Overview
Canada’s mergers and acquisitions market is one of the
world’s most active and sophisticated, particularly in the
mining, oil and gas, industrial products and real estate
sectors. In choosing a Canadian law firm for a succession
plan, clients look for not only legal expertise but also
industry knowledge. The Mergers & Acquisitions (M&A)
Group at Fraser Milner Casgrain LLP (FMC) is one of
Canada’s most experienced in the gold, metals and
minerals, oil and gas, power, technology and real estate
industries.
Virtually every succession transaction involves
negotiating tax aspects of the deal. The way tax laws are
applied can sometimes be a deal‐breaker, whether in
complex mergers, management buy outs, or a sale to the
next generation. The tax lawyers at Fraser Milner
Casgrain LLP (FMC) creatively resolve tax issues, turning
them from deal‐breakers to deal‐makers. We work
closely with our colleagues in other practice areas,
providing expert tax advice in all corporate and
commercial transactions. Our expertise covers all sectors,
from entertainment and international transactions, to
real estate, mining and natural resources.
To learn more about FMC, please visit www.fmc‐law.com
Types of Succession Planning
There are a number of options open to plan for the
succession of a business. The controlling shareholder
may be bought out over time – this can involve the
controlling shareholder’s replacement by either a single
replacement shareholder or a broader ownership group
if no single replacement option exists. Another common
route is the sale of the entire business (whether by sale
of shares or assets) to a competitor or a complementary
business. A similar alternative is to merge with a
competitor or complementary business. Finally,
depending on its size, taking a company public (by way of
initial public offering or reverse takeover) can be an
attractive option, though it does involve giving up the
advantages of being a privately held company.
Letters of Intent
A Letter of Intent (“LOI”) serves to set out the ground
rules of conduct between parties to a proposed
transaction involving the purchase and sale of a business.
This includes identifying factors which may later figure
into the purchase (third party consents, board of director
or shareholder approval, Competition Act or foreign
investment approvals or notifications,) and the timelines
each party must follow in moving towards closing, such
as the purchaser completing due diligence by a certain
date or the vendor obtaining third party approvals by a
certain date. In order to be effective, a LOI requires a
minimum level of certainty with respect to fundamental
business terms: parties, type/structure of the
transaction, price (or the process through which the price
will be determined), and the property which is subject to
the transaction (i.e. shares or assets).
LOIs fall into two categories: binding and non‐binding.
While non‐binding LOIs are true to their name in the
broad sense, they often contain confidentiality, non‐
disclosure, and/or standstill provisions which are
intended to be binding on the parties either during an
exclusivity period or even if the transaction does not
close. Moreover, parties to non‐binding LOIs should be
wary, as recent court cases in Canada have held that
even LOIs which the parties believed to be non‐binding
can give rise to legally enforceable obligations. Some
common occurrences of this include:
If there is a future dispute over the interpretation of
the final executed binding purchase agreement which
is related to the LOI, the LOI may be used to
determine the common intention of the parties
If the parties’ intention was to be bound and the LOI contains all essential terms required for the particular
transaction
If an LOI contains language akin to a formal agreement – for example “agreed upon” or “acceptance”
It is settled law that an agreement to agree is not enforceable. However, a common interpretation of an LOI is that
the parties are bound temporarily by the preliminary agreement which is to be replaced by the more detailed
formal purchase agreement. The standard imposed by Alberta courts is that any LOI which “merely records a
future intent to enter into a contract” will not create a legally binding relationship. It is this standard that a party to
a non‐binding LOI must keep in mind.
Purchase Price Adjustments
The purchase price in the transaction is typically negotiated at the LOI stage, but this price – usually based on
financial statements provided during the period of negotiations is only a “historical snapshot” of the business at
that point in time. However, the value of the business at the time of the closing of the transaction may have
changed. As a result, the payment of the entire purchase price on the closing of the transaction may not suit the
business needs of the parties and adjustments to the purchase price may need to be made.
One mechanism used to adjust the purchase price is a working capital adjustment. Typically, a working capital
target (or a range) is agreed to by the parties and after the actual working capital is calculated as at closing date
(done by taking the company’s current assets less its current liabilities), the purchase price is either increased or
decreased (dollar for dollar) according to the difference between the target working capital and the actual working
capital as at the closing date. As it takes time to determine the actual working capital, this adjustment is typically
done 90 to 120 days (or longer) after the closing date.
Alternatively, the purchase price may be dependent on the future earnings of the business over a period of time.
As these earnings will not be known at the time of closing, a portion of the purchase price is then structured as an
“earn out”. This can be done in a number of ways:
Future earnings compared to earnings at the same time in the previous fiscal year (i.e. month over month),
with a percentage of any positive difference between previous earnings and current earnings paid to the
vendor
A target earnings figure for a specified time period is established in the purchase agreement and the purchaser
then pays a percentage (or the entire amount) of the earnings which exceed the target (this could also be
structured as different earnings targets for multiple years after closing)
The vendor is to receive a specified percentage of gross or net earnings, or gross margins, for a specified period
of time after closing
Though this method may be attractive to vendors who are confident in their business, purchasers can be hesitant
to employ this transaction structure. For example, an earnings target may be met when it otherwise would not be
as a result of extraordinary situations such as sales of assets out of the ordinary course of business or non‐arm’s
length transactions. It may also be the case that the purchaser attracts many new customers to the business after
previous customers of the vendor have left. These factors, especially the former, may need to be specifically
contemplated in the purchase agreement.
Vendor’s Representations and Warranties
Representations and warranties are a fundamental part of every purchase agreement and are typically heavily
negotiated. Representations are statements of fact speaking to the past or present and warranties are guarantees
that a fact is or will be true in the future. The purchaser will of course want the vendor’s representations and
warranties as broad as possible while the vendor will seek to narrow them.
There are three common types of exceptions vendors use to reduce the scope of their representations and
warranties. The first of these is the “knowledge qualifier” whereby a vendor will try to limit its representations and
warranties to things falling within the “actual knowledge” of certain named individual vendors (the majority
shareholders or management shareholders for example). In these cases the purchaser will almost always want
“knowledge” to require the vendor to have made a reasonable inquiry into the matter or knowledge to include
what a reasonable person, using reasonable care or diligence, should have known. This is termed “constructive
knowledge”. For the sake of certainty, if the phrase “to the knowledge of the vendor” is included in the purchase
agreement to qualify any of the vendor’s representations, the agreement should also include an interpretation
section concerning the meaning of the phrase.
A second common qualifier is the “materiality” exception. Adding a level of materiality to representations will
protect a vendor in that “immaterial breaches” of those representations will not result in a breach of the purchase
agreement and open up the vendor to liability. If the word “material” is left undefined in the purchase agreement
it will be left to the parties to argue at a later date on a subjective level. However, in relation to the vendor’s
disclosure regarding its agreements, commitments and expenditures, the word “material” is often defined based
on a certain minimum aggregate dollar value, either on an annual basis or as a percentage of the purchase price.
This allows for an objective, bright line test.
A third manner of qualifying a vendor’s representations and warranties is for specific exceptions to disclosure
(usually based on the results of due diligence by both parties) to be listed and described in schedules to the
purchase agreement (i.e. “Except as disclosed in the Vendor’s Disclosure Schedules, there has been no….”).
Indemnification Clauses
Indemnification clauses are included in purchase agreements to protect the purchaser from a breach of a
representation or warranty of the vendor and specifically contemplate the vendor’s indemnification of the
purchaser in these circumstances. Indemnification clauses are typically drafted to include both the direct losses
that the purchaser may suffer as a result of a breach of representation and warranty and the losses the purchaser
may suffer if a third party brings an action relating to a breach of a vendor’s representation or warranty.
Limitations on the Vendor’s Indemnification Obligations
Survival Period of Indemnities
The purchase agreement should include a survival clause expressly setting out the time period for which the
vendor’s representations and warranties will last. After the expiry of that period (and provided there has been no
breach of the vendor’s representation and warranty prior to that expiry date), the purchaser will no longer be
entitled to seek indemnity from the vendor for a breach of a representation and warranty that occurs after that
expiry date. Many general representations and warranties cannot be certified until post‐closing such that a
purchaser will generally not accept a survival period of less than one year after closing. Typical survival periods
range from 1 to 3 years after closing.
Indemnification Baskets
An indemnification basket is the minimum loss/damage (expressed in dollars) that must be suffered by a purchaser
for a breach of a vendor’s representations and warranties (or the vendor’s breach of other covenants or provisions
of the purchase agreement) before the purchaser can recover damages from the vendor pursuant to the
indemnification provisions in the purchase agreement. Vendors typically negotiate for baskets with a high value,
while purchasers seek baskets with a low one (or no basket at all).
Generally, there are two types of indemnification baskets: (1) deductible baskets and (2) dollar‐one baskets. Under
a deductible basket provision, the vendor is only responsible for damages exceeding the basket amount. For
example, if there was a deductible basket of $1,000 and a claim by the purchaser of $1,500, the vendor would only
be responsible to pay the purchaser $500. Under a dollar‐one basket provision (also referred to as a ‘first dollar
basket’), the vendor is responsible for all damages suffered by the purchaser once the purchaser’s damages reach
the threshold. For example, if there was a dollar‐one basket of $1,000 and a claim by the purchaser of $1,500, the
vendor would be responsible to pay the purchaser the full $1,500 once the $1,500 threshold was reached.
It is also possible to have a combination basket. In such a case, there is one figure for the minimum loss suffered
and another for the threshold above which the vendor is responsible for indemnification. For example a
combination basket could have figures of $10,000 and $5,000, where the vendor would not be required to
indemnify the purchaser for losses until the minimum threshold of $10,000 was reached, and even at that point,
would only be responsible for losses in excess of $5,000.
Indemnification Caps
An indemnification cap sets out the maximum total amount of damages a purchaser is able to recover from the
vendor under the indemnification provisions in the purchase agreement. The purchaser will negotiate for as large a
cap as possible (either unlimited (being no cap) or a cap up to the entire purchase price), while a vendor will want
to limit the value of the cap as much as possible. Indemnification caps can either be expressed as a specific dollar
amount or as a percentage of the purchase price.
Escrow
Escrow is often used as a form of collateral or security for the vendor’s potential indemnification obligations to the
purchaser. The escrow funds (or holdback funds), typically being an agreed upon portion of the purchase price, are
withheld from being paid to the vendor on closing and are deposited by the purchaser with an escrow agent (often
the purchaser’s solicitors) into an interest bearing trust account at closing for a certain period of time (being the
escrow period)‐ often an equivalent time as the survival period of the vendor’s representations and warranties.
These escrow funds then serve to provide a form of protection to the purchaser for future indemnification claims,
as the amount of its claims are then deducted from the escrow funds prior to any release of the escrow funds on
the specified release date or dates.
Contact Information
Edmonton Office
2900 Manulife Place
10180 101 Street
Edmonton, AB T5J 3V5
780‐423‐7100
Calgary Office
15th Floor Bankers Court
850‐2nd Street SW
Calgary, AB T2P 0R8
403‐268‐7000
Top Related