Jonathan Lin - Fundamentals of mergers and acquisitions
Whether driven by succession planning, the cost of capital, company valuations or otherwise, Canadian private mergers and acquisitions (i.e., M&A) activity has been robust over the last few years. As we expect this trend to continue, this article provides buyers and sellers with an overview of the key provisions typically found in private M&A purchase agreements in Canada.

Most private M&A purchase agreements include the following key terms. Each term will be discussed below.

  1. Deal Structure
  2. Representations and Warranties
  3. Pre-Closing Covenants
  4. Closing Conditions
  5. Indemnification
  6. Termination Rights
  7. Post-Closing Covenants

Deal Structure
All purchase agreements will describe the structure of the acquisition. Specifically, purchase agreements will describe: (1) what is being purchased (i.e., shares or assets), (2) the purchase price and the form of consideration being paid (for example, the purchase price may be paid using one or a combination of the following: cash, shares, assets, earn-outs and other contingent consideration, the assumption of debt and/or other liabilities, etc.), (3) whether the purchase price is adjustable (for example, adjustments may be made at or after closing, and may relate to the company’s debt levels, working capital and/or cash) and (4) when the purchase price is to be paid (for example, all or part of the purchase price may be sent into escrow, held back by the buyer, paid at some point in the future or paid at closing, etc.).

Representations and Warranties
Most purchase agreements will include representations and warranties of the target company and the parties signing the agreement.

Representations and warranties are statements of fact and assurances made by the buyer, the seller and often times the company, that help the parties determine the quality, nature and risks of what is being acquired. They will (1) provide the parties with additional disclosure / information about the buyer, the seller and the target (for example, they may include statements that describe the ownership of the assets and/or title to shares of the target, the accuracy of the target’s financial statements, the existence of any litigation and the authority of the buyer and seller to enter into the purchase agreement), (2) allocate risk among the parties by requiring that certain representations and warranties are made, (3) sometimes serve as a closing condition (i.e., as further discussed below, the parties may agree that the sale will occur only if certain representations and warranties are true as at a particular time) and (4) establish a basis for post-closing indemnification claims (i.e., as further discussed below, if any of the representations and warranties given by a party are incorrect, then the other party may have a claim for damages after the acquisition is complete).

Pre-Closing Covenants
Acquisitions close either when the purchase agreement is signed or at some point after the purchase agreement is signed. If closing occurs after the M&A agreement is signed, then the purchase agreement may require that the parties promise (i.e., covenant) to perform or provide certain acts or items during the interim period between signing of the agreement and the closing. Some common interim period / pre-closing covenants follow: (1) the seller must operate the business in the ordinary course during the interim period, (2) all third-party consents, waivers and approvals are obtained, (3) all regulatory filings are made and (4) the seller is prohibited from soliciting, offering or negotiating alternative deals for the target with any potential third-party buyers.

Closing Conditions
Purchase agreements will commonly provide that the acquisition will close only after certain conditions have been satisfied. What constitutes a closing condition is heavily negotiated between the buyer and seller. As conditions to close are deal specific, they will vary depending on the deal. However, it is common for purchase agreements to include some of the following as closing conditions: (1) receipt of certain third party consents or approvals, (2) receipt of shareholder approval, (3) continued accuracy of the representations and warranties, (4) performance / satisfaction of the pre-closing covenants, (5) delivery and execution of certain agreements (such as, for example, non-competition and non-solicitation agreements, employment or consulting agreements, transition services agreements, releases, etc.) and (6) the buyer having obtained the financing required to close the deal.

Most purchase agreements include an indemnity construct, which is another heavily negotiated section of purchase agreements. Indemnity provisions set out and provide a contractual remedy that allows the buyer and seller to agree in advance as to who will bear the liability associated with certain specified risks. For instance, most indemnity provisions provide that if a party breaches any of its representations and warranties, or fails to satisfy / comply with any pre-closing or post-closing covenants, then the other party to the agreement has the right to recover from the breaching party any damages that it sustains as a result of the breach. The indemnity construct may also include deal-specific items (called stand-alone indemnities) (for example, stand-alone indemnities that relate to environmental hazards, litigation matters, tax, etc.), and that provide that one party must indemnify the other if damages are sustained in connection with the deal specific item.

Indemnity provisions usually also include limitations, including limitations as to (1) the length of time that an indemnity will survive post-closing, (2) any damages thresholds that must be reached before indemnity obligations are triggered and (3) any caps on the amount that a party may be required to pay after closing.

Termination Rights
If an acquisition is set to close after a purchase agreement is signed, then purchase agreements may include a section that governs the rights of the parties to terminate the deal before closing. Common termination rights arise in the following contexts: (1) pursuant to the mutual consent of buyer and seller, (2) the failure to close the deal by a date specified in the M&A agreement, (3) the failure to receive shareholder approval, (4) the material breach of a representation and warranty or a covenant, and the failure to cure same within an agreed upon cure period, (5) the failure of the buyer to obtain financing and/or (6) the failure to obtain regulatory approval.

Occasionally, the purchase agreement may require that one party pay another party a specified amount in the event that the agreement is terminated. If the seller is required to make a payment to the buyer, the payment is called a break fee. If the buyer is required to make a payment to the seller, the payment is called a reverse break fee.

Post-Closing Covenants
After the deal closes, the purchase agreement may require that the parties promise (i.e., covenant) to perform or provide certain acts or items after closing. Post-closing covenants are deal-specific, but may include the following: (1) seller non-competition and non-solicitation restrictions, (2) requirements that the buyer and seller cooperate to complete necessary post-closing tax filings and (3) buyer obligations to conduct the business in particular ways (often times included if a seller earn-out forms part of the purchase price).

M&A deals are complex and involve many moving parts, including the negotiation of purchase agreements. It is important for the buyer and the seller to engage a team of experienced M&A advisors in order to ensure overall transaction efficiency and success. Please do not hesitate to reach out to the author to further discuss the contents of this publication and/or any M&A deal activity matters.

Read more about privacy, intellectual property and IT matters that may arise in connection with M&A transactions.

This publication is intended to convey general information about legal issues and developments as of the indicated date. It does not constitute legal advice and must not be treated or relied on as such. Always obtain the advice of a lawyer with respect to decisions and actions that could have legal consequences. Statements in this publication about the law are of a general nature only and in no way pre-determine the positions that we may take with respect to a specific fact situation or particular client matter.

Jonathan Lin is a Partner with the Business Law Group at Harrison Pensa. Jonathan has a diversified corporate and commercial law practice, focusing on mergers and acquisitions, securities, corporate finance, private equity, banking and corporate governance.

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