In this presentation, FMC’s Leanne Krawchuk discusses risk apportionment in the purchase and sale transaction, including: - Representations and Warranties - Indemnity Clauses and Limitations - Purchase Price Adjustments and Holdbacks/Escrow - Maximize the Value Proposition - Due Diligence

1. FMC Law Presentation to the
CBA’s Alberta Law Conference 2013
Risk Apportionment in the Purchase
and Sale Transaction
Presented by: Leanne C. Krawchuk, Partner
1

2. Outline – Risk Apportionment
1. Representations and Warranties
2. Indemnity Clauses and Limitations
3. Purchase Price Adjustments and Holdbacks/Escrow
4. Maximize the Value Proposition
5. Due Diligence
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3. Representations and Warranties
3

4. Representations and Warranties
• What is a representation?
– it is a statement of fact, past or existing (it does not speak
to the future)
• What is a warranty?
– it is a promise that a fact is or will be true
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5. 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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6. Who should be giving them and regarding
what?
• Asset Sale • Share Sale
– The vendor is the corporation – The shareholders are the
(only several liability; not vendors
joint) – Target corporation is not a
– Sometimes the shareholders party unless providing
of the vendor corporation collateral covenants
(may then be joint and – Joint and several liability
several liability) among vendor shareholders
– Regarding the purchased or only several liability
assets not the vendor – Regarding target corporation
corporation and its historical business
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7. 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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8. Liabilities
• In a share purchase, the purchaser is buying all known
and unknown liabilities
• In an asset sale, the purchaser is usually only buying
assets not liabilities, but could buy certain specified
liabilities (i.e. assume debt related to certain
purchased assets)
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9. 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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10. Exceptions Introduced by the Vendor to
Reduce Liability
1. Knowledge qualifier
2. Materiality
3. Other Exceptions to Disclosure> the Schedules
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11. Knowledge Qualifier
• The vendor will try to limit its representations and
warranties to “the knowledge of the vendor”
• Vendor will want this phrase to mean only “actual
knowledge” and of only certain vendors (the majority
shareholders or management shareholders)
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12. 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
12

13. 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 % of
the purchase price
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14. Materiality Exception
• “The vendor shareholder represents and warrants
that, as at the Closing Date, the target corporation is
not a party to any material contract except as
disclosed on Schedule A”.
• “material” means, in relation to any contract, having
an aggregate minimum value of at least $100,000 on
an annual basis”
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15. 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).”
15

16. 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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17. Indemnity Clauses and Limitations
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18. 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
18

19. Mobil Oil Canada Ltd. v. Beta Well Service Ltd. (1974),
43 DLR (3d) 745 (Alta Sup Ct App Div)
• Indemnification By Contractor:
“10. Contractor [Beta] shall be liable for and shall indemnify and save harmless
Mobil Oil of and from all manner of actions, causes of action, proceedings,
claims, demands, loss, costs, damages and expenses whatsoever which may be
brought or made against Mobil Oil, or which it may sustain, pay, or incur as a
result of or in connection with the performance, purported performance or
non‐performance of this agreement or other work hereunder by Contractor or
his sub‐contractors and whether the same results from or in connection with
the use by Contractor or his sub‐contractors of any machinery, tools or
equipment belonging to Mobil Oil, or from or in connection with the negligence
or wilful acts or omissions of Mobil Oil, its servants, agents, employees or its
other contractors, while acting under the direction or control of Contractor or
his sub‐contractors, and Contractor shall further indemnify and save harmless
Mobil Oil from all claims, suits, and demands for infringement of any patent or
similar right growing out of or incident to Contractor’s performance of said
work or the use of material or equipment furnished by Contractor.”
19

20. Mobil Oil Canada Ltd. v. Beta Well Service Ltd. (1974),
43 DLR (3d) 745 (Alta Sup Ct App Div)
• Held: The clause only required the Defendant (Beta) to indemnify the
Plaintiff (Mobil Oil) against claims brought by third parties, and did not
apply to direct loss caused by the operations of the Defendant to the
Plaintiff.
• Reasons: “[T]he “liability” provision and the “indemnification provisions”
are linked together by the conjunction “and” … The clause may therefore
be interpreted as providing for the acceptance by the contractor (Beta) of
liability for, and an undertaking to indemnify Mobil Oil against, claims of
third parties, rather than direct claims of Mobil Oil against the contractor
for loss or damage it might sustain… It must be borne in mind that this is
Mobil's contract. The rule or principle of contra proferentem requires the
words of written documents to be construed more forcibly against the
party using them.”
• Decision upheld at the Supreme Court of Canada (Mobil Oil Canada Ltd. v.
Beta Well Service Ltd. (1974), 43 DLR (3d) 745 (SCC)).
20

21. TransCanada Pipelines Ltd. v. Potter Station Power
Limited Partnership (2003), 226 DLR (4th) 262 (ONCA)
• “10. Potter Power shall indemnify and save harmless TransCanada
from and against all liability, actions, claims, losses, costs and
damages which may be brought against or suffered by TransCanada
and which TransCanada may incur, sustain or pay arising out of or in
connection with:
(a) construction, operation and maintenance of the Facility
(including the Duct System);
(b) the negligence or willful misconduct of Potter Power, its
directors, officers, employees, agents, servants, contractors and
subcontractors arising out of or incidental to this Agreement; or
(c) a breach by Potter Power of any of the terms and conditions set
forth in this Agreement,
except to the extent that such losses or damages, result from the
negligence or willful misconduct of TransCanada.”
21

22. TransCanada Pipelines Ltd. v. Potter Station Power
Limited Partnership (2003), 226 DLR (4th) 262 (ONCA)
• Held: The wording of the clause was not ambiguous; it was not confined to
third party claims, and clearly included losses suffered directly by the
Plaintiff.
• Reasons: “In particular, I adopt the motion judge’s reasoning that the
words “losses, costs and damages which may be… suffered by
TransCanada” introduce an obvious alternative to “all liability, actions,
claims…. which may be brought against…. TransCanada” and that, when
read in context, the alternative is “more appropriately associated with
damage to TransCanada itself”.
• “The key difference between the two provisions [this one and the one in
Mobil Oil] is the compelling alternative introduced by the words “which
may be brought against or suffered by” in the Indemnity. In the Mobil Oil
provision, there is no similar clear alternative.”
22

23. TransCanada Pipelines Ltd. v. Potter Station Power
Limited Partnership (2003), 226 DLR (4th) 262 (ONCA)
• “Rather, in Mobil Oil, the potential alternative is between the words “which may be
brought or made against” and the words “which it may sustain, pay, or incur”.
However, while the words “which may be brought or made against” appear to be
used synonymously, such that each verb applies individually to only some of the
preceding nouns, it is not obvious whether the words “which it may sustain, pay, or
incur” are to be interpreted synonymously and applied individually to only some of
the preceding nouns or whether they are to be interpreted as introducing an
alternative by applying each verb individually to all of the preceding nouns. Put
another way, in Mobil Oil, the words “which it may sustain, pay, or incur”, when
juxtaposed against “which may be brought or made against” and interpreted in
conjunction with the rest of the clause, do not produce the same compelling
alternative that exists in the Indemnity”.
• “In addition, the commercial context of the two cases is vastly different. Mobil Oil
involved an indemnity contained in a repair contract between an oil and gas well
servicing company and a well owner. A clause in the repair contract required the
servicing company to perform its work in a good and workmanlike manner. It
therefore established a standard of performance that was inconsistent with
absolute liability on the part of the contractor… In contrast… neither the specific
terms of the … Agreement nor its surrounding context weigh against interpreting
the Indemnity as extended to damages suffered by [the Plaintiff] … directly.”
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24. What Alberta Courts are Saying About Mobil Oil ‐
Herron v. Hunting Chase Inc., 2003 ABCA 219
• Section 9.1(a) provides that the shareholder vendors “shall
indemnify and save harmless the Purchaser […] from and
against all Losses which [it] may suffer, sustain, pay or incur as
a consequence of a breach of a representation and warranty
[…] or a breach by a Vendor of any of the covenants made by it
in this Agreement […]”
• Section 9.1(b) provides indemnification for losses which
Hunting (the Purchaser) “may suffer, sustain, pay or incur in
connection with any Claim relating to any product produced or
sold, or any service provided, by or on behalf of Chase (the
target company) prior to the Time of Closing.”
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25. What Alberta Courts are Saying About Mobil Oil ‐
Herron v. Hunting Chase Inc., 2003 ABCA 219
• Held: The indemnification provision would apply to non‐third party
losses resulting from breaches of covenants of the shareholder
vendors, including losses resulting from breach of the retained
earnings covenant.
• Reasons: “Subsequent Alberta decisions have not treated Mobil Oil…
as authority for limiting the application of indemnification clauses to
third parties… Rather than relying on Mobil Oil, the plain and
ordinary meaning of each contract must be assessed in its own
context with a focus on the intention of the parties…”
• “It follows that s. 9.1(a) provides indemnification for losses suffered
by a party whether or not they relate to claims by third parties… This
section [s. 9.1(b)] specifically indemnifies for third party claims, but
in no way limits the broader indemnification in s. 9.1(a).”
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26. What Alberta Courts are Saying About Mobil Oil ‐
Sinclaire v. South Trail Shell (1987), 2002 ABQB 378
• 2.14 Indemnity
“You will indemnify us and hold us harmless against any claim
against us (including costs and expenses) resulting from or
connected with your business at the Site, including, without
limitation, any claim for damages relating to environmental
contamination; any persons entering, coming on, or leaving
the Site, or using your services; and loss or damage to
property.”
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27. What Alberta Courts are Saying About Mobil Oil ‐
Sinclaire v. South Trail Shell (1987), 2002 ABQB 378
• Held: “It [Clause 2.14] would require Cannon… to indemnify Products for
liability for negligence of Cannon… on the Site whether Cannon’s
negligence was whole or partial. The Clause would not, however, cover
liability for negligence of Shell or Products on the Site whether whole or
contributory.”
• Reasons: “… Mobil Oil remains, in my view, authority for the proposition
that indemnity clauses should be read in the overall context of the
agreement, and also should be read, where the total [is] unclear, in light of
the principle of contra proferentum…
• The interpretation by Shell and Products would… seem to impose upon
Cannon the duty to indemnify Shell and Products even if the loss were
found to be exclusively as a result of the negligence of Products… Such an
absolute shifting of responsibility should… require much clearer language
than exists here.
• …Clause 2.14 is ambiguous in and of itself… apply the contra proferentum
principle.”
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28. Preserve Common Law Right to Sue for Breach
•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
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29. Negotiating a Cap
• Vendor Should Negotiate Caps Percentage of Deals
Including Caps for
on Indemnity: i.e. a percentage of Transactions completed
the purchase price or a fixed dollar in 2007, 2008 and 2009*
amount
CAP SITUATION PERCENTAGE
(2007, 2008,
2009)
Cap less than the 35%
Purchase Price
Cap equal to the 24%
Purchase Price
Cap not determinable 17%
from public information
Agreement silent as to 24%
Cap with the result that
there is no Cap
* Source: American Bar Association’s Business Law Section – 2010 Canadian Private Target Mergers & Acquisitions Deal Points 29

30. Negotiate an Indemnification Basket
• Vendor to Negotiate Indemnification Baskets: the minimum
loss/damage ($$) that must be suffered by a purchaser for a
breach of a vendor’s representations and warranties
– (1) deductible baskets and (2) dollar‐one baskets and
sometimes (3) combination baskets
Baskets as Percentage of Transaction Value for Transactions
completed in 2007, 2008, and 2009*
BASKET TYPE MEAN MEDIAN MINIMUM MAXIMUM
Deductible 1.76% 0.5% 0.1% 11.6%
(1.77% in 2008) (0.5% in 2008) (0.096% in 2008) (11.4% in 2008)
First Dollar 0.75% 0.4% 0.1% 4%
(0.57% in 2008) (0.39% in 2008) (0.0005% in 2008) (1.8% in 2008)
All Baskets 1.18% 0.45%
(0.99% in 2008) (0.48% in 2008)
* Source: American Bar Association’s Business Law Section – 2010 Canadian Private Target Mergers & Acquisitions Deal Points 30

31. • Buttressing the Indemnity Covenant
– In an asset sale, the shareholders may be requested to provide
guarantees to back‐stop the vendor (shell) corporation’s (several)
indemnity obligations
– Holdbacks from the purchase price may be used by the purchaser as
“security” for the indemnity obligations of the vendor and used to set‐
off any losses
• Joint and Several or only Several Indemnity?
– Joint and several representations> generally leads to joint and several
indemnity obligations, with vendors then attempting to limit
indemnity amount to their share of purchase price
 Joint and several = advantage purchaser
 Several = advantage vendor
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32. Purchase Price Adjustments and
Holdbacks/Escrow
32

33. Purchase Price Adjustments
• Purchase price may be dependent on future earnings of the business
over a period of time after closing. As future earnings will not be known
at the time of closing, a portion of the purchase price is then structured
as an “Earn‐Out”
• If vendor not involved in the business after closing, vendor has no control
on whether earn‐outs are met
• If vendor has no control in the business after closing, purchaser or target
company may spin out the business or key assets resulting in targets not
being achievable
– Normal Earn‐Out vs. Reverse Earn‐Out
• Normal earn‐out added to price = Advantage buyer as earn‐out is
taxable income
• Reverse earn‐out taken from price = Advantage vendor as adjustment is
all on account of capital (proceeds)
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34. Holdbacks/Escrows
• Can the vendor avoid holdbacks or escrow altogether?
• Avoid agreeing to too large a portion of the purchase price being
held back to secure the indemnity obligation (or other covenants) of
the vendor or guarantors in the purchase agreement
• Ensure any holdback funds are placed in a solicitor’s escrow account
or obtain security from the purchaser to secure the purchaser’s
obligation to pay the future (potential) holdback
Percentage of Deals Employing Escrow for Transactions*
Deals in Which Escrow Deals in Which Escrow Not
Used Used
2010 Study 26% 74%
2008 Study 29% 71%
* Source: American Bar Association’s Business Law Section – 2010 Canadian Private Target Mergers & Acquisitions Deal Points 34

35. Maximize the Value Proposition
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36. Maximizing The Value Proposition
A. Legal Factors That Hurt Value in Vendor Business
• Failure to appreciate the value in the Vendor or more importantly
in the management that need to stay involved after the closing
• Failure to properly protect intellectual property (i.e. Copyright,
Trademark, Trade Secrets, Industrial Design Issues)
• Failure to address important liabilities
– Litigation, Environmental liabilities, Tax liabilities and Employee
severance cost liabilities
• Failure to appreciate the time involved in completing the
transaction, include due diligence requirements
36

37. Maximizing The Value Proposition
A. Legal Factors That Hurt Value in Vendor Business Cont…
• Inappropriate or pre‐mature disclosure
– Without Confidentiality Agreement
– Disclosing too much information too soon
– Lack of control of information disclosure
37

38. Maximizing The Value Proposition
B. Understanding the Unanimous Shareholder Agreement
(USA):
– What is the share structure?
– Does the USA drag along minority shareholders or do they have
pre‐emptive rights?
C. Purchaser will typically want non‐compete from key
employees and/or departing shareholders
D. Key personnel and strength of management team: ensure
they are going to be in place post‐closing
E. Ensuring survivability of business transactions/material
contracts/key suppliers/key customers
38

39. Due Diligence
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40. Due Diligence
What is Due Diligence and Why Conduct it?
• Investigations into target company’s business, legal and financial affairs
– Reviewing contracts, financial statements, legal public search
results, environmental phase I’s or II’s, etc.
• To help ensure the intended results:
– Is the vendor selling the assets it intends to sell and that the
purchaser expects to purchase?
– Is the vendor giving appropriate and correct representations and
warranties? Do the Schedules contain accurate disclosure?
• Scope, depth and purpose is transaction specific
• To determine what consents/notices /rulings are required and how this
affects Closing– regulatory, other third parties? (i.e. bankers,
shareholders approvals, customers, Competition Act, Investment
Canada Act)
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41. Due Diligence
• Resource Allocation by Vendor
– Which employees will be involved?
• “Presale Due Diligence”
– Consider overall process in advance
• What documents and arrangements need to be disclosed
• How will they be assembled, collected and disclosed
– Develop a system to collect, index and retain documents
• Where is that major customer agreement kept?
• Where are the share certificates that are being purchased located?
• Will an electronic datasite be used and who will populate and manage it?
– Correct issues/defects with current agreements and
arrangements
41

42. Questions?
Presented by:
Leanne C. Krawchuk, Partner
Edmonton
780 423 7198
leanne.krawchuk@fmc‐law.com

43. The preceding presentation deals with the kinds
of issues companies dealing with risk
apportionment could face. If you are faced with
one of these issues, please retain professional
assistance as each situation is unique.