction, third party consents are required for
contracts which contain a no assignment provision.
o Change of Control - In a share purchase transaction, consent may be required in the
event the contract contains a change of control provision.
o When and how can the contract be terminated?
It is important to take detailed notes when reviewing due diligence materials and to prepare reports/summaries of the review in order to report back to clients and to use as an internal record/resource.
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Structure
A Seller and Purchaser will consider legal and tax factors when determining the preferred structure for the purchase. Tax planning is essential to optimize tax outcomes for the parties.
Share Transaction
Seller’s Perspective Purchaser’s Perspective
Preference is to sell the shares of a target company because an individual Seller can realize a capital gain or loss on the sale. The individual Seller may also take advantage of the lifetime capital gains exemption.
The Purchaser is exposed to more risk and liability.
In a share sale it can be harder for a Purchaser to exclude unwanted assets of the target.
The target may have favourable tax traits that can be used by it after the acquisition (i.e. non-capital losses).
Asset Transaction
Seller’s Perspective Purchaser’s Perspective
Generally less favourable to a Seller because all or some of the proceeds may be included as income.
Each asset sold must be effectively transferred (including obtaining consents). This can be time consuming process and may pose confidentiality issues.
A Purchaser typically prefers an asset purchase because it will limit its exposure to liabilities and obligations to the target assets.
Sales taxes and land transfer taxes (LTT) might be levied. There are certain exemptions (i.e. HST and PST exemption for a sale of all or substantially all of the assets of the business).
The Letter of Intent (LOI)
The LOI serves as the preliminary non-binding offer made by the Purchaser to purchase the target business or assets. It is not unusual for an LOI to be subject to a Purchaser’s ongoing due diligence.
Key elements of a LOI include:
What is being bought and from whom.
Purchase price and payment terms. An at times, an explanation on what basis the business was
valued.
Key deal terms (i.e. employment of key personnel/transition terms).
Purchaser’s right to conduct due diligence and confidentiality provisions (if no separate
agreement).
No shop/Exclusivity covenant.
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Seller’s Perspective Purchaser’s Perspective
Commitment and basis on which to proceed with definitive agreement and continue due diligence.
Creates a moral obligation to commit to terms of the deal.
Costs of an LOI can be expensive depending on how its negotiated and better spent on definitive agreement.
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TAB 2
Restrictive Covenants in Commercial and
Employment Contexts: Key Cases and
Considerations
Adrian Ishak, Rubin Thomlinson LLP
Parisa Nikfarjam, Rubin Thomlinson LLP
March 8, 2017
Buying or Selling a Business
1
RESTRICTIVE COVENANTS IN COMMERCIAL AND EMPLOYMENT CONTEXTS: Key Cases and Considerations
Prepared by: Adrian Ishak and Parisa Nikfarjam
Restrictive covenants such as non-competition covenants (“non-compete”) and non-
solicitation covenants (“non-solicit”) are often contentious clauses in contracts but they serve
as protective tools for both purchasers of a business and employers.
A non-compete prevents a party who has the knowledge of, and experience with, a business
from using such knowledge and experience to compete with the purchaser of a business or a
previous employer. A non-solicit prevents the direct or indirect solicitation of customers or
employees by the party subject to the covenant.
By imposing such restrictions, these covenants are a restraint of trade for the person who is
subject to the covenant, and are, as a result, resisted by the courts to varying degrees.
In this paper, we will explore the manner in which restrictive covenants have been scrutinized,
depending on the circumstance (commercial versus employment relationship), to highlight the
framework in which they may successfully imposed.
A. Restrictive Covenants in the Commercial Context
Restrictive covenants such as non-competes and non-solicits largely serve to protect a purchaser
in the context of a sale of business by preventing a seller from competing with the purchaser,
particularly in the critical period of time following the business sale.
While often negotiated during the sale transaction, the covenants’ restrictions may apply for
months, if not years, after the sale has been completed. Therefore, in order to prevent restrictive
covenants from constituting an unenforceable restraint on trade, certain factors must be
carefully considered when drafting these clauses.
Leading Case: Payette v. Guay Inc. (“Payette”)1
The Supreme Court of Canada (“SCC”) most recently provided guidance on the validity of
restrictive covenants in a sale of a business in Payette.
In Payette, Guay Inc. acquired assets belonging to corporations owned by Payette. The
agreement between the parties contained the following restrictive covenants:
10.1 Non-competition - In consideration of the sale that is the subject of this offer, each of the Vendors and the Interveners covenants and agrees, for a period of five (5) years from the Closing date or, in the case of the Interveners, for a period of five (5) years from the date on which an Intervener ceases to be employed, directly or indirectly, by the Purchaser, not to hold, operate or own, in whole or in part, directly or indirectly and in any capacity or role whatsoever, or in any other manner, any business operating in whole or in part in the crane rental industry, and not to be or become involved in, participate
1 2013 SCC 45.
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in, hold shares in, be related to or have an interest in, advise, lend money to or secure the debts or obligations of any such business or permit any such business to use the Vendor's or the Intervener's name in whole or in part. The territory to which this non-competition clause applies for the above-mentioned period of time is the province of Quebec.
10.2 Non‑solicitation - Moreover, each of the Vendors and the Interveners covenants and agrees, for a period of five (5) years from the Closing date or, in the case of the Interveners, for a period of five (5) years from the date on which an Intervener ceases to be employed, directly or indirectly, by the Purchaser, not to solicit on behalf of the Vendor or the Intervener, or on behalf of others, and not to do business or attempt to do business, in any place whatsoever, in whole or in part, directly or indirectly and in any manner whatsoever, with any of the customers of the Business and the Purchaser on behalf of a crane rental business. In addition, the Vendors and the Interveners shall not solicit or hire (unless an employee is dismissed or resigns without any solicitation by the Vendors or the Interveners), in any way whatsoever, directly or indirectly, as an employee or a consultant, or in any other capacity whatsoever, any of the employees, officers, executives or other persons (hereinafter collectively referred to as the “Employees” for the purposes of this article) working for the Business or the Purchaser on the date this offer to purchase is presented or on the Closing date, and shall not attempt in any way whatsoever, directly or indirectly, to encourage any of the said employees to leave their employment with the Business or the Purchaser. For greater certainty, the parties agree that steps taken by the Vendors to collect accounts receivable shall not be interpreted as a breach of the non‑competition and non‑solicitation
provisions of this offer to purchase.
In addition to the covenants above, the parties also agreed that Payette would work full time for
Guay as a consultant for six months following the sale in order to ensure a smooth transition,
with the option of entering into an employment relationship thereafter. Ultimately, following
the sale, Payette and Guay exercised this option and Payette became an employee of Guay under
a separate employment contract.
Several years later but within five years of the closing date of the sale, Guay dismissed Payette,
and Payette secured alternate employment with Mammoet Canada Eastern Ltd. (“Mammoet”),
a competitor of Guay. Guay sought an injunction against Mr. Payette working for Mammoet, and
relied on the terms of its restrictive covenants.
While the trial court refused to impose the non-compete, the Quebec Court of Appeal did not
and ordered Payette and Mammoet to comply with the non-compete. They instead sought an
appeal to the SCC.
The SCC first distinguished between restrictive covenants in the context of a commercial and
employment relationships. The SCC held that the resistance to restrictive covenants in a
commercial context is less severe because in a commercial context, the parties often negotiate on
“equal terms” and are advised by competent of professionals. In other words, these contracts do
no create an imbalance between the parties.2 Given the lack of imbalance in commercial
contracts, restrictive covenants are often interpreted in the manner consistent with the intention
2 Ibid. at para. 39.
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of the parties. In other words, in a commercial context, the onus is on the seller to prove that the
restrictive covenant is unreasonable.3
The SCC then determined whether the restrictive covenants at play in the case were in relation
to a commercial (i.e. sale) contract. The SCC found that, given the context, the covenants were
part of the commercial sale as they (1) appeared in the sales agreement; and (2) the
“consideration” for the covenants was stated to be the sale, not the employment relationship.4
Having determined that the covenants were related to a commercial transaction, the SCC then
moved to deciding whether each covenant was reasonable. In the case of the non-compete, the
SCC considered the following factors:
The term: the SCC held that non-competes in a commercial contract must be limited as
to time, having consideration to the nature of the business. The SCC held that the highly
specialized nature of the business activities in this case weighed in favour of finding a
longer restriction period reasonable. The SCC found that the five-year term was similar
to terms in clauses upheld by courts and reasonable in the circumstances.5
Territorial Scope: the SCC stated that the territory to which a non-compete applies is
limited to “that which the business being sold carries on its trade or activities…as of the
date of the transaction.” The SCC then took a contextual approach to find that given the
unique and mobile nature of the business in this case, the territory set out in the non-
compete was reasonable.6
In the case of the non-solicit covenant, the SCC stated that such covenants are narrower in their
restriction and therefore more liberally interpreted when determining their reasonableness. In
fact, the identification of a territory was not required for the non-solicit in this case to be held to
be reasonable.
In sum, the SCC held that both the non-compete and the non-solicit covenants were reasonable
and lawful in the circumstances of this case, and Payette’s conduct was in violation of the
restrictions of the covenants.
Legacy of Payette
Subsequent decisions have followed the principles and analysis of Payette. For example, in:
Brand Solutions by Promotion Solutions Inc. v. Elsey7, a five year non-compete
covenant in the context of a shareholder’s agreement was upheld, as the parties agreed to
the terms after extensive negotiations and had the benefit of legal advice throughout.
Moreover, both parties to the agreement were business owners and sophisticated. In this
circumstance, the Ontario court, applying Payette, gave deference to the non-compete
covenant, also holding its time frame of five years to be reasonable.
3 Ibid. at para. 58. 4 Ibid. at para. 46. 5 Ibid. at para. 64. 6 Ibid. at para. 65 7 2015 ONSC 2895.
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Imperial Parking Canada Corp. v. Anderson8, restrictive covenants in an asset purchase
agreement and subsequent consulting agreement were all upheld given that they arose in
a commercial context. In this case, the parties had entered into an asset purchase
agreement which contained a non-compete covenant of four-year duration. The seller
also entered into a consulting arrangement with the buyer, which contained a six-year
non-compete covenant, which was extended for a further two years (for a total of eight
years) to correspond with the extensions to the consulting arrangement. The British
Columbia court held that all of the non-compete covenants arose as a result of the
commercial transaction, and were therefore presumed enforceable unless proved
otherwise. The British Columbia court found that the non-compete covenants were
reasonable as (1) the parties were sophisticated; (2) the parties had the benefit of legal
counsel throughout the transaction; (3) the geographical scope was not overly broad
given the nature of the business; and (4) the length of the term was extended for
additional consideration.
Since Payette, a few cases have also added to the factors to consider when scrutinizing the
enforceability of a restrictive covenant. For instance, simply proving that a restrictive covenant
is reasonable with respect to time and geographical location may not be enough if the covenant
does not actually protect a legitimate proprietary interest, as recently highlighted in MEDIchair
LP v. DME Medequip Inc.9
In this case, DME Medequip Inc. had purchased a franchise of MEDIchair LP, which included a
non-compete covenant preventing DME Medequip from operating a similar store within a 30-
mile radius for 18 months after the termination of the agreement. After seven years, DME
Medequip did not renew the agreement but continued to operate the same premises but without
the MEDIchair LP signage. MEDIchair LP, which did not have any plans to open a store in that
area, sought to uphold its non-compete covenant. While the trial judge upheld the non-compete
covenant, the Ontario Court of Appeal did not. The Court of Appeal found that the non-compete
covenant was not enforceable given that it was not necessary to protect the actual, legitimate
and proprietary interests of MEDIchair LP, which had no plans of doing business in the area.
Notwithstanding this decision, the jurisprudence suggests that restrictive covenants in a
commercial context are presumed to be enforceable based on the perception that sophisticated
parties agree to these restrictions after negotiations and with the aid of legal representatives.
The presumption is only rebutted if the covenant in unreasonable in scope or term, or does not
relate to a legitimate proprietary interest. The analysis of these factors is, naturally, case specific.
For instance, courts have upheld terms exceeding five years with respect to non-competes when
the nature of the relationship justifies it and adequate consideration is provided.
This deference to restrictive covenants in a commercial context does not exist, however, when
the restrictions relate to an employment relationship.
B. Non-Competes in the Employment Context
Restrictive covenants in an employment relationship serve to protect the employer, often at the
end of the employment relationship, from an employee who may use their knowledge of the
8 2015 BCSC 2221. 9 2016 ONCA 168 [“MEDIchair”].
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employer’s business and resources to either compete with the employer or solicit the employer’s
clients or employees.
While the covenants aim to protect the post-employment conduct of an employee, they are
negotiated and agreed to at the outset of or during the employment relationship. As such, there
is an imbalance of power between the parties when the restrictive covenants are entered into.
For this reason, restrictive covenants in an employment relationship are prima facie
unenforceable.
That said, a number of cases have historically found non-compete covenants enforceable where
the circumstances make the restrictions reasonable.
Leading Case: J.G. Collins Insurance Agencies v. Elsley10 (“Elsley”)
In Elsley, Elsley managed the agency’s insurance business for seventeen years after selling the
business to J.G. Collins. Elsley’s contract of employment contained the following non-compete
covenant:
3. (…) the Manager shall not, while in the employ of the Company (…) or during the period of five years next after (…) and whether as principal, agent, director of a company (…) carry on (…) or take part in the business of a general insurance agent within the corporate limits of the City of Niagara Falls, the Township of Stamford and the Village of Chippawa, all in the County of Welland (…).
During his years of service, Elsley exclusively served the customers of the business and to them
he was the face of the business. When Elsley’s employment was terminated, he began his own
insurance business, and soon employed two insurance salesmen and an insurance clerk formerly
employed by J.G. Collins. Soon after, approximately 200 clients took their business to Elsley,
which represented 50% of J.G. Collins’ business. J.G. Collins sought to enforce the non-compete
covenant in Elsley’s contract and at issue was whether the non-compete covenant was
enforceable.
The SCC first confirmed that restrictive covenants are prima facie unenforceable unless proved
reasonable by the employer. The SCC then outlined a three-step inquiry for assessing the
reasonableness of a non-compete covenant:
1) Does the employer have a proprietary interest entitled to protection?
2) Are the temporal and spatial features of the covenant too broad?
3) Is the covenant unenforceable as being against competition generally and not limited to
proscribing solicitation of clients?
The SCC held that J.G. Collins had a proprietary interest in its clients and employees. Next, it
noted that while a five-year non-compete would normally be abusive in a typical employment
contract, it was reasonable in this case as J.G. Collins was uniquely vulnerable given that Elsley
was essentially the business. Finally, the SCC held that the non-compete was necessary because
a non-solicit would not have adequately protected J.G. Collins’ business.
Elsley was, therefore, held to have breached the non-compete covenant and liable for damages.
10 [1978] 2 S.C.R. 916.
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Legacy of Elsley
Since Elsley, courts have continued to deem non-compete covenants unenforceable in an
employment context unless reasonable under the circumstances. Courts have noted that a non-
compete covenant is a more drastic weapon in an employer’s arsenal. The focus of a non-
compete clause is much broader than an attempt to protect the employer’s clients or customer
base; it extends to an attempt to keep the former employee out of the business. Generally
speaking, courts have not enforced a non-compete covenant if a non-solicit covenant would
adequately protect an employer’s interests.11
That said, the court will continue to engage in a contextual analysis in determining the
enforceability of a non-compete covenant. Take for example, Renfrew Insurance Ltd. V.
Cortese,12 which involved an insurance brokerage business. Both defendants were shareholders
of Renfrew and received shares in Renfrew in exchange for the non-solicit and non-compete
covenants in a Unanimous Shareholder’s Agreement (“USA”).
The USA specifically prohibited the defendants from competing in the insurance business within
a 60 kilometer radius of Renfrew’s office in Calgary and for a period of six months following
termination. In addition, both defendants agreed not to solicit Renfrew’s customers or
employees for a period of 18 months.
The defendants resigned from their positions at Renfrew and joined a competitor, located within
the defined geographical area outlined in the restrictive covenants. In addition, two former
customer service representatives who previously worked with the defendants at Renfrew joined
the competitor business and two former clients switched their business from Renfrew to the
competitor.
The trial judge found that the non-competition clause comprising a 60-kilometer radius of a
specific location in Calgary for a period of six months was “quite reasonable.” The judge stated
that a book of business in the insurance industry is an invaluable asset making restrictions to an
employee’s use of it reasonable. Moreover, as both defendants had the benefit of independent
legal advice with respect to the restrictive covenants contained in the USA, voluntarily accepted
the offer to become owners of Renfrew, and did not fear that the continuation of their
employment was dependent on the signing of the agreement, there was an absence of inequality
of bargaining power between the parties, further justifying the reasonableness of the covenants.
As a result, the trial judge concluded that the non-compete and non-solicit covenants were both
reasonable. The trial judge’s decision was also upheld by the Alberta Court of Appeal.13
As can be seen above, the contextual analysis of restrictive covenants remains the key method in
determining whether a covenant is reasonable. In some situations, a lengthier restriction period
(i.e. five to eight years) have been upheld14 As such, the limitations of scope and term will
depend on the specific nature of the relationship and business at play.
11 Lyons v. Multari, (2000), 50 OR (3d), 3 CCEL (3d) 34, 2000 CarswellOnt 3186. 12 2014 CarswellAlta 450. 13 Renfrew Insurance Ltd. V. Cortese, 2014 CarswellAlta 958, 2014 ABCA 203. 14 See: Dale & Co v Land (1987), 56 Alta LR (2d) 107, 84 AR 52, 1987 CarswellAlta 249, where the Alberta Court of Appeal upheld a five-year non-compete clause stating that the covenant must be “measured against what appears to be the unique ability of the [company] to retain the loyalty of clientele”; Dyform Engineering Ltd v Ittup Hollowcore International Ltd, [1985] BCWLD 1699, 19 BLR 1, 1982 CarswellBC
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C. Key Considerations When Drafting Restrictive Covenants
There are, however, situations where a restrictive covenant may exist in a situation that involves
both a commercial and employment relationship, creating a hybrid contract. These situations
occur, for example, in situations where sale of a business also involves the employment of (or
undertaking to employ) the seller of a business by the purchaser following the sale.
In such situations, the decision of Payette provides helpful guidance as to the enforceability test
to be applied. The SCC stated that where the sales agreement is a hybrid contract:
To determine whether a restrictive covenant is linked to a contract for the sale of assets
to or a contract of employment, it is… important to clearly identify the reason why the
covenant was entered into. The 'bargain' negotiated by the parties must be considered in
light of the wording of the obligations and the circumstances in which they were agreed
upon. The goal of the analysis is to identify the nature of the principal obligations under
the master agreement and to determine why and for what purpose the accessory
obligations of noncompetition and non-solicitation were assumed.15
This is a process of contractual interpretation whereby the terms of the contract as well as the
circumstances surrounding the contract are used to ascertain why the restrictions were put into
place. Where the restrictions cannot be dissociated from commercial agreement, the less robust
analysis of the reasonability of the covenants will take place.
However, to avoid any risk of restrictive covenants being analyzed through the more narrow
employment relationship lens, parties to a sale of a business may be well served by clearly
separating the employment arrangements from the commercial sale transaction and having
stand-alone documents with their own respective restrictive covenants and consideration.
Notwithstanding whether the employment and commercial relationship can be separated, the
leading and recent jurisprudence show that decision-makers will pay careful attention to the
following factors when determining whether a restrictive covenant – specifically as a non-
compete covenant - is reasonable and enforceable:
1. The extent to which there is equal bargaining power between the parties. Careful
attention will be paid to whether the parties are both sophisticated; were provided time
to negotiate the terms of the restrictive covenant; and had the benefit of independent
legal advice. The more equal the bargaining power, the better the chance that the
restrictive covenant will be honoured.
2. The term, scope, and interests covered in the restrictive covenant will be key in
determining whether the restrictions are reasonable. There is no bright line rule with
473, where the British Columbia Court of Appeal found that an eight-year non-compete clause was reasonable given the nature of the business, investment of capital and the clear intentions of the parties. 15 Supra note 1 at para. 45.
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8
respect to terms and scope. Careful attention will be paid to the nature of the business at
play to determine if the restrictions are practically needed in the specific circumstance.
3. The restrictive covenant must be clear and non-ambiguous in terms of its restrictions
and to the party (or parties) and locations to which the restrictions will apply.
Given the enforcement requirements at play, corporate entities and their counsel should
carefully draft restrictive covenants that are appropriate in the context in which they will be
applied, in order to fully enjoy the benefits of these restrictions and protections, both in the
commercial and employment relationship.
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TAB 3
Who’s your client?
Ian Palm, Gowling WLG (Canada) LLP
Jeffrey Simpson, Torkin Manes LLP
March 8, 2017
Buying or Selling a Business
TOR_LAW\ 9130390\1
Who’s Your Client?
Buying or Selling a Business
Law Society of Upper Canada CPD Program
March 8, 2017 - Toronto, Ontario
Presenters: Jeffery J. Simpson, Partner Torkin Manes LLP
W. Ian Palm, Partner, Gowling WLG
The Facts:
• Palm Simpson Industries (“PSI”) is a second-generation Ontario
corporation, founded by two brothers in the 1950’s.
• PSI is an industrial manufacturer, with a global customer base.
Annual revenue is in the $50 million range, the company has 60
employees, and operates from a factory/front office facility which
it owns located outside of Toronto.
• Shareholders are family members. The two founding brothers own
30 per cent. Each have three children, two of whom are involved
in the business, owning a further 20 per cent of the equity in
varying proportions. The remaining 20 per cent of the equity is
held by a European-based conglomerate that is also a key supplier
to PSI.
• The two founders and another family member shareholders
together with a representative of the supplier shareholder are also
the four directors of the company.
• Two of the second-gen shareholders are married and have teenage
children who have expressed no interest in joining the business.
• The company has a shareholders agreement, long out of date and
adhered-to only on a haphazard basis.
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TOR_LAW\ 9130390\1
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• The older gen shareholders are aware from their accountants that
they should be tax-planning an exit strategy and perhaps
considering an estate freeze. This has, however, never been done
and the company has only ever issued common, voting shares.
• Two of the younger generation shareholders, including one who is
not a director of the company, hold secured shareholder loans,
advanced several years ago and still outstanding.
• The supplier shareholder had invested some years ago when
prospects for the business were better. Returns on the investment
have been mediocre and the supplier shareholder has been
agitating for change.
• A number of key employees had earlier been provided with
unwritten promises of options or other equity incentives in the
company.
• The company has always been financed by Bank X, which is owed
several million dollars on a revolving line, guaranteed by some, but
not all, of the shareholders; two of the guarantors have pledged
their personal residences as security to Bank X for their
obligations. Bank X holds security against the assets of PSI, and
the shareholders have subordinated their equity and debt in favour
of the Bank.
The Deal:
• The founders are eager to take some chips off the table. The
supplier shareholder is a motivated seller. The second generation
shareholders that are active in the business would like to remain
but have decided to exit the business altogether, predicting that
conditions for heavy manufacturing in Ontario will continue to
deteriorate. A proposed purchaser has been located with the help
of a consultant, who was brought to the table by, and works for,
PSI’s accounting firm.
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• Some details have been worked out, and a preliminary purchase
price has been arrived at but there’s no letter of intent in place yet.
• For various reasons, the parties have decided on an asset sale.
Purchaser Co. (the “Purchaser”) will be purchasing substantially
all of the assets of PSI on closing, with a 15 per cent deposit
payable on signing of the anticipated asset purchase agreement
and the balance in cash on closing subject to a 20 per cent hold
back. The Purchaser had been pushing for the founding
shareholders to agreeing to vendor take-back financing for part of
the purchase price but have the dropped the point for now.
Your Retainer:
• Two of the shareholders, both directors of the company, approach
you to act for PSI on the sale of substantially all of its assets.
• The parties have worked out very little of the details, although they
have a mid-sized accounting firm giving them advice on various
business-related issues.
• The two directors want you to “do the deal” for them.
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TAB 4
Annotated Sample Earn-Out Provisions
Brad Ross, Goodmans LLP
March 8, 2017
Buying or Selling a Business
ANNOTATED SAMPLE EARN-OUT PROVISIONS1
ARTICLE III
3.3 Definitions
“Adjusted EBITDA” means the net income before interest, income taxes, depreciation and amortization
of the Business for such period, determined in accordance with GAAP but applied and calculated in a
manner consistent with the EBITDA calculation derived from the Audited Financial Statements for the
most recent financial year end, adjusted to exclude any sales of the Product to Affiliates of the Purchaser.
[IN THIS SAMPLE PROVISION, EARN-OUT PAYMENTS ARE A MULTIPLE OF ADJUSTED
EBITDA. ALTERNATIVELY, ADJUSTED EBITDA CAN ALSO BE USED AS A TARGET FOR
TRIGGERING EARN-OUT PAYMENTS. IN EITHER CASE, IT WILL BE IMPORTANT TO
CAREFULLY DESCRIBE EXACTLY WHAT “ADJUSTED EBITDA” IS MEANT TO INCLUDE OR
EXCLUDE SO AS TO REMOVE ANY UNCERTAINTY AND ADDRESS ANY CONTEXT-SPECIFIC
CONSIDERATIONS. FOR EXAMPLE, CONSIDER A PURCHASER THAT IS INTEGRATING THE
PURCHASED BUSINESS INTO ITS OWN OPERATIONS. IT IS POSSIBLE THAT THE
PURCHASED BUSINESS WILL EXPERIENCE INCREASED EBITDA AS A RESULT. WHETHER
OR NOT THE INCREASE IN EBITDA THAT IS ATTRIBUTABLE TO THE INTEGRATION OF
THE PURCHASED BUSINESS – FOR EXAMPLE, AS A RESULT OF REFERRALS FROM OTHER
DEPARTMENTS – OUGHT TO BE CONSIDERED WHEN NEGOTIATING THE EARN-OUT
TRIGGER OR PAYMENT CALCULATION. ANY TARGET OR PAYMENT CALCULATION
SHOULD BE EXPLICIT AND ADDRESS ALL APPLICABLE FACTORS. TO THE EXTENT
POSSIBLE, CONSIDERATION SHOULD ALSO BE GIVEN TO ATTACHING A SAMPLE
ADJUSTED EBITDA CALCULATION TO THE PURCHASE AGREEMENT.]
“Earn-Out Financial Statements” means, in respect of Years One and Years Two, consolidated
financial statements of the Business for that year, consisting of a balance sheet and a statement of
earnings.
“GAAP” means
[CONSIDERATION SHOULD BE GIVEN AS TO THE APPROPRIATE ACCOUNTING
STANDARDS (I.E.., IFRS, ASPE, ETC.)]
“Year One” means the one calendar year period beginning on January 1, 2017 and ending on December
31, 2017.
“Year One Earn-Out Amount” means the amount equal to six times Adjusted EBITDA for Year One
less the Initial Purchase Price.
[EARN-OUT PAYMENTS CAN TAKE DIFFERENT FORMS. WHILE A SET AMOUNT MAY
OFFER SIMPLICITY, A VARIABLE AMOUNT – FOR EXAMPLE, ONE TIED TO EBITDA – MAY
HELP PARTIES SETTLE ON WHAT IS AN APPROPRIATE PAYMENT. PAYMENTS CAN BE
BASED ON FINANCIAL, OPERATIONAL AND EVENT-DRIVEN FACTORS. SUCH FACTORS
CAN ALSO FORM THE BASIS FOR TRIGGERING AN EARN-OUT PAYMENT.]
1 This sample provision does not constitute legal advice and should be used solely as a guide. When doing so, it is
important that you consider any other issues or facts that may be relevant to your transaction and that may not be
covered by this precedent. Be especially mindful of the interests of your client, strategic and otherwise, in the event
that any provisions of this precedent are subject to negotiations.
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“Year Two” means the one calendar year period beginning on January 1, 2018 and ending on December
31, 2018.
[GENERALLY, EARN-OUTS HAVE A ONE TO THREE YEAR TERM; HOWEVER, THIS WILL
ULTIMATELY TURN ON THE NATURE OF THE TARGET’S BUSINESS AND DEAL FACTS.
LONGER AND SHORTER PERIODS AFFORD BOTH VENDORS AND PURCHASERS CERTAIN
BENEFITS AND DISADVANTAGES. FOR EXAMPLE, A SHORTER PERIOD MAY PROVIDE FOR
A VENDOR RECEIVING EARLIER PAYMENT BUT MAY ALSO PUT THE VENDOR AT RISK OF
NOT ACHIEVING AN EARN-OUT TARGET. ALONGSIDE ANY BENEFITS AFFORDED BY A
LONGER EARN-OUT PERIOD (TO THE VENDOR AND/OR THE PURCHASER), PARTIES
SHOULD BE COGNIZANT THAT A LONG PERIOD DELAYS A “CLEAN BREAK”, WHICH IS
PARTICULARLY RELEVANT WHEN POST-CLOSING COVENANTS OR OBLIGATIONS ARE IN
PLACE.]
“Year Two Earn-Out Amount” means the amount equal to five and one-half times Adjusted EBITDA
for Year Two less the sum of the Year One Earn-Out Amount and the Initial Purchase Price.
3.4 Earn-Out Amounts
The Purchaser shall pay the Earn-Out Amounts to the Vendor as part of the Purchase Price for the
Purchased Shares as follows:
(a) Year One Earn-Out Amount – Within fifteen (15) days after the delivery of the Earn-
Out Financial Statements for Year One as provided in Section 3.5, but not, in any event,
later than sixty (60) days after the end of Year One, the Purchaser shall pay the Year One
Earn-Out Amount to the Vendor, by wire transfer or such other method as the Vendor
and the Purchaser agree in writing;
(b) Year Two Earn-Out Amount – Within fifteen (15) days after the delivery of the Earn-
Out Financial Statements for Year Two as provided in Section 3.5, but not, in any event,
later than sixty (60) days after the end of Year Two, the Purchaser shall pay the Year
Two Earn-Out Amount to the Vendor, by wire transfer or by such other method as the
Vendor and the Purchaser agree in writing.
(c) Maximum Amount – Notwithstanding anything in this Agreement to the contrary, the
Purchaser shall only be obligated to make payments pursuant to Section 3.4(a) and
Section 3.4(b) up to a maximum amount of $ in the aggregate. For the avoidance of
doubt, the Purchase Price, including the Initial Purchase Price, the Year One Earn-Out
and the Year Two Earn-Out, shall not exceed $.
[EARN-OUT PAYMENTS THAT ARE BASED ON A FORMULA CAN POTENTIALLY BECOME
QUITE SIGNIFICANT. A CAP MAY HELP PROTECT A PURCHASER AGAINST THIS. IN
CONTRAST, A VENDOR WILL NATURALLY OPPOSE A CAP. ONE STRATEGY THAT CAN BE
USED BY A VENDOR IS TO REQUIRE A MINIMUM PAYMENT AMOUNT IN EXCHANGE FOR A
CAP.]
3.5 Delivery of Earn-Out Financial Statements
As soon as reasonably practical, and in any event not later than sixty (60) days after the end of each of
Year One and Year Two, the Purchaser shall deliver the Earn-Out Financial Statements to the Vendor.
The Earn-Out Financial Statements shall be prepared by the Purchaser in accordance with the principles
set out in Schedule 3.4 (as may be amended from time to time upon written agreement of the Purchaser
and the Vendor) and otherwise in accordance with GAAP applied on a basis consistent with those applied
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in preparing the Company Financial Statements. Along with the Earn-Out Financial Statements for Year
Two, the Purchaser shall also deliver to the Vendor the information as to sales of the Product required to
determine whether any adjustments to the Year Two Earn-Out Amount are required to be made pursuant
to Section 3.4(b).
3.6 Objections
(a) Delivery of Objection Notice – If the Vendor objects in good faith to any aspect of the
determination of an Earn-Out Amount, the Vendor shall so advise the Purchaser by
delivery to the Purchaser of a written notice (an “Objection Notice”) within ten (10) days
after delivery to the Vendor of the relevant Earn-Out Financial Statements. The
Objection Notice shall set out detailed reasons for the objection as well as the amount
under dispute and reasonable details of the calculation of such amount.
(b) Resolution of Disputes – The Vendor and the Purchaser shall attempt to resolve all of
the items in dispute set out in any Objection Notice within thirty (30) days after the
Objection Notice is received by the Purchaser and shall instruct the Independent Auditor
to assist in that resolution. The resolution of any items in dispute by agreement of the
Purchaser and the Vendor shall be binding on all of the Parties. Any items in dispute not
so resolved within such thirty (30) day period shall be referred as soon as possible
thereafter by the Vendor and the Purchaser to the Independent Auditors. The
Independent Auditors shall be required to determine the items in dispute that have been
referred to them as soon as reasonably practicable but in any event not later than thirty
(30) days after their initial instruction. In doing so, the Independent Auditors shall be
entitled to consult with independent legal counsel and such other experts as they may
deem necessary or appropriate. In making their determination, the Independent Auditors
shall act consistently with this Article III and shall stay within the boundaries of the
positions taken by the Vendor and the Purchaser in respect of each individual item
referred to them. The Vendor and the Purchaser shall provide or make available, and
shall cause the Independent Auditor to provide or make available, all documents and
information as are reasonably required by the Independent Auditors to make their
determination. The determination by the Independent Auditors shall be final, conclusive
and binding upon the Parties for the purposes of this Agreement and the Parties shall be
deemed to have agreed to such determination.
(c) Audit Expenses – The fees and expenses of the Independent Auditors in acting in
accordance with this Article III shall be shared equally by the Purchaser, on the one hand,
and the Vendor, on the other hand.
(d) Payment in Accordance with Determination – Within five (5) days after resolution by
agreement of the dispute which was the subject of the Objection Notice, or within five (5)
days after the determination of the Independent Auditors, the Purchaser shall pay to the
Vendor such amount, if any, by which the Earn-Out Amount is adjusted as a result of
such resolution or final determination. Such payments shall be made by cheque, bank
draft or by such other method as the Purchaser and the Vendor agree in writing.
[WHEN PREPARING DISPUTE RESOLUTION PROVISIONS FOR AN EARN-OUT, CONSIDER
INCLUDING LIMITS ON THE NATURE OF OBJECTIONS THAT CAN BE RAISED. FOR
EXAMPLE, ONLY OBJECTIONS ON THE BASIS THAT A VALUE WAS CALCULATED
INCONSISTENTLY WITH THE AGREEMENT OR THAT THERE WAS A NUMERICAL/FACTUAL
INACCURACY]
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3.7 Holdbacks from Earn-Out Amounts
The Purchaser may withhold from any Earn-Out Amount required to be paid under Section 3.3 an amount
equal to the aggregate of the Purchaser Claim Amounts of any and all Purchaser Claims made, brought or
initiated by the Purchaser on or prior to the date on which such Earn-Out Amount is required to be paid.
The Purchaser shall forthwith pay any such withheld amount to the Escrow Agent to be held by the
Escrow Agent pursuant to the Escrow Agreement pending final resolution of the Purchaser Claims. Prior
to the payment of any such amounts to the Escrow Agent, the Purchaser and the Vendor agree to enter
into the Escrow Agreement with the Escrow Agent, with such modifications as the Escrow Agent may
require and are acceptable to the Purchaser and Vendor, acting reasonably.
3.8 Post-closing Operations
Following the Closing, the Purchaser shall have sole discretion with regard to all matters relating to the
operation of the Business, including, but not limited to, entering into distribution agreements for the
Product; provided however that the Purchaser shall not, directly or indirectly, take any actions in bad faith
that would have the purpose of avoiding or reducing any of its obligations under this Article 3.
[SATISFACTION OF EARN-OUT TRIGGERS AND CALCULATION OF EARN-OUT PAYMENTS
WILL GENERALLY TURN ON POST-CLOSING BUSINESS OPERATIONS. ACCORDINGLY,
VENDORS WILL OFTEN SEEK LIMITATIONS/CONTROLS ON POST-CLOSING OPERATIONS
AND POST-CLOSING COVENANTS FROM PURCHASERS. A PURCHASER WILL NATURALLY
WANT POST-CLOSING OBLIGATIONS AND COVENANTS KEPT TO A MINIMUM. EXAMPLE
POST-CLOSING COVENANTS/OBLIGATIONS INCLUDE VETO RIGHTS IN FAVOUR OF THE
VENDOR FOR SIGNIFICANT BUSINESS DECISIONS, RIGHTS FOR THE VENDOR TO ELECT A
MEMBER TO THE PURCHASER’S BOARD, A COVENANT OF THE PURCHASER TO MAINTAIN
A MINIMUM LEVEL OF WORKING CAPITAL AND A COVENANT TO KEEP CERTAIN
INDIVIDUALS EMPLOYED DURING THE EARN-OUT PERIOD.]
3.9 Buyout Option
At any time after the Closing Date, the Purchaser may, in its sole discretion, elect to make a payment (the
“Buyout Payment”) to the Vendor in accordance with Exhibit “A” and upon such Buyout Payment being
made, the Purchaser, its successors and assigns shall be fully released and discharged from any further
liability or obligation under this Article 3.
[A BUYOUT PROVISION MAY BE USED TO ALLEVIATE A PURCHASER’S CONCERNS
REGARDING A LENGTHY EARN-OUT PERIOD. THIS MAY BE PARTICULARLY IMPORTANT
WHEN THERE ARE SIGNIFICANT POST-CLOSING COVENANTS. SIMILARLY, AN
ACCELERATION PROVISION THAT REQUIRES EARN-OUT PAYMENTS TO BECOME DUE
UPON THE OCCURRENCE OF A SPECIFIED EVENT – FOR EXAMPLE, A CHANGE OF
CONTROL – CAN ALLEVIATE VENDOR CONCERNS REGARDING THE TERM OF THE EARN-
OUT.]
3.10 Allocation of the Purchase Price
The Purchase Price, including, for greater certainty, the Year One Earn-Out Amount, if any, and the Year
Two Earn-Out Amount, if any, shall be allocated among the Purchased Shares in accordance with the
provisions of Schedule 3.8. Each of the Vendor and the Purchaser agree to report the purchase and sale of
the Purchased Shares in any Tax Returns required to be filed in accordance with the provisions of
Schedule 3.8.
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TAB 5
From LOI to Definitive Agreement
Ryan Done, Miller Thomson LLP
March 8, 2017
Buying or Selling a Business
BUYING OR SELLING A BUSINESS MARCH 8, 2017
“FROM LOI TO DEFINITIVE AGREEMENT”
CHECKLIST OF LOI CONSIDERATIONS
(Ryan Done, Miller Thomson LLP)
If No, the parties and legal counsel are left to draft and negotiate the Definitive Agreement and virtually every possible deal point is “on the table” and open for negotiation.
If Yes, consider how detailed the LOI should be.
While certain clients may wish to move quickly past the LOI stage (particularly if there are cost sensitivities), there are significant benefits to both clients and legal counsel of a negotiated LOI as it can set the framework for the transaction and drafting of the Definitive Agreement.
With that said, it is certainly not uncommon to see LOIs that reserve the
substantive negotiation to the Definitive Agreement stage – e.g. by including relatively ambiguous statements such as “…the Definitive Agreement will contain such representations and warranties and indemnification obligations as are customary for transactions of this nature”. These statements can lack utility particularly when either the parties or counsel (or both!) have limited or differing M&A experience or simply refuse to subscribe to what is generally known or perceived to be “market”.
While the typical LOI is largely non-binding and should clearly not commit either party to the transaction or its terms, a negotiated LOI can create a “moral obligation” on the parties that can help to anchor the fundamental deal points and mitigate subsequent negotiation or “re-trading” that might threaten the deal or, at minimum, create reputational risk.
Items to consider for inclusion in the LOI that can be of assistance at subsequent stages of the deal process include:
Who are the parties? Will any guarantors be required to address creditworthiness? Are all such relevant parties signing the LOI?
Unless a binding commitment is intended, ensure the LOI is expressly non-binding (other than specific sections that are intended to be binding – e.g. confidentiality, exclusivity / standstill / no-shop, costs, etc.).
What is the transaction structure, if known (e.g. share purchase or asset purchase transaction, other unique sale structure, etc.)?
Is there an indicative purchase price (which is often subject to confirmatory due diligence)? What is the price comprised of (e.g. cash, notes, shares, contingent payments, etc.)? If applicable, will future payment obligations be secured?
Will the parties use a LOI / Term Sheet as the blueprint for the Definitive (Purchase) Agreement?
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Are there any particular due diligence requirements of the Purchaser that should be expressly outlined? Will the parties set parameters around due diligence access rights / limitations (e.g. involvement or control by the Seller)?
Will conditions precedent to the transaction be listed in the LOI? Will any of these conditions “fall away” at the Definitive Agreement stage?
Although the LOI is generally non-binding and does not create legal obligations to complete the transaction, there may be advantages to “flagging” key conditions that may need to be included in the Definitive Agreement – e.g. financing requirements, board / shareholder approval, regulatory or other third party approval, material consents, environmental due diligence, the hiring of key employees, etc. Including such conditions can also further support the non-binding nature of the LOI.
Are there any known “material deal issues” that should be addressed in the LOI, even if at a high level? E.g. how an outstanding litigation claim will be addressed, how a retained executive will be compensated post-closing, will any pre-closing reorganization be necessary, critical timing (e.g. tax-driven deadlines), etc.
Will the LOI outline the requirement for, and key particulars of, any material ancillary transaction documentation – e.g. non-competition and non-solicitation agreement, executive employment agreement, transition services agreement, releases, etc.
Will any detail be provided concerning expected representations and warranties of the Seller? Will the concept of “knowledge” be addressed?
Will any detail be provided concerning indemnification obligations? Will the often contentious topics such as: survivability of representations & warranties, indemnification thresholds (deductibles, tipping baskets, etc.), liability caps, pro- vs. anti- “sandbagging”, etc. be addressed in the LOI or left for negotiation at the Definitive Agreement stage?
In light of recent case law from the Supreme Court of Canada concerning good faith principles in contract law, together with recent U.S. case law from Delaware, parties and their counsel should be highly sensitive to, and avoid, expressly committing to negotiating in good faith or creating similar obligations (e.g. using best efforts, taking commercially reasonable steps, etc.) to consummate the transaction. Assuming the LOI is intended to be non-binding (save for any limited binding provisions), the inclusion of good faith commitments may open the door to an aggrieved party to claim that the LOI was, in fact, something more than a non-binding outline of the contemplated transaction.
CAUTION! Don’t let good faith commitments potentially eviscerate your otherwise
non-binding LOI
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TAB 6
Letters of Intent
A. Paul Mahaffy, C.S., Bennett Best Burn LLP
March 8, 2017
Buying or Selling a Business
Letters of Intent
©2017 A. Paul Mahaffy. All Rights Reserved.
Adapted from the Letters of Intent chapter in the author’s
Business Transactions Guide published by Carswell.
Introduction
Once the seller of a business and prospective buyer have arrived at a stage in their
discussions over the purchase and sale of the business where they feel that they have the
basis of a deal, they may then decide to confirm in writing what they have agreed upon.
They will likely set out the basic terms of their proposed purchase and sale in a
preliminary document variously described as a letter of intent, term sheet, memorandum
of understanding, or heads of agreement.
Whatever such a document is called, and for the purposes of this paper it will be referred
to as a letter of intent, the terms set out in it will eventually be repeated and expanded
upon in a definitive purchase and sale agreement, if the parties get that far in their
negotiations. The definitive agreement is ordinarily intended to replace the letter of
intent.
However, the letter of intent can become quite a detailed and comprehensive document.
Some letters of intent are not legally binding at all. Others are fully binding, although
they are often so loaded with various conditions that the obligations which they set out
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may be difficult to enforce.
The “hybrid” form of letter of intent, part of which is non-binding and part of which is
binding, is becoming more commonplace in practice. The non-binding part usually
contains the principal business terms of the deal. The binding part usually sets out the
rights of the parties and the process to be followed up to the signing of the definitive
purchase and sale agreement, or to the termination of the deal in the absence of such a
signing.
The letter of intent provisions discussed below may be used either in binding or non-
binding formats, although the expense reimbursement, deposit, exclusivity and
confidentiality provisions are almost always made binding. The provisions discussed
below can take on many possible variations, and should not be taken as reflecting a “best
practice” or as favouring one party over the other.
Some letters of intent are considerably more detailed than others, even though they may
all cover the same basic terms. Though some may simply refer to such other “standard”
terms and conditions as are used in “generally comparable transactions”, others may be
quite specific, sometimes attaching certain portions of the definitive agreements as
schedules to the letter of intent. They may actually prescribe specific definitive
agreements to be produced, which may include, in addition to the purchase and sale
agreement, a shareholder agreement, employment and consulting agreements, non-
competition agreements, option agreements, and possibly many more.
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Where the proposed deal presents any concern which is particularly important to either
party, such concern should be specifically addressed in the letter of intent. By addressing
its concerns at this stage of the deal continuum, each party will have an opportunity to
determine early on, before both parties have incurred considerable time and expense,
whether the other party takes a strongly opposite position as to how such concern might
be resolved. In other words, the “deal killers” should be identified and resolved in the
letter of intent.
The comprehensiveness of the letter of intent depends to some extent upon the relative
bargaining power of the parties involved, the importance of the deal to each party, and
how quickly each of the parties wants or needs the deal to be closed. Whether the
business being sold is profitable or unprofitable, whether the seller has “deep pockets” or
is selling off assets to stave off bankruptcy, or whether the prospective buyer needs to add
the business to its existing product lines to match its closest competitor, can all affect the
level of detail found in the letter of intent.
Shares vs. Assets
If the business to be sold is carried on in the form of a company, one of the issues to be
decided at the outset is whether the deal should be structured as a sale of shares or a sale
of assets. Buyers generally prefer to acquire a company by buying its assets, not shares.
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In a share sale, the buyer acquires the company as a whole, with all of its liabilities as
well as its assets, including those liabilities which may be unknown at the time of closing.
In an asset sale, the buyer acquires only those assets, and assumes only those liabilities,
of the company which are identified in the purchase agreement.
Avoiding the obligation to take on undisclosed or hidden liabilities, and the potential
risks such liabilities might entail, is often the main reason why a buyer will insist that the
purchase be structured as an asset sale. A failing business will usually be sold by way of
assets, not shares.
A seller, by contrast, generally prefers a share sale as a way of shifting any residual
liabilities of the company on to the buyer. However, the seller may still be subject to
certain residual liabilities for a certain period of time after the deal closes through its
indemnification of the buyer in the purchase agreement.
Avoiding the risk of unknown liabilities is not the only reason a buyer might have for
preferring an asset sale. There are certain tax advantages to a buyer in an asset sale as
well, especially when the assets being purchased have a fair market value in excess of the
tax cost of such assets recorded on the company’s books. The purchase price may be
allocated by buyer and seller amongst the various purchased assets to provide the buyer
with a higher cost base for such assets, thereby enabling the buyer to claim after closing
larger capital cost allowances on such assets. 1
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From a tax perspective, the seller usually prefers a share sale, especially if the seller is an
individual and the lifetime capital gains exemption2 is still available to him. While the
exemption is afforded to individuals with respect to the sale of shares of a “qualified
small business corporation”, any gains on the sale of assets by the company would not
qualify for the exemption.
Even without using the exemption, the capital gains tax liability to the seller on a share
sale is likely to be less than such liability to the company on an asset sale, given that the
company will likely have to include in its income any “recaptured” capital cost allowance
when the purchase price for any depreciable assets exceeds the undepreciated capital cost
of such assets as recorded on the books of the company.3 However, a seller may prefer an
asset sale over a share sale if the company has considerable loss “carryforwards” which it
can use to reduce the income earned on the sale.4
Deciding between a sale of assets and a sale of shares affects the actual purchase price
which a buyer is prepared to pay and a seller is prepared to receive. For example, a buyer
in a share sale will want to discount the price because of the risks of contingent liabilities,
but a seller may be prepared to accept such a discount for the share sale if it’s roughly
equal to the seller’s available capital gains exemption.
The Non-Binding Provisions
In the non-binding part of the letter of intent, the parties acknowledge that they are not
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legally bound by these provisions but intend to proceed to negotiate and execute a
definitive purchase and sale agreement which may contain many of these provisions. The
words used in these provisions often suggest a less than binding obligation, such as
“may” and “would”, or “possible” and “proposed”, in contrast to the wording used in the
binding provisions, such as “shall” and “agree”.
Identity of the Parties
All of the parties expected to eventually sign the purchase and sale agreement should be
made a party to the letter of intent. If the parties signing the letter of intent will not, or
may not, be the parties signing the purchase and sale agreement and the other definitive
agreements for closing, the letter of intent should allow for substitute parties.
Many letters of intent provide for other members of a party’s corporate group to acquire
the shares or assets involved, often to achieve the most tax-effective structure. Sometimes
a special purpose entity will be incorporated by the buyer to carry out the acquisition, or a
seller will incorporate a new company to hold only the assets and liabilities desired by the
buyer and proceed to sell the shares of such new company to the buyer.
Either way, the other party may insist that the covenants and indemnities to be contained
in the purchase and sale agreement and the other definitive agreements should be given
by, or at least guaranteed by, the original party signing the letter of intent.
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In other circumstances, it may be intended that certain parties be bound only by a few,
selected provisions, such as the confidentiality or exclusivity provisions, or have their
liability restricted to only a few warranties. Other parties may be intended to guarantee
only certain financial obligations. However restricted the role certain parties may play in
the deal, those who are intended to be liable for any part of it should be made parties to
the letter of intent.
Included and Excluded Assets
If the parties agree that the deal is to be an asset sale, the main assets desired by the
prospective buyer, especially the “jewels in the crown”, should be specifically set out in
the letter of intent as included assets. Those which the buyer wants to reject should be
specifically set out as excluded assets.
However, many letters of intent identify the assets being sold as simply all of the assets
used in the purchased business, and thereby lead to the conveyance to the buyer of many
things which aren’t necessary for carrying on the business. Stale accounts receivable,
unmarketable inventory, obsolete technology, malfunctioning equipment, personal use
vehicles and undesirable leasehold premises are all examples of the kinds of assets which
may be used in the purchased business but are often specifically excluded from the deal.
If the parties decide that the deal should be structured as a share sale instead of an asset
sale, the assets desired by the prospective buyer might first be transferred to a newly
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incorporated company, the shares of which are then made the subject of the share sale.
Alternatively, the assets which the prospective buyer wants to exclude might be
transferred to another company before the shares of the transferring company are to be
sold to the buyer. Either way, those assets to be transferred should be itemized in the
letter of intent, and the proper completion of such transfer made a condition to the closing
of the share sale.
Included and Excluded Liabilities
Just as the assets being included or excluded from the sale should be itemized in the letter
of intent, those liabilities of the purchased business which are to be assumed by the
prospective buyer should also be set out. Any material liabilities which have been
incurred outside of the ordinary course of business, particularly those which represent
long-term commitments, should be identified as being either included or excluded.
Identifying such liabilities early on in the deal process serves to address what mortgages,
security interests, leases and other charges will be “permitted encumbrances” when the
purchase and sale agreement is eventually prepared, or alternatively will have to be
discharged on or before closing. Knowing well in advance what liabilities will have to be
paid off before closing should accelerate arrangements with the financial institutions or
other third parties involved and reduce the need for closing on the basis of an undertaking
by the seller to obtain the required discharges.
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In the letter of intent for an asset sale, it may be desirable to identify whether provision
will be made for the payment of the company’s trade creditors in general immediately
after the sale, or otherwise address how any bulk sales legislation, if applicable, might be
complied with on closing.5 If compliance with such legislation is to be waived and an
indemnity of the seller in favour of the prospective buyer is to be given instead, the letter
of intent should clearly set this out.
Purchase Price, Payment Holdbacks and Security
The amount of the purchase price, whether it is to be paid in one lump sum or in a
number of installments, and whether security for the unpaid installments is to be given,
should be set out in the letter of intent. Furthermore, whether the purchase price is to be
adjusted following a post-closing audit, and whether it is to be calculated upon reference
to post-closing earnings of the purchased business, should also be set out.
The applicable formula to be used in any such adjustment needs to be specified. For
example, the letter of intent may provide that the purchase price is to be adjusted to
reflect the financial position of the company indicated in audited financial statements
prepared as of the closing date. Adjustments are often provided for in the event that the
receivables or inventory, or the net book value, or perhaps the earnings for the latest
period, fall outside of an agreed upon range.
If any part of the purchase price is to be paid to a third party to be held in escrow pending
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determination of certain conditions, such escrow requirements should be identified in the
letter of intent. For example, the letter of intent may provide that funds are to be held by
an escrow agent for a specified time as security for any undisclosed liabilities and
breaches of representations, warranties and covenants, with the cost of such escrow being
shared by the parties equally.
Representations and Warranties
While many letters of intent simply describe the representations and warranties applying
to the deal as those which are generally used in comparable transactions, mention should
be made of those representations and warranties which either party is particularly
concerned about or feels may be too contentious to defer until the purchase and sale
agreement is being prepared.
If the prospective buyer is likely to want the seller to make certain representations and
warranties which the seller will not be in a position to give on closing, the limitations or
qualifications which the seller will need in order to make such representations and
warranties should be described in the letter of intent.
For example, if the business being purchased consists almost entirely of intellectual
property, the representations and warranties regarding intellectual property ownership
and non-infringement might be settled at the time the letter of intent is being prepared
and made a schedule to it. Also, if the seller knows at that time that certain
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representations and warranties will have to be restricted to the actual knowledge of
certain people, or made subject to materiality thresholds, those people or thresholds
should be specified.
Indemnities and Survival Periods
Since the remedy for a false representation is ordinarily provided by way of a claim under
the indemnity sections of the purchase and sale agreement, the basic scope of such
indemnities and any general limitations of liability should be addressed in the letter of
intent.
The length of time after closing or “survival period” during which an indemnity claim
can be made for a misrepresentation, and whether the liability under the indemnities is
unlimited or is to be capped at a specified dollar amount, should be clearly described in
the letter of intent. It may also be desirable to even set out any minimums or deductible
levels for an indemnity claim.
Joint and Several Liability and Guarantors
If liability under the non-binding provisions of the letter of intent is intended to be jointly
instead of just separately or “severally” imposed upon any parties when incorporated in
the purchase and sale agreement, the letter of intent should state so.
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Furthermore, if one of the parties expects a third party to guarantee the performance of
the other party’s obligations under the transaction, the letter of intent should clearly refer
to the guarantee and, as mentioned above, provide for signature by the guarantor.
Employees
While employee issues aren’t ordinarily mentioned in a letter of intent for the purchase
and sale of shares, except perhaps for certain employment or consulting contracts which
may be conditions of closing, a letter of intent for the sale of assets should describe how
the employees of the business are to be treated in light of the sale, given that the
prospective buyer may have various liabilities as a successor employer under applicable
employment legislation.6
If it is foreseeable that any employees are to be terminated, the letter of intent should
address the extent to which each party is to be responsible for compensating the
employees terminated. The obligations of the business for employee compensation are
usually coupled with an indemnity from the seller in favour of the prospective buyer, and
can be subject to a survival period and monetary cap in the same way as other
indemnities referenced in the letter of intent.
Often a letter of intent for an asset sale simply provides that the seller shall terminate all
of the employees, and that the seller shall be responsible for all severance costs
associated with those employees who are not re-hired by the buyer upon closing.
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Non-Competition and Non-Solicitation Covenants
The prospective buyer is likely to insist that the seller covenant not to compete with the
buyer, or not to solicit the employees and customers of the purchased business, after the
deal closes. If the seller intends to retire, providing such covenants should not pose a
problem. However, problems will arise if the seller intends to retain a related business or
is reasonably expected to establish a new business similar to the purchased business.
Since such covenants are usually more contentious than other matters which are
discussed between the parties during the preparation of the purchase and sale agreement,
the letter of intent should at least describe how long such covenants should remain with
the seller and in which geographical areas they should apply.
These covenants are in contrast to the covenant of the prospective buyer not to solicit the
employees and customers of the business which ordinarily appears in the letter of intent
as a binding provision, as discussed below.
Conditions of Closing
Because the numerous conditions for closing the sale of a business are set out in
considerable detail in the purchase and sale agreement, they are usually glossed over in
the letter of intent unless they are expected to be quite difficult and time consuming to
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satisfy, or are of such specific importance to one of the parties who wouldn’t consider
doing the deal unless such conditions are first satisfied.
These stated conditions often relate, as with the identification of the included assets, to
the “jewels in the crown” of the purchased business. They might cover the re-issuance of
an essential government permit, or the receipt of a favourable environmental report, or
the extension of the term of a crucial customer contract. Or they might just require the
execution of employment contracts with certain key executives currently employed in the
business, or require the consent of a landlord to waive the “non-assignment” or “change
of control” prohibitions found in a premises lease which is for a particularly valuable
location at below market rental. Such essential conditions, therefore, should be included
in the letter of intent.
The Binding Provisions
In the binding part of the letter of intent, the parties acknowledge that they are legally
bound by these provisions even though they intend to proceed to negotiate and execute a
definitive purchase and sale agreement which may expand upon many of these provisions
and which will generally replace them. The words used in these provisions, such as
“shall” and “agree”, suggest binding obligations. This part should clearly indicate if
liability is being imposed jointly and not just severally on any of the parties.
Confidentiality and Non-Disclosure
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In addition to any confidentiality agreement which the parties signed at the outset of the
deal, the duty of confidentiality which each party owes to the other should be reinforced
by affirming in the letter of intent the continuing application of that agreement to the
deal, or setting out any exceptions to that agreement which may have become necessary.
The letter of intent should also provide that the confidentiality agreement and the duties
prescribed under it are to survive the failure of the deal to close. Reiterating these duties
of non-disclosure and confidentiality also serves to reinforce the duty of exclusivity,
discussed below, which is likely to be imposed by the prospective buyer upon the seller
who might otherwise be tempted to “shop” the letter of intent around in the hope of a
better offer from other possible buyers.
There will often be a “private and confidential” notice on the top of the first page of the
letter of intent to reinforce its confidential nature. Furthermore, the letter of intent may
provide that if any disclosure to a third party with respect to the deal is felt desirable or
necessary, the parties should agree to cooperate with each other in the preparation of the
announcement or disclosure to be made.
Access for Inspection and Phased Disclosure
To facilitate the prospective buyer’s due diligence investigations, the letter of intent may
give the buyer access to the seller’s place or places of business during regular business
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hours upon written notice to look at the seller’s books and records, and interview certain
employees, relating to the business.
Alternatively, in an effort to reduce disruption to the ongoing operations of the business
and maintain confidentiality, the letter of intent may specifically provide for the
establishment of a “data room”, possibly located away from the seller’s place of business,
which contains copies of all of the relevant minute books, accounting and tax records,
contracts, and other materials. The prospective buyer’s access may be restricted to that
room only. Electronic copies of the materials may be accessible instead through a secure
server on the Internet and not at any physical location.
The extent and timing of permitted access and due diligence disclosure often depend
upon the amount of trust and comfort the parties share with each other. If they are direct
competitors in the same market, the seller may insist that the letter of intent provide for
access to and disclosure of sensitive financial and customer information only upon the
signing of the purchase and sale agreement. The parties may use the letter of intent to set
out a phased disclosure schedule, itemizing when particular categories of documents will
be made available for inspection, or when certain customers, suppliers or employees may
be interviewed.
If it is expected that signing of the purchase and sale agreement and closing will occur at
the same time, such access and disclosure may not be given by the seller until a relatively
short time before the expected closing date.
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Expenses, Deposits and Break Fees
The process for buying and selling a business generally involves considerable time and
professional fees being spent by the parties during the due diligence and document
preparation stages without any assurance that the deal will actually close. Most letters of
intent state that the parties will be responsible for their own fees and expenses. Yet both
parties incur not only out-of-pocket expenses but, more significantly, an “opportunity
cost” of pursuing the deal instead of using their resources to pursue alternative business
opportunities which could prove to be even more financially beneficial.
This notion of opportunity cost may be particularly relevant to the seller who is an
individual. Depending upon his own finances, health and personal goals, he may feel he
is under considerable pressure to select a buyer and complete the sale of the business
within a relatively short time frame. Facing the possibility of a protracted deal failing to
close and then having to start all over again with all of the attendant additional expenses
may strongly influence his desire for some cost protection.
But both parties will be making a considerable investment in attempting to close the deal,
and will therefore explore the possibility of recovering their investment from the other
should the other prevent the deal from closing. The letter of intent will often set out one
or more of a number of possible mechanisms to enable a party to recover its investment
from the other. Which party receives such a right of recovery in the letter of intent often
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depends on the bargaining power of the parties and how anxious each party is to close.
For example, the seller may insist that the prospective buyer advance a fixed amount on
signing of the letter of intent which is to be held by the seller or seller’s lawyer as a
deposit and applied on closing to the purchase price owing, or be forfeited by the buyer
should the buyer fail to close.
Alternatively, the prospective buyer may be required to pay the seller’s professional fees
and other expenses incurred in respect of the deal, up to a prescribed amount, in the event
the buyer fails to close. Or, the seller may be required to pay the prospective buyer’s fees
and expenses, again up to a stated maximum amount, should the seller fail to close. These
obligations of one party to pay the fees and expenses incurred by the other are sometimes
called “break fees”, although the party entitled to be reimbursed runs the risk of being
unable to collect from the other.
In addition to addressing the fees and expenses directly incurred by one party for its own
benefit, there are often fees and expenses incurred by one party for the benefit of the
other party, or for the benefit of both parties, such as the cost of environmental audits,
property surveys, mechanical inspection reports, or government approvals to the deal.
Such costs should be identified and allocated amongst the parties in the letter of intent.
Consulting Agreements
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Many of the agreements with third parties which the seller or prospective buyer may
enter into as part of the due diligence process create more than just cost issues which
should be addressed in the letter of intent. These agreements, sometimes referred to as
consulting agreements, involve the retention by either the seller or buyer of certain
consultants to conduct various studies and carry on certain analyses for due diligence and
business valuation purposes. They might involve environmental reports, technology
audits, insurance adequacy reports, mechanical fitness inspection reports, property
surveys, furniture and equipment valuations, and so on.
The letter of intent should address not only who pays for these reports and related
services as suggested above, and whether the payment by one party or the other should be
contingent on the closing of the deal, but also who owns the work product created by the
consultant, or who has the copyright in the delivered report, should the deal close or fail
to close.
If completion of the deal is to be conditional upon delivery of satisfactory reports, the
letter of intent should try to define what is meant by satisfactory, who decides and how
much discretion can be exercised. If satisfactory is to mean that no additional cost is to be
incurred in order to achieve a recommended standard, it’s preferable to state this in the
letter of intent.
Conduct of the Business up to Closing
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Depending upon the amount of time expected to elapse between the signing of the letter
of intent and the signing of the purchase and sale agreement, the letter of intent may
generally require that the seller operate the business in this interim period in the same
manner in which it has operated the business before, but may leave it to the purchase and
sale agreement to more comprehensively set out the specific rules for running the
business up to closing.
However, if the purchase and sale agreement is likely to be signed at the closing along
with all of the other definitive agreements, a practice which occurs more frequently than
not, the letter of intent may provide more specific guidance to the seller for the pre-
closing period. A list of “major decisions” requiring the prior consent of the prospective
buyer, such as material capital expenditures, long term contracts, the hiring or firing of
key officers, a significant raising of compensation levels, the declaration of dividends, or
borrowing for more than ordinary operations, might be agreed upon and either set out in
the letter of intent or attached as a schedule to it.
Non-Solicitation of Employees and Customers
In an effort to deter the prospective buyer from using the access afforded during the due
diligence period to become familiar with the employees and customers of the purchased
business and then subsequently entice them away should the deal fail to proceed, the
seller should insist that the letter of intent prohibit the buyer from soliciting those
employees and customers.
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This non-solicitation provision usually survives the termination of the letter of intent
unless it is replaced by a similar provision in the purchase and sale agreement.
Sometimes this provision is made reciprocal, thereby preventing a seller from soliciting
any of the buyer’s employees who may be involved in carrying out some of the due
diligence.
Exclusive Dealing
Often called a “lock-up” or “no-shop” provision, a duty is usually imposed in a letter of
intent upon a seller to refrain from talking to any other parties about possibly investing in
the seller or buying a significant portion of the seller’s assets for a certain period of time
after the letter of intent has been signed. This is designed to protect the “opportunity cost”
mentioned above of both parties and to motivate them to focus their time and resources
on closing the deal. The length of time covered by the exclusivity provision can be hotly
debated, but is intended to reflect the amount of time which the parties anticipate is
reasonably required in order for the deal to be completed.
However, in its attempts to get the highest possible purchase price, the seller may want to
encourage other parties to submit offers and effectively create an auction. The seller
might be able to avoid giving outright exclusivity to the prospective buyer by substituting
in the letter of intent a “go-shop” provision with a right of first refusal in favour of the
buyer. The seller would then be permitted to solicit other offers, yet the buyer would have
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the right to buy the business on the same or better terms which may be offered to the
seller by a third party.
Negotiation in Good Faith
Given that the seller and the prospective buyer may not be under an implied duty to
negotiate with each other in good faith7, the letter of intent should state that they will
exercise good faith during the preparation of the purchase and sale agreement.8 However,
the buyer is likely to insist that this duty should terminate in the event that the buyer
comes to the conclusion that the due diligence results are unsatisfactory and thereby
wishes to terminate the letter of intent, as discussed below.
Termination and Survival
The binding provisions of a letter of intent may usually be terminated if the due diligence
investigations prove to be unsatisfactory to the buyer, or if the purchase and sale
agreement is not executed by the parties by a certain deadline. Some letters of intent also
provide for termination if a crucial report or necessary third party consent, or up-to-date
financial statements, are not obtained by a prescribed date. These termination dates are
often called “drop-dead” dates.
A letter of intent usually provides that termination will not relieve any party from liability
for breach of any of the binding provisions prior to termination, and usually provides that
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at least some of the binding provisions survive termination and continue to be
enforceable. The non-disclosure and confidentiality provisions, along with the non-
solicitation and expense provisions, are generally stated to survive the termination, but
are usually superseded by comparable provisions in the purchase and sale agreement once
that agreement is signed.
However, the exclusive dealing and negotiation in good faith provisions are ordinarily
applicable for only a specified period of time and do not survive termination.
Governing Law
Far from being an innocuous “boilerplate” provision, the law chosen to govern a
transaction can have substantial cost significance to the party whose own local law is not
chosen, and therefore should be addressed early on in the discussions and inserted as a
principal term in the letter of intent.
Although the law chosen is often the law of the place where the business is primarily
conducted, a buyer located in a different jurisdiction may want to use for the deal the
documents (and the law firm) it has used in previous deals in its own home jurisdiction
and with which it is already quite comfortable.
Should the seller accede to a prospective buyer’s request to have the law of the buyer’s
jurisdiction, if different, designated as the governing law, the parties will then have to
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customize the buyer’s forms to reflect the specific laws applicable to the various assets of
the purchased business. More significantly, the seller will then be faced with the cost of
retaining counsel in the buyer’s jurisdiction to assist with document reviews and
rendering of a legal opinion regarding the enforceability of the documents under the laws
of that jurisdiction.
________________________________________________________________________
© 2017 A. Paul Mahaffy. All rights reserved. A. Paul Mahaffy practises business law
with Bennett Best Burn LLP of Toronto, with particular emphasis on purchase and sale
transactions, business succession, private company governance, technology transfers,
joint ventures and financing. He can be reached by e-mail at [email protected], and
his recent publications can be viewed online at http://paulmahaffy.com.
1 Section 68 of the Income Tax Act R.S.C. 1985, c.1 (5th Supp.) (the “ITA”) allows the buyer and seller to
elect what amount of the overall purchase price is to be allocated to specific classes of the assets being
purchased. In an effort to minimize their respective tax liabilities resulting from the deal, the buyer and
seller will attempt to allocate the purchase price amongst the various asset categories, while recognizing
that a high value allocated to a particular category may be advantageous to one party and disadvantageous
to the other. While the seller may be concerned about the tax implications of such values for the year of the
sale, the buyer may be more concerned about the tax implications for those years following the sale and the
extent of various deductions then available. For example, a high value allocated to depreciable property
may provide the buyer with greater deductions for capital cost allowance in subsequent years, but may
trigger a recapture of capital cost allowance for the seller in the year of the sale. The buyer may prefer to
allocate high values to inventory, whereas the seller may prefer to allocate high values to non-depreciable
capital property. Although the Canada Revenue Agency may be entitled to reallocate the purchase price
among all of the purchased assets pursuant to section 68 if it deems the allocations made by the parties to
be unreasonable, the allocations negotiated between arm’s length parties are generally upheld. A special
election is available to the buyer and seller under section 22 of the ITA regarding accounts receivable. They
may jointly elect what value is to be allocated to the seller’s accounts receivable in order to reduce the
amount of tax which might otherwise be paid by the seller if the face amount of the receivables was taken
into the seller’s income. A purchase price allocation to receivables which is for less than their face value
creates a loss for the seller which can be deducted from the seller’s income, but which is included in the
buyer’s income. 2 Subsection 110.6(2.1) of the ITA. The lifetime capital gains exemption is available only to individuals
resident in Canada, and shelters from tax a maximum of $835,716 for 2017 (and thereafter indexed to
inflation) in capital gains arising from the disposition of the shares of a qualified small business
corporation, or QSBC. It is not available to the company upon the sale of any of the company’s assets, nor
is it available upon the redemption by the company of the company’s shares. If the seller has already used
his $100,000 ordinary capital gains exemption (before it was eliminated in 1994), he will only have a
$735,716 capital gains exemption available. His maximum entitlement in any one year can also be limited
if he has a cumulative net investment loss balance or has previously deducted allowable business
investment losses. 3 Subsections 13(1) and 39(1) of the ITA. 4 Subsection 111(1) of the ITA.
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5 For example, subsection 4 (1) of the Ontario Bulk Sales Act (Ontario), R.S.O. 1990, c. B.14., requires a
seller in a bulk sale to provide the buyer with a sworn statement listing the amount of the seller’s debts to
each of the seller’s secured and unsecured creditors. Upon delivery of the sworn statement, the buyer may
then elect under subsection 8 (1) to pay the sale proceeds to the seller if the seller has also sworn that all of
the creditors have been paid in full or if the seller has made provision for payment of all of the creditors
immediately after the closing except for those creditors waiving their rights to immediate payment. 6 For example, subsection 9(1) of the Ontario Employment Standards Act, 2000, S.O. 2000, c.41 and
subsection 69(2) of the Ontario Labour Relations Act, 1995, S.O.1995, c. 1, Sched. A, impose certain
obligations of the seller towards employees upon the purchaser of a business as a successor employer. 7 See, for example, SCM Insurance Services Inc. v. Medisys Corporate Health LP, 2014 ONSC 2632, Oz
Optics Limited v. Timbercon, Inc., 2010 ONSC 310, Peel Condominium Corp. No. 505 v. Cam-Valley
Homes Ltd., (2001) 53 O.R. (3d) (C.A.), and Martel Building Ltd. v. Canada, [2000] 2 S.C.R. 860. 8 See Bhasin v. Hrynew, 2014 SCC 71, for the law governing the duty of good faith in contract
performance.
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