Mergers and acquisitions are among the most complex transactions in commercial law. They involve months of negotiations, extensive due diligence, layers of interlocking agreements, and significant sums of money. When everything goes according to plan, the deal closes and both sides move on. But when something goes wrong, whether before signing, between signing and closing, or after the transaction is complete, the result is often litigation that is every bit as complex as the deal itself.
M&A litigation in Canada spans virtually every area of contract law: interpretation disputes over ambiguous clauses, claims that no binding agreement was ever formed, allegations that representations and warranties were breached, disagreements about whether a material adverse effect has occurred, disputes over whether closing conditions have been satisfied, and claims for damages when a deal falls apart. Each of these areas has generated significant case law, and the principles that apply are not always intuitive.
This guide explains the most common ways litigation arises from private M&A transactions in Canada, what courts look for when resolving these disputes, and how buyers and sellers can protect themselves through careful drafting and negotiation. Whether you are negotiating an acquisition, defending a claim that a deal has been breached, or evaluating whether to walk away from a transaction, understanding these litigation risks is essential. Our commercial litigation practice and commercial transactions practice advise on all aspects of M&A disputes in Ontario.
Contract Interpretation: The Most Common M&A Dispute
Contract interpretation disputes are the most common type of contract law dispute generally, and M&A is no exception. The Supreme Court of Canada’s decision in Sattva Capital Corp. v. Creston Moly Corp. is the leading authority on how Canadian courts approach contract interpretation. The court held that the interpretation of a contract is an exercise in determining the objective intentions of the parties, assessed in light of the “factual matrix,” meaning the surrounding circumstances known to both parties at the time the agreement was made.
In the M&A context, the factual matrix can be unusually broad. M&A negotiations are often multifaceted and multi-staged, involving preliminary term sheets, letters of intent, multiple rounds of due diligence, and extensive negotiations over specific provisions. Each of these stages may form part of the factual matrix that a court considers when interpreting a disputed clause. This creates a particularly thorny challenge in M&A: distinguishing between admissible evidence of the factual matrix and inadmissible evidence of the parties’ negotiations. In M&A, where the negotiation of the definitive agreement is often preceded by a non-binding term sheet or letter of intent, and where multiple related agreements are negotiated together, the line between factual matrix and negotiating history is often blurred.
The Objective Standard and Business Common Sense
Canadian courts apply an objective third-party standard: what would a reasonable third-party observer interpret the contract to mean? The subjective intentions of the parties are irrelevant. Courts also routinely consider “business common sense” when interpreting and applying contracts, and this principle can play into M&A disputes in many ways. A court may refuse to adopt an interpretation that produces a commercially absurd result, even if the literal language of the clause supports it. Conversely, courts are often unimpressed by what they view as unnecessarily overcomplicated drafting, a common feature of M&A agreements given the input of multiple groups of advisors and specialists (financial, accounting, operational, technical, and legal), the high stakes involved, and the one-off, adversarial nature of many transactions.
The Principle Against Redundancy
A key principle of contract interpretation is that courts strive to give force to each clause and avoid rendering any provision redundant. However, commentators and courts have argued that this principle may be less applicable in M&A, where it is routine for different teams of lawyers to work on different sections of a lengthy agreement and where commercial certainty (or the attempt at commercial certainty) may be valued over economy of expression. The result is that M&A agreements often contain overlapping or partially redundant provisions, and courts must decide how to read them together without artificially creating conflicts.
Sophistication of the Parties
Courts do not formally distinguish between sophisticated and unsophisticated parties in contract interpretation, but in practice the sophistication of the parties often influences the analysis. A sophisticated commercial party represented by experienced counsel will generally be held to the strict literal meaning of the words it agreed to, even if the result is commercially unfavourable. Conversely, M&A agreements made by small business owners or first-time buyers, especially those negotiated without legal counsel, may receive more latitude from the court. This can leave a sophisticated party trapped by the strict application of poorly drafted language, while an unsophisticated party may benefit from a more purposive interpretation.
Multiple Transaction Agreements
M&A transactions often involve the execution of multiple related agreements: a share purchase agreement, a shareholders’ agreement, employment agreements, non-compete agreements, escrow agreements, and transition services agreements. When a dispute arises, the court may need to interpret two or more of these documents together. An “entire agreement” clause in one document will not necessarily prevent the court from considering related transaction documents as part of the factual matrix. This is because collateral transaction agreements may be treated as external context illuminating the meaning of the principal agreement. Different transaction agreements separated in time but related in substance might also be read together, creating the possibility of unintended interactions between provisions that were drafted by different lawyers at different stages of the transaction.
Pre-Execution Liability: When Does a Deal Become Binding?
One of the most fertile areas for M&A litigation involves the question of whether a binding agreement was ever formed. Before a definitive purchase agreement is signed, the parties typically negotiate through preliminary documents: term sheets, letters of intent (LOIs), and memoranda of understanding (MOUs). These documents can be binding, non-binding, or partially binding, and the line between these categories is not always clear.
Was There Intent to Be Bound?
Where the parties dispute whether a preliminary arrangement for the purchase of a business is enforceable, much turns on whether the conduct of the parties objectively indicated an intent to be bound. A party who has acted consistently with a binding agreement, for example by beginning to perform its obligations, permitting due diligence, or communicating the deal to employees and customers, may have difficulty later arguing that no binding agreement existed.
Agreement on Essential Terms
Even where intent to be bound is established, the parties must also have reached agreement on all essential terms. What constitutes an “essential term” in an M&A transaction is fact-specific. Some courts have held that consensus on price, the number of shares, and a closing date is sufficient. Others have required clarity on financing, security, payment schedules, post-closing adjustments, and the retention of key employees. Representations and warranties have generally not been treated as essential terms.
If an important term is left uncertain, the agreement may fail for uncertainty even if the parties clearly intended to be bound. A failure to address the exact structure of the deal, including tax efficiencies, or to resolve key due diligence issues like a critical lease, can be fatal.
Hybrid Term Sheets
Many M&A term sheets are deliberately structured so that some provisions (typically confidentiality, exclusivity, and costs) are binding while the remainder is expressly non-binding. Difficulties arise when the document sends conflicting signals about which provisions were intended to be enforceable, or when clauses of a legal nature are included without the document clearly stating whether they are binding.
Handshakes, Emails, and Voicemails
Canadian courts have upheld M&A transactions concluded by voicemail, by statements made during conference calls, and by email correspondence. The informality of these communications does not prevent a binding agreement from being formed if the essential elements of contract formation are present. However, email threads can create particular problems because of their informal tone, overlapping or disjointed exchanges, and the difficulty of identifying a clear offer and acceptance.
“Subject to Contract” Qualifiers
A common drafting device in M&A is the inclusion of a “subject to definitive agreements” or “subject to contract” qualifier in a term sheet or LOI. In England, such a qualifier will negate intent to contract in all but exceptional cases. Canadian law gives significant weight to these qualifiers but does not treat them as quite so absolute. Rather, it is a “question of construction” whether the execution of the further contract is a condition of the bargain, or merely an expression of the parties’ desire as to the manner in which the transaction already agreed will go through. A qualifier that is ambiguous or inconsistent with the parties’ conduct may not prevent a binding agreement from being found.
Agreements to Negotiate in Good Faith
Canadian law is clear that an “agreement to agree” is unenforceable. But the question of when a duty to negotiate in good faith may exist is more complicated. Canadian courts have recognized several exceptions to the general rule that no duty of good faith exists between arm’s-length parties negotiating a commercial contract.
Where such a duty has been recognized in M&A, the practical consequences vary widely. A seller may not be required to disclose contemporaneous negotiations with other interested buyers. But actions intended to undermine the negotiations rather than advance them, such as reversing course on key terms that were agreed in a letter of intent or deliberately frustrating due diligence, have drawn the ire of the courts. Following the Supreme Court of Canada’s decisions in Bhasin v. Hrynew and C.M. Callow Inc. v. Zollinger, the duty of honest performance in contractual dealings has increasing relevance to M&A, particularly during the interim period between signing and closing.
The execution of binding preliminary agreements, such as confidentiality agreements and exclusivity agreements, can also trigger good faith obligations that put pressure on the parties and their advisors to consider whether their negotiation strategies are consistent with a genuine commitment to the integrity of the negotiation process.
Representations and Warranties: Where Most Post-Closing Disputes Begin
Representations and warranties are the backbone of risk allocation in M&A. The seller represents and warrants that certain facts about the target company are true, such as that its financial statements are accurate, that it is in compliance with applicable laws, that there is no pending litigation, and that its material contracts are in good standing. If a representation turns out to be false, the buyer may have a claim for breach.
Market practice in Canada and the United States is for M&A agreements to refer to both “representations and warranties” in a single broad stroke, without distinguishing between statements intended as a “representation” (a statement of fact that induces the other party to enter the contract) and those intended as a “warranty” (a contractual promise that certain facts are true). Any potential difference between the two is typically negated by the agreement itself, which usually provides that indemnification is the exclusive remedy for breaches. Nonetheless, some courts have confused matters by failing to appreciate this market convention.
No General Duty to Disclose or Verify
Generally, Canadian courts do not impose a duty on M&A counterparties to disclose information to one another beyond what the agreement requires. Similarly, there is no general obligation on a buyer to verify the accuracy of the seller’s representations and warranties through its own due diligence. The buyer is entitled to rely on the seller’s representations as given, even if independent investigation might have revealed the inaccuracy. That said, obligations of disclosure or verification can arise from the specific terms of the agreement or from the parties’ course of conduct, and a buyer that actually discovers a breach before closing faces the separate question of whether it can still bring a post-closing indemnification claim (the “sandbagging” issue discussed below).
Disclosure Schedules
Representations and warranties in M&A are almost always qualified by disclosure schedules, in which the seller identifies specific exceptions to its representations. For example, the seller may represent that there is no pending litigation against the target, except as disclosed in Schedule X, which lists the three lawsuits currently pending. The disclosure schedule functions as the seller’s mechanism for carving out known issues from the scope of its representations. Disputes over disclosure schedules are common and can involve questions about whether a particular item was adequately disclosed, whether the disclosure was sufficiently specific to put the buyer on notice of the issue, and whether the disclosure schedule can be read to expand or limit the scope of the underlying representation.
Financial Statement Representations
The representations regarding the target’s financial statements are among the most important a seller gives. Their substance lives at the intersection of legal and accounting principles, because the representation typically warrants that the financial statements have been prepared in accordance with generally accepted accounting principles (GAAP). Disputes often turn on technical accounting questions that require expert evidence and that can be difficult for courts and lawyers to resolve without specialized accounting knowledge.
Litigation Representations
Representations about the absence of pending or threatened litigation can be drafted in many different ways, with varying levels of qualification and scope. The risks covered by litigation representations can also overlap with representations about compliance with laws and governmental investigations, creating the possibility of inconsistent treatment and uncertain risk allocation. A seller’s failure to disclose a regulatory investigation, for example, may be characterized as a breach of the litigation representation, the compliance representation, or both, with potentially different consequences depending on which representation is at issue.
Contract Representations
Representations about the target’s material contracts are critically important because contracts are among a company’s most valuable assets and a potential source of material liabilities. Disputes under these representations can involve questions about whether a particular arrangement qualifies as a “contract,” whether a dispute exists between the target and a counterparty, and the broader history and context of the target’s commercial relationships. Courts may look beyond the specific contract or language in dispute to consider the full reality of the target’s relationship with the counterparty.
Materiality Qualifiers
Many representations are qualified by materiality thresholds. The standard that Canadian courts apply to determine “materiality” in M&A may surprise some practitioners. Courts frequently apply a “total mix” of information test derived from securities law, which asks whether the information would have been important to the buyer’s decision to purchase. This is a disclosure-based analysis that can involve both objective and subjective inquiries, including an examination of what the buyer knew and did before and after execution. Some courts and commentators have questioned the appropriateness of applying a disclosure-based standard to evaluate contractual compliance, but it remains the prevailing approach.
Knowledge Qualifiers
Many representations are limited to the seller’s “knowledge,” meaning the seller warrants only that the facts are true to the best of its knowledge and not in absolute terms. This raises its own set of litigation issues. Courts have grappled with whether “knowledge” means actual knowledge only, or whether it extends to constructive knowledge (what the seller should have known if it had made reasonable inquiries). The “corporate identification” doctrine, under which a corporation’s knowledge is determined by the knowledge of its directing minds, adds further complexity. Where a seller’s representations are qualified by knowledge, disputes can arise about who within the seller’s organization was required to know (or should have known) the relevant facts, and whether a “wilful blindness” analysis might apply.
Material Adverse Effect (MAE) Clauses
MAE clauses are among the most heavily negotiated and most litigated provisions in M&A. An MAE clause typically defines the circumstances in which a material adverse change in the target’s business, operations, financial condition, or prospects gives the buyer the right to refuse to close the transaction or to terminate the agreement.
What Constitutes an MAE?
The threshold for an MAE is high. Both Canadian and US courts have set a demanding standard, requiring the buyer to demonstrate a significant adverse impact on the target’s overall business and earnings that is durable and not merely temporary. In the US, the Delaware Court of Chancery’s landmark decision in Akorn, Inc. v. Fresenius Kabi AG was the first time a Delaware court found that an MAE had been established, after decades of decisions in which buyers failed to meet the threshold. In the leading Canadian case, Fairstone Financial Holdings Inc. v. Duo Bank of Canada, the Ontario Superior Court applied both qualitative and quantitative considerations to determine whether the buyer had established an MAE. The court drew heavily on Delaware precedent in conducting its analysis, making Fairstone the most comprehensive Canadian decision on MAE clauses to date.
The analysis involves several distinct components: the magnitude of the adverse effect (both quantitatively, in terms of the impact on the target’s revenue, earnings, or financial condition, and qualitatively, in terms of the impact on the target’s business operations, customer relationships, or regulatory standing); whether the effect is the result of systemic risks (such as an economic downturn or a pandemic) or target-specific risks; the timing of the effect (whether it has materialized or is merely anticipated); and the duration of the effect (whether it is temporary or long-lasting).
Durational Significance and the Strategic vs. Financial Buyer Distinction
One of the most important aspects of the MAE analysis is “durational significance”: the requirement that the adverse effect persist long enough to be considered “material” in the context of the transaction. A short-term dip in earnings is generally insufficient. In Fairstone, the court held that an adverse effect of approximately two years’ duration was the relevant benchmark, but it emphasized that this duration was context-specific and reflected the fact that the buyer in that case was a strategic acquirer (a Schedule I Canadian bank) that intended to integrate the target into its broader operations for long-term synergistic benefits.
This raises an open question in both Canadian and US law: should a different durational standard apply when the buyer is a “financial” buyer (such as a private equity fund) with a shorter investment horizon? Courts have noted the potential distinction. A strategic buyer that acquires a business for long-term integration will view a short-term earnings decline differently than a financial buyer that intends to hold the business for three to five years and resell it. Some commentators have argued that the durational requirement should be shorter for financial buyers, reflecting their shorter investment horizons and their reliance on leverage that makes the tolerance for earnings declines much smaller. The Delaware Court of Chancery has acknowledged this debate without definitively resolving it, and the Ontario Superior Court in Fairstone similarly left the door open by emphasizing the importance of context and the identity of the buyer.
Carve-Outs and Carve-Backs
MAE definitions typically include carve-outs for events that will not constitute an MAE even if they would otherwise meet the threshold, such as changes in general economic conditions, changes in the applicable industry, changes in law, natural disasters, pandemics, or the effects of the announcement of the transaction itself. These carve-outs allocate systemic risk to the buyer: if the economy enters a recession or a new regulation affects the entire industry, the buyer cannot invoke the MAE clause unless the effect disproportionately impacts the target compared to its peers.
The carve-outs often have their own carve-backs, which restore the buyer’s right to invoke the MAE if the carved-out event has a “disproportionate” effect on the target compared to other companies in the same industry or sector. The interpretation of “disproportionate” and the identification of the relevant comparator group have generated significant litigation. The question of which companies should be included in the comparator group can be outcome-determinative: a narrowly defined group may show disproportionate impact, while a broadly defined group may not.
The Burden of Proof
The burden of proving that an MAE has occurred rests on the buyer. The buyer’s burden has been described in US case law as “heavy,” though the Fairstone court in Canada characterized the analysis differently, holding that it should be examined “from the perspective of the party for whose benefit” the MAE clause was granted, which the court generally indicated was the buyer’s perspective. The shifting burden works in two stages: the buyer must first establish that a material adverse effect has occurred, and if successful, the burden shifts to the seller to show that the effect falls within one of the carve-outs. If the seller succeeds, the burden shifts back to the buyer to show that the carve-back applies.
Interim Period Covenants: Ordinary Course of Business
Between signing and closing, the seller is typically required to operate the target’s business in the “ordinary course” and not to take any actions outside the ordinary course without the buyer’s consent. These provisions are designed to preserve the value of the business the buyer has agreed to purchase.
Disputes over ordinary course covenants have been among the most prominent M&A disputes in recent years, particularly in the wake of the COVID-19 pandemic, which forced many target companies to take extraordinary measures to respond to unprecedented disruptions. The question of whether actions taken in response to a global pandemic constituted operating in the “ordinary course” or were instead a breach of the covenant generated significant litigation, most notably in the US in AB Stable VIII LLC v. Maps Hotels & Resorts One LLC, where the Delaware Court of Chancery held that the seller’s pandemic-driven operational changes (including furloughing employees and closing hotels) breached the ordinary course covenant, even though those measures may have been commercially prudent or even necessary for the survival of the business.
This decision sent shockwaves through the M&A community because it suggested that “ordinary course” means ordinary course of the specific business as historically conducted, not what a reasonable business operator would do in extraordinary circumstances. The implication is that a target facing a crisis during the interim period may need the buyer’s consent before taking actions that deviate from historical practice, even if those actions are plainly necessary. This has led to significant changes in M&A drafting, with some agreements now including explicit exceptions allowing the target to take actions required by public health orders or necessary to protect the health and safety of employees.
In Canada, ordinary course covenants are typically qualified by standards such as “consistent with past practice,” “in all material respects,” or subject to the buyer’s consent (not to be unreasonably withheld). Each of these qualifiers has its own body of interpretive case law.
The Interaction Between Ordinary Course Covenants and MAE Clauses
An important and unsettled area involves the interaction between the ordinary course covenant and the MAE clause. If a pandemic or other systemic event is carved out of the MAE definition (meaning the buyer cannot invoke the MAE to terminate the deal), but the target’s response to that event breaches the ordinary course covenant, can the buyer refuse to close on the basis of the covenant breach? The Delaware court in AB Stable held that it could, effectively allowing the buyer to use the ordinary course covenant as a back door to achieve the result that the MAE carve-out was designed to prevent. This interpretation has been criticized as undermining the risk allocation the parties agreed to in the MAE clause, but it reflects the court’s view that the two provisions serve distinct functions and must be interpreted independently.
Buyer Consent Provisions
Many ordinary course covenants require the target to obtain the buyer’s consent before taking specified actions (such as entering into material contracts, making capital expenditures above a threshold, or changing employee compensation). A recurring source of dispute is whether the buyer has unreasonably withheld or delayed consent. Courts assess reasonableness from the perspective of a reasonable buyer in the position of the actual buyer, considering the buyer’s legitimate interest in preserving the value of the business it has agreed to purchase.
A particularly difficult situation arises where the buyer withholds consent not because the proposed action would harm the business, but because the buyer is looking for a reason to avoid closing the deal entirely. The duty of good faith, and in particular the duty to exercise contractual discretion in good faith, is directly relevant to these disputes.
Efforts Clauses
M&A agreements routinely require the parties to use their “best efforts,” “reasonable commercial efforts,” or “commercially reasonable efforts” to satisfy closing conditions, obtain regulatory approvals, and secure financing. Canadian courts treat “best efforts” as the most demanding standard, requiring the obligor to do everything it can to fulfil the obligation, stopping short only of actions that would be commercially unreasonable or self-destructive. “Reasonable commercial efforts” and “commercially reasonable efforts” are treated as less demanding, requiring the obligor to take steps that a reasonable business person would take in the circumstances, considering its own commercial interests.
The distinction between these standards can be outcome-determinative. A party that is required to use its “best efforts” to obtain regulatory approval, for example, may be required to offer concessions or divestitures that it would not be required to offer under a “commercially reasonable efforts” standard.
Closing Conditions, Termination, and Walking Away
Most M&A agreements are structured so that the buyer’s obligation to close is conditional on the satisfaction of specified conditions precedent: the accuracy of the seller’s representations and warranties at closing, the seller’s compliance with its interim covenants, the absence of an MAE, and the receipt of required regulatory approvals and third-party consents. If these conditions are not met, the buyer may have the right to refuse to close.
Disputes Over Whether a Condition Has Been Met
Many M&A disputes turn on whether a closing condition was in fact satisfied. The answer often involves close interpretation of the language of the condition, combined with a detailed factual inquiry into the events that occurred between signing and closing. Conditions that involve subjective elements (such as “satisfactory” financing or “satisfactory” due diligence) are particularly vulnerable to disputes because of the difficulty of determining whether the party’s dissatisfaction was genuine or pretextual.
Time Is of the Essence
M&A agreements commonly include “time is of the essence” provisions and “drop-dead dates” after which either party may terminate if closing has not occurred. Courts treat these provisions seriously. If the transaction does not close by the drop-dead date, the right to terminate may be exercised by the party that was otherwise ready, willing, and able to close. A party that was not ready to close cannot invoke the drop-dead date to terminate a deal it was itself unable or unwilling to complete.
Good Faith in Closing
The Supreme Court of Canada’s evolving good faith jurisprudence, including the duty of honest performance (Bhasin v. Hrynew), the duty not to exercise contractual discretion in bad faith (Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District), and the duty not to actively deceive a counterparty about matters relevant to the performance of the contract (C.M. Callow Inc. v. Zollinger), has increasing relevance to M&A closing disputes. A buyer that exercises a termination right for pretextual reasons, or a seller that deliberately frustrates a closing condition to avoid completing a transaction it no longer wants, may face a claim for breach of the duty of good faith.
Damages and Remedies in M&A Disputes
When an M&A deal fails, the innocent party’s remedies include damages, specific performance, and (where the agreement provides for it) the forfeiture or payment of a termination fee or reverse break fee.
Expectation Damages
The standard measure of damages for a failed M&A transaction is expectation damages: the amount needed to put the innocent party in the position it would have been in had the contract been performed. For a seller whose buyer wrongfully refuses to close, this is typically the difference between the agreed purchase price and the value of the business at the time of the breach. For a buyer whose seller wrongfully refuses to close, this is typically the difference between the value of the business and the price the buyer agreed to pay.
Loss of Chance
In some M&A disputes, the court may be unable to determine with certainty whether the transaction would have closed even without the breach. In such cases, the court may award damages based on the loss of a chance, assessed as a percentage reflecting the probability that the deal would have been completed.
Specific Performance
Specific performance, meaning a court order compelling the breaching party to complete the transaction, is available in M&A disputes but is not automatic. The party seeking specific performance must demonstrate that damages would be an inadequate remedy, which is generally easier to establish for the purchase of a unique business than for a transaction involving readily available assets.
Post-Closing Disputes: Indemnification Claims
Most private M&A agreements include an indemnification regime that is the buyer’s exclusive remedy for breaches of representations and warranties discovered after closing. These indemnification provisions are heavily negotiated and can generate significant litigation on their own.
Survival Periods
Representations and warranties in M&A agreements typically “survive” closing for a limited period, commonly 12 to 24 months for general representations and longer (sometimes indefinitely) for fundamental representations such as those relating to title, authority, and tax. If the buyer discovers a breach after the survival period has expired, it loses the right to make an indemnification claim. Disputes frequently arise over whether a claim was brought within the survival period, whether the buyer provided adequate notice, and whether the survival period should be extended or equitably tolled.
Caps, Baskets, and Deductibles
Indemnification obligations are typically subject to a cap (the maximum amount the seller can be required to pay), a basket or deductible (a threshold amount of losses that must be exceeded before the seller’s indemnification obligation is triggered), and various exclusions. The interplay between these provisions is complex and generates its own category of disputes. For example, the parties may disagree about whether a particular loss falls within an excluded category, whether multiple related losses should be aggregated to satisfy the basket, or whether a “tipping basket” (where the seller is responsible for all losses once the basket is exceeded) or a “true deductible” (where the seller is responsible only for losses in excess of the basket) applies.
“Sandbagging” Provisions
A recurring issue in M&A litigation is whether a buyer can bring an indemnification claim for a breach of representation that the buyer knew about before closing. “Pro-sandbagging” clauses expressly preserve the buyer’s right to bring a claim regardless of its pre-closing knowledge. “Anti-sandbagging” clauses extinguish the buyer’s claim if it had knowledge of the breach before closing. Where the agreement is silent on the issue, Canadian law is uncertain, and courts have reached different conclusions depending on the circumstances.
Post-Closing Purchase Price Adjustments
Many M&A agreements include a purchase price adjustment mechanism under which the final purchase price is adjusted based on the target’s working capital, net debt, or other financial metrics as of the closing date. These adjustments are designed to ensure that the buyer pays a price that reflects the actual financial position of the business at the time of closing, rather than the estimated financial position at the time of signing.
Disputes over purchase price adjustments are among the most common forms of post-closing M&A litigation. They typically involve disagreements about the application of accounting principles to specific line items, the treatment of unusual or non-recurring items, the valuation of inventory or receivables, and whether the seller manipulated the target’s working capital in the period leading up to closing. These disputes are often resolved through the contractual dispute resolution mechanism (typically an independent accountant or auditor), but they can escalate to litigation or arbitration when the amounts at stake are large or when the parties allege fraud or bad faith.
Earn-Out Disputes
An earn-out is a purchase price mechanism under which a portion of the consideration is contingent on the target’s post-closing financial performance. Earn-outs are common in M&A transactions where the buyer and seller disagree about the value of the business. They allow the seller to participate in the future upside if the business performs well, while protecting the buyer from overpaying if it does not.
Earn-out disputes are notoriously contentious. The seller, who is no longer in control of the business, often suspects that the buyer is deliberately managing the business in a way that depresses the earn-out metrics. The buyer, who now owns the business, may argue that it is entitled to operate the business as it sees fit, including by making changes that happen to reduce the earn-out payment. Courts examine whether the buyer has a duty to operate the business in a manner that maximizes the earn-out (or at least does not deliberately frustrate it), and the answer depends on the language of the earn-out provision and whether the agreement imposes an express or implied obligation to operate the business in a particular manner during the earn-out period. The Supreme Court of Canada’s good faith jurisprudence, and in particular the duty to exercise contractual discretion in good faith articulated in Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, is directly relevant to earn-out disputes.
Other Sources of M&A Litigation
Non-Compete Disputes
M&A transactions frequently include non-compete and non-solicitation covenants that restrict the seller’s ability to compete with the business it has sold. These covenants are enforceable in Canada only if they are reasonable in scope, duration, and geographic reach. A non-compete that is too broad may be struck down as an unreasonable restraint of trade. Non-competes in the M&A context are generally treated more favourably by courts than non-competes in the employment context, because the seller has received substantial consideration for the restriction and the parties are assumed to have negotiated at arm’s length. Corporate legislation such as the Canada Business Corporations Act and the Ontario Business Corporations Act governs the corporate mechanics of many M&A transactions, including shareholder approvals and director duties, but the enforceability of restrictive covenants is determined by common law principles.
Finder’s Fees and Quantum Meruit Claims
An unexpected source of frequent M&A litigation involves claims for finder’s fees and related claims in quantum meruit. These disputes typically arise when an intermediary facilitated the introduction between buyer and seller, or performed work that contributed to the transaction, but the parties disagree about whether a fee is owed and, if so, in what amount. Where the parties have a written fee agreement, the dispute centres on whether the transaction that closed falls within the scope of that agreement. Where there is no written agreement, the intermediary may bring a quantum meruit claim for the reasonable value of services rendered.
Breach of Confidence
M&A negotiations inevitably involve the exchange of sensitive commercial information. Obligations of confidence can arise even without a formal confidentiality agreement. Where confidential information obtained during M&A negotiations is misused, for example to compete with the target or to gain an unfair advantage in a subsequent transaction, the aggrieved party may have claims for breach of confidence, constructive trust, or damages.
Tortious Interference
Where a binding preliminary agreement exists between a seller and an initial buyer, a subsequent buyer who induces the seller to breach that agreement may face a claim for tortious interference with contractual relations. Courts will examine the subsequent buyer’s awareness of the existing arrangement, the impact of its actions on the seller’s relationship with the initial buyer, and the full range of the subsequent buyer’s motives and intentions.
M&A disputes are among the most complex and highest-stakes matters in commercial litigation. Whether you are a buyer alleging that the seller’s representations were false, a seller defending against a claim that you breached your interim covenants, or a party seeking to enforce or escape a preliminary agreement, the analysis requires a deep understanding of both transactional practice and litigation strategy. Our commercial litigation practice advises on all aspects of M&A disputes in Ontario. Contact Grigoras Law to discuss your situation.
Conclusion
Private M&A transactions are designed to transfer businesses from sellers to buyers in a predictable and orderly way. But the complexity of these transactions, the high stakes involved, and the adversarial nature of the negotiations mean that disputes are common. From the earliest stages of negotiation (where a handshake or email may create an unexpected binding obligation) through the interim period (where ordinary course covenants and MAE clauses can become flashpoints) to closing and beyond (where representations and warranties, indemnification provisions, and non-compete covenants determine the allocation of risk), the potential for litigation is present at every stage.
The best protection against M&A litigation is careful drafting, informed by an understanding of how courts have interpreted the clauses that are standard in Canadian M&A practice. But when disputes arise despite the best drafting, the litigation that follows requires lawyers who understand both the transactional architecture of the deal and the litigation principles that will determine the outcome.
