Canadian Lawyer

October 2019

The most widely read magazine for Canadian lawyers

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BANKING ON CORPORATE OPINION 14 www.canadianlawyermag.com Say what is and isn't meant A recent Ontario Superior Court decision is a reminder of how common contractual tools can have very different consequences in litigation THERE ARE, it seems, good reasons for corporate lawyers to read reported cases from time to time. It is not merely because some decisions bring long-forgotten rules of civil procedure back to scintillating life. Nor is it because the extraordinary facts of some cases can help contextualize suspicions that reality television is not representative of real life. And, since paper editions mostly disappeared, it's harder to find ads for mind-blowing super-conferences on new tools for document filing being held at surprisingly inaccessible regional airport conference centres. On top of these solid reasons, some cases will likely remind corporate practitioners of the apparent benefit of seeing how creative litigators treat common provisions. The recent Ontario Superior Court decision in Crescent (1952) Ltd. v. Jones was such a case, demon- strating not just how facts don't necessarily precisely follow the wording of negotiated agreements but how common contractual tools can have very different consequences in litigation depending on their structure and how the very nature of the contractual rela- tionship itself comes into play. The case revolved around the sale of two companies engaged in the transportation insurance broker business. The purchase agreement provided that about three-quar- ters of the consideration was payable at closing, with the balance payable after three years subject to downward adjustment if the companies didn't meet a specified earn- ings target. As structured, the buyer bought and paid for the common shares at closing, and three years later, it acquired and paid for the preferred shares. Consequently, the vendor continued to be as a shareholder during the earn-out period. When the earn- ings target was missed, the vendor argued that the purchaser had essentially sabotaged the purchased companies' ability to achieve the target by constructively dismissing two critical employees. The reported decision doesn't explain why the earn-out was structured as it was, with the vendor hanging on to its preferred shares post-closing, but the impact is obvious. The action itself was framed to include a deriv- ative action against the board for breach of fiduciary duty for having failed to protect the vendor's interests as a shareholder, as well as an oppression action. As noted, a central element of the case is whether two key producers in the business were constructively dismissed. The agree- ment anticipated that possibility and even provided a formula for the adjustment of the earnings target in that event. Notably, given the structural considerations refer- enced, the court held that even if it didn't find that the employees had been constructively dismissed (which it did), it would have found the purchaser's conduct oppressive. The court also dismissed the vendor's creative argu- ment that the damages paid by one of the key employees' new employers should be calcu- lated into the earnings of the business, on the basis that, had the parties intended for that to occur, the agreement would have addressed it. The decision also demonstrates the chal- lenges of dealing with commercial outcomes not contractually anticipated, which can be particularly challenging with earn-outs. Prior to the transaction, the purchaser, a placing broker for insurance, had used the purchased companies to underwrite some insurance arrangements under which both parties earned a commission from the ultimate insurer. When the insurer decided to reduce the total commissions post-transaction, the natural question (please permit me to enjoy my unfettered hindsight) was how to allocate that reduction. The vendor also argued that, because of the earn-out feature, the sale contract was relational, creating a relationship that implied duties of co-operation and good faith. The court dismissed that, noting that relational contracts were those that are longer-term arrangements requiring co-operation such as employment or franchise agreements, not a purchase contract. What also struck me reading the decision was the purchaser's argument that the adjust- ment affected not just the deferred component of the purchase price but the entire purchase price. It was an inventive point that the court dismissed, but it left me thinking that, in drafting, corporate lawyers need to say not just what is meant but what is not meant. "The decision also demonstrates the challenges of dealing with commercial outcomes not contractually anticipated, which can be particularly challenging with earn-outs." Neill May is a partner at Goodmans LLP in Toronto focusing on securities law, with an emphasis on M&A and corporate finance. The opinions expressed in this article are his alone.

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