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 pmahaffy@bbburn.com, 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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