The document discusses key topics related to letters of intent (LOIs) and mergers and acquisitions agreements.
It outlines the purpose of LOIs, which is to set out the proposed parties' intentions for a commercial transaction and establish guidelines for moving forward. It describes the types of LOIs and key provisions that should be included.
The document also cautions that non-binding LOIs could still become legally enforceable under certain circumstances based on recent court cases.
Finally, it discusses common provisions found in mergers and acquisitions agreements, such as definitions of material adverse change/effect, covenants regarding the interim period between signing and closing, and restrictions on the target company's operations during this time
4. The Purpose of a Letter of Intent (“LOI”)
• Identifies other factors in a transaction that may need to be
factored into the process
– ex. Third party consents required, such as TSX approval, landlord
consent, board of director and/or shareholder approval
• LOI needs enough certainty with respect to the fundamental
business terms in order to be effective: need certainty with
respect to parties, price, property subject to the transaction
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7. Key Provisions of LOI
• Due diligence requirements of the parties and timelines for
completion of due diligence
• Conditions precedent to transaction proceeding, and timelines
to be met:
– ex: Satisfactory legal and financial due diligence, consent and/or
approval of third parties, board of director and/or shareholder
approval, securing financing on acceptable terms, securing
employment of certain key employees
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8. Role of Legal Counsel at LOI Stage
• Best to be engaged sooner rather than later once a business
deal has been agreed to, to assist with documenting intention
of the parties and protecting each parties and protecting each
party’s assets and confidential information through the due
diligence process
• Legal counsel can assist with building in wording to protect the
vendor or the purchaser while moving forward to the next
steps, and build in proper wording that will allow the LOI to
expire and/or be terminated if the conditions precedent are
not met within the timelines set forth in the LOI
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9. Cautionary Note with Respect to Non‐
Binding LOIs
• Be wary as there are recent court cases in Canada which have held that
LOIs (even non‐binding ones) can give rise to legally enforceable obligations
among the parties.
• A survey of the recent case law shows that there are instances where non‐
biding LOIs have been held to be enforceable despite the intention of the
parties to create a non‐binding deal:
– If there is a future dispute over final 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, such as “agreed upon”
or “acceptance”
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10. Cautionary Note with Respect to Non‐
Binding LOIs
• There are sometime estoppel arguments that may be raised
that would dictate some guidelines for conduct
• In Alberta, the courts have regularly held that a LOI will not
create a legally binding relationship if it “merely records a
future intent to enter into a contract”; however, if the terms of
the LOI specifically demonstrate an intention to create a
binding relationship, then the LOI will be held to be a binding
agreement
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14. Material Adverse Change/Material
Adverse Effect
• Most M&A transactions qualify:
– Representations and warranties
– The satisfaction of closing conditions; and
– Compliance with covenants
With the concept of Material Adverse Change and/or Material Adverse Effect
Accordingly, the definition of Material Adverse Change can be a heavily
negotiated point in a transaction
For Example:
– Most M&A Agreements contain a Purchaser’s Condition to Close, which
conditions the Purchaser’s obligation to consummate and effect the
transaction on there not having occurred a Material Adverse Change/Material
Adverse Effect in relation to the Target since the date of the Agreement
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15. Material Adverse Change/ Material
Adverse Effect (Cont’d)
• Definition ‐ Material Adverse Change:
– Means, in respect of a Party, any fact or state of facts, circumstances,
change, effect, occurrence or event which either individually is or in
the aggregate are or would be expected to be, material and adverse to
the business, operations, results of operations, properties, assets, or
condition (financial or otherwise) of such Party and its Subsidiary
(considered as a whole), except:
• Exceptions to the occurrence of a Material Adverse Change in
the business, assets, liabilities and condition of a Target are
the focus of negotiating this Definition
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16. Material Adverse Change/Material Adverse
Effect
• Current formulations of common exceptions that are
found in definitions of Material Adverse
Change/Material Adverse Effect, include:
– Political and Economic Conditions – an exception for any effects
relating to a general political, economic or financial conditions in
Canada/North America or elsewhere, as applicable
– Credit Markets – an exception for any effects relating to the state of
credit or banking generally, including the imposition of limitations of
the extension of credit generally
– Exchange Rates – an exception for any effects arising as a result of
changes to currency exchange rates, interest rates and/or commodity
prices
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17. Material Adverse Change/Material
Adverse Effect (Cont’d)
– Industry Conditions – an exception for any conditions generally
affecting the relevant operating industry as a whole
– Changes in Law – an exception for any effects relating to a change in
law or in the interpretation, applications or non‐application of any law
– War or Terrorism – an exception for any effects relating to national or
international social conditions including hostilities, the declaration of a
national emergency, war or a terrorist attack
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18. Material Adverse Change/Material
Adverse Effect
– Failure to Meet Public Expectations – an exception for any effects
relating to the failure of the Target to meet public estimates or
expectations relating to revenues, earnings or results of operations
– Actions or Inactions – an exception for any effects relating to any
action or inaction taken by the Target with the express consent of the
Purchaser
– Changes in Trading Price – an exception for changes to the trading
price of the listed securities the Target
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19. Material Adverse Change/Material
Adverse Effect (Cont’d)
– Disclosed Matters – an exception for any effects relating to any
matters that had been publicly disclosed by the Target or otherwise
disclosed by the Target to the Purchaser
– Disproportionate Effect – a qualification of the application of the
various exceptions to the extent that the change, effect, event or
occurrence relating to or resulting from any of the enumerated
exceptions has a disproportionate material adverse effect on the
business, assets or operations of the Target
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20. Interim Period / Operations
• Public M&A Agreements typically impose constraints and controls on the
business activities of the Target during the time between the execution of
the definitive agreement and the closing date for the transaction
• The Interim Period is required to obtain securityholder, third party and/or
regulatory approval for the Transaction
• Such provisions provide the Purchaser with assurances that the business,
operations and assets of the Target will continue to be operated and
maintained in the ordinary course
• Essentially that the Purchaser will get what it bargained for
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21. Interim Period / Operations (Cont’d)
• Current formulations of covenants relating to the
Interim Period/Operations of the Target, include:
– Ordinary Course – a covenant on the part of the Target that it will conduct
its business only in the usual and ordinary course of business consistent with
past practice and in compliance with applicable laws
– Fundamental Changes – a covenant on the part of the Target not to:
• Issue, grant, sell, pledge, lease, dispose of or encumber its shares or its
assets
• Amend its governing documents
• Split, combine or reclassify any of its outstanding shares
• Declare or pay any dividend or other distribution; or
• Redeem any of its shares or other securities
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22. Interim Period / Operations (Cont’d)
– Acquisitions – a prohibition on the part of the Target on the
acquisition of any third party corporation or assets
– Indebtedness – a prohibition or restriction on the Target from
incurring any indebtedness for borrowed money or any other material
liability or obligation
– Material Rights or Claims – a prohibition or restriction on the
Target from entering into, amending or terminating any material
contract, or waiving, releasing or assigning any material rights or
claims
– Litigation – a prohibition or restriction on the Target from
commencing or settling any litigation, proceeding, claim, action,
assessment or investigation
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23. Interim Period / Operations ‐ End
– Capital Expenditures – a prohibition or restriction on the Target
from incurring or committing to capital expenditures
– Keep the Purchaser Fully Informed – a covenant of the Target
to keep the Purchaser fully informed as to the material decisions
required to be made or actions required to be taken with respect to
the operations of its business
– Communications – a requirement of the Target to furnish promptly
to the Purchaser a copy of each notice, report, report of proxies
submitted, schedule or other document or communication delivered,
filed or received by it in connection with the transaction
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25. Introduction
• Payment of the entire purchase price on closing will often not
suit the business purposes of the parties. Purchase price
generally negotiated at the “Letter of Intent” or “Term Sheet”
stage, based on a “snapshot” of the business at that point of
time.
– Purchase price based on financial statements provided at the time of
negotiation. Value of the business at the date of closing may have
changed.
– Future earnings of a business may be factored in the purchase price. As
future earnings cannot be determined at the date of closing, the
purchase price may be structured as an “earn‐out”
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26. Purchase Price Adjustments
• Agree on closing date Net Asset Value/Working Capital/EBITDA
requirement and adjust for difference at closing.
– If the amount at closing is less, purchase price will be reduced by that
amount; if the closing amount is more, purchase price is increased by
that amount
• Net Asset Value or Working Capital Adjustment – Assets less
Liabilities
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27. Purchase Price Adjustments
• Assets – cash, securities, accounts receivable, inventory,
equipments, prepaid expenses, taxes receivable
• Liabilities – short term/current portion of debt, accounts
payable, tax payable, accrued liabilities (long term debt usually
paid out or assumed)
• Dollar for Dollar Adjustment –purchase price will be
increased/decreased by the difference between the Net Asset
Value/Working Capital at the closing date and target
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28. Mechanism
• Estimated Balance Sheet as at the closing date, prepared
immediately prior to the closing date, to be used as a basis for
the adjustments. Purchase price, as adjusted pursuant to the
draft Balance Sheet, will be paid on closing
• Subsequent to closing date, final closing date financial
statements are prepared. The final adjustment to the purchase
price will be determined based on these statements
• May result in a return of purchase price to the Purchaser or an
increase of the purchase price to the Vendor
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31. Alternatives
• Earnings compared to earnings at the same time in the
previous fiscal year (usually month over month). Percentage of
any positive difference between previous earnings and current
earnings will be paid to the Vendor
• Target earnings for a specified period established in the
Purchase Agreement. Purchaser pays a percentage of or the
entire amount of the earnings which exceed the target
• Specified percentage of gross or net earnings for a specified
period of time paid to the Vendor
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32. Issues
• Consulting/employment arrangement with the Vendor, or key
principal of the Vendor company
– What happens if:
• Vendor dies or becomes permanently disabled?
• Purchaser wants to terminate Vendor’s contract for cause?
• Growth in the company but it is not attributable to Vendor; rather, it is
attributable to innovative ideas of Purchaser?
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33. Issues (Cont’d)
– What happens if:
• Target is met but it is due to many new customers that Purchaser has
attracted and many previous customers of Vendor no longer do business
with the company?
• Increase in revenue is attributable to extraordinary situations (sales of
assets out of the ordinary course or non‐arms length transactions)?
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35. Identifying IP
• Distinguish between IP and what is protected by IP
– Software and databases are NOT IP – they MAY be protect by IP
– Generally distinguish IP Rights (copyrights, patents, trade secrets etc.)
from IP (IP Rights, software, databases etc.), even though this is
technically incorrect
• As a seller, if you do not distinguish between IP and IP rights,
your representations and warranties will be either too broad,
or invariably inaccurate. It also impacts what the seller needs
to disclose in the schedules
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36. Identifying IP
• Distinguish between Registered and Unregistered IP
• Registered: Canadian Intellectual Property Office Searches
– Copyrights, patents, trademarks
• Unregistered: Real Due Diligence
– Copyrights, trade secrets, confidential Information, know‐how
• Disclose only registered IP, or every written document or
process protected by trade secret would have to be disclosed
• Representations about validity and good standing of IP is
relevant only for registered IP – trade secrets, unregistered
copyright cannot be said to be valid or in good standing
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37. Ownership Issues
• Who actually owns the IP?
– Employees
• For the key IP, can all employees who contributed to its development be
identified?
• Employers own copyright created by an employee acting in the scope of
employment, but employers do not own patent rights created by an
employee unless an agreement says otherwise
• Have all/key employees signed Invention Disclosure and Assignment
Agreements? Confidentiality Agreements?
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38. Ownership Issues
– Contractors/Consultants/Developers/Suppliers
• Even if a company pays for something to be created, without a written
agreement, the inventor or creator will own the IP in the invention or
creation
• Are there assignment of IP provisions in contractor agreements?
• Are there NDAs/confidentiality agreements dealing with works protected
as trade secrets?
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39. Ownership Issues
• How were seller IP/products/services created? Can the seller:
– Identify all creators/inventors?
– Identify all third party tools, software, IP used to create/invent create
the IP/products/ services? Any third party items included in
IP/products or services will be owned by the third parties and may be
subject to license rights that are not sufficiently broad to permit the
seller to do what they think they can do (e.g. open source software)
– Provide copies of all licenses for such third party tools, software, IP? If
not, how does the purchaser know what is being acquired?
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40. Representations and Warranties
• Validity or enforceability of the IP? From a vendor’s
perspective, and it should only apply to registered IP as of a
certain date
– TMs can be challenged after the application is granted, rights to TMs
can be lost, future patents can limit or prevent the enforcement of
your current patent, and there is no central database of copyrights
– Can state that registrations and registered IP has been maintained
– Can represent that have received no claims of infringement
– If are willing to take risk, can say that as of a certain date, the use of
the IP does not infringe a third Party’s IP (or that the target has no
knowledge that the use of the IP infringes a third party’s IP rights)
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41. Representations and Warranties
• Disclose only registered IP rights, or if the disclosure relates to
all IP, provide a general disclosure of all unregistered IP
• Sufficiency to run business as of effective date
• No knowledge of competing claims
• No knowledge that the seller’s IP has been infringed
• No exclusive licenses
• No loss or unauthorized disclosure of confidential information,
all disclosure of confidential information is under NDA
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44. Representations and Warranties
• They become meaningful when tied to the indemnity
provisions in the definitive agreement
• The purchaser is seeking assurances from the vendor(s) that
certain facts are true, and will be true, relating to the
purchased assets or purchased entity; if they prove not to be
true, the purchaser is to be compensated for its losses
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45. Who should be giving them and regarding
what?
• Asset Sale • Share Sale
– The vendor is the corporation – The shareholders are the vendors
(only several liability; not joint) – Target corporation is not a party
– Sometimes the shareholders of unless providing collateral
the vendor corporation (may covenants
then be joint and several liability) – Joint and several liability among
– Regarding the purchased assets vendor shareholders or only
not the vendor corporation several liability
– Regarding target corporation and
its historical business
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46. Who should bear the risk?
• It is dependent on:
– The purchase price
– Adjustments to the purchase price
– Bargaining strength of the parties
– Transaction factors
• The “Closing Date” or “Effective Date” is the date that
delineates the date for risk apportionment and is the date the
vendor’s representations/warranties are to be true
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48. Negotiating the Risk
• As a result, in a share sale, the purchaser is looking for
exhaustive representations on all known liabilities and is
hoping to extract vendor representations on unknown
liabilities as well
• The vendor will be motivated to reduce its potential liability
for a breach of a representation/warranty and will introduce
exceptions
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51. Knowledge Qualifier
• If the purchaser permits this qualification:
– The purchaser will want “knowledge” to either:
– require the vendor to have made a reasonable inquiry into the matter;
or
– To be the knowledge a reasonable person should have using
reasonable care or diligence
– The purchase agreement should contain an interpretation section
regarding this phrase
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52. Materiality Exception
• The vendor will want to add a level of materiality to
representations/warranties so that “non‐material breaches”
will not result in a breach of the purchase agreement giving
rise to indemnity obligations
• Can be defined in relation to having a certain minimum
aggregate dollar value per year or as a percent of the purchase
price
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54. Other Exceptions to Disclosure
• The vendor will attempt to qualify the purchaser’s broadly
worded representations with specific exceptions to disclosure
which are set out in Schedules; often the result of due
diligence
• “The vendor shareholder represents and warrants that except
as set forth in Schedule B, the target corporation has never
received notice of non‐compliance with the Occupational
Health and Safety Act (Alberta).”
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55. Survival Periods
• Purchase agreement must contain a survival clause so that the
representations/warranties do not merge on closing
• How long should they last?
– Typical range is 1 to 3 years; some are indefinite or extend until the
expiry of any assessment period
• Acts as a time limit on ability to claim for indemnity
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56. Indemnity Clauses
• An obligation on the first party to indemnify a second party for
a loss incurred by the second party
• Serves to protect the purchaser for a breach of
representation/warranty of the vendor that occurs during the
survival period (and vice versa)
• Should be drafted to include both direct losses/claims and to
include third party claims (Mobil Oil Canada Ltd. v. Beta Well
Service Ltd)
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57. Indemnity Clause and Further Limitations
• Often, the purchaser still wishes to also preserve its common
law right to sue for breach of contract in addition to right to
indemnity from vendor; purchase agreement must be clear on
this
• Vendor will try to limit indemnity by:
– Requiring a minimum threshold dollar amount before purchaser can
bring a claim
– Limiting exposure to a total dollar amount (i.e. proportionate share of
purchase price)
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