In this webinar presenation, you will learn practical tips on drafting and understanding commercial agreements. Extract practical insights to drafting and understanding commercial agreements and learn techniques used to allocate or transfer economic risk.

1. Welcome
Economic Risk in Commercial Agreements

2. Agenda
Dashboard
Speakers
Q&A
Follow-Up

3. Glen Lekach
Miller Thompson, LLP

4. Economic Risk
In Commercial Agreements
GLEN LEKACH

5. Overview
• Transferring risk in the context of purchase and
sale agreements and other commercial
agreements such as supply agreements, service
agreements, employment agreements, loan
agreements and the like
• Parties expend considerable effort to transfer
risk to avoid or reduce liability or an event of
default

6. Practical points on strategies to transfer risk
• Use of definitions
• Control drafting
• Due diligence
• Parties to the agreement
• Use of deposits and escrows
• Representations, warranties, and indemnities
• Boiler plate

7. Controlling Drafting
• Avoid temptation to allow Vendor’s solicitor to
draft the purchase agreement
• Controlled auction exception
• In other agreements, to the extent possible, the
party receiving the benefit should draft

8. Four reasons to control drafting
– timing of negotiations
• (timed in accordance with turnarounds of drafts and
disclosure of information)
– obtaining information
• (use of broad terms such as representations and warranties
to see where push-back occurs)
– protecting of the Purchaser
• (if vendor drafts, protection of purchaser is of no interest)
– detecting deficiencies in other side’s drafting is difficult

9. Strength of Bargaining Power
• Determine the relative bargaining positions:
– client who is not afraid to walk (able to take hard
positions)
– client who needs the deal (will make concessions)
• Deals fail where lawyers are not sensitive to this
dynamic (e.g. lawyer intransigent on every point
regardless of client’s position)

10. Drafting for Different Types of Agreements
• Custom may drive content
• Good business sense should drive content
• E.G.: a commercial real estate agreement often needs
no indemnity
• Good drafting: definitions, interpretations, covenants,
representations and warranties, conditions to
performance, indemnities, general matters
• Don’t follow standard form agreements, if they do not
suit the transaction

11. Parties
• Use of a co-covenantor:
– Determine solvency of Vendor
– Shell Purchaser
– Vendor financing
– Assignment of contracts
– Vendor liquidating assets and distributing proceeds to
shareholders

12. Parties
• More than one Vendor or co-covenantor
• Joint liability
• Several liability
– Problems exist where one party is insolvent and the other party
is in management and works for the party having a claim
• Joint and several liability
• If co-covenantor unrelated
• Parties who are jointly liable should enter into side
agreement allocating liability amongst them

13. Execution of the Purchase Agreement
• Interim period if signing occurs before closing
• Material adverse changes during interim period
or reps and warranties not true
• Execution of purchase agreement on or near the
closing
• Sometimes cannot avoid interim period where
regulatory approvals need to be obtained or third
party consents required

14. Deposits
• Useful where:
– Purchaser does not have deep pockets
• Risk of walking away before closing
– Co-covenantor does not have deep pocket or no co-
covenantor exists
– Committing a Purchaser to a transaction
• “Skin in the game”

15. Deposits
• Deposit can offset the Vendor’s damages if
Purchaser fails to complete
• Liquidated Damages
– not a penalty
– should not be excessive, extravagant, or
unconscionable
– should estimate actual damages
• obtain acknowledgement from Purchaser that it is a genuine
pre-estimate of damages

16. Escrow Holdbacks
• A holdback of some of the purchase price
• Useful where:
– to fund indemnity claims post-closing
– to fund claims for post-closing adjustments
– Vendor will be wound up post-closing
– no co-covenantors are present

17. Escrow Holdbacks
• Funding of earn out
– Vendor wants funds secured up front
• Use of tranches
– release holdbacks in one or more tranches
– term of holdback can correspond with survival of reps
and warranties
• Loss of key customer or employee or other risk
– For the benefit of the Purchaser

18. Due Diligence
• Purchaser’s desire to investigate
– unrestricted before signing – use confidentiality agreement
– between signing and closing – often just confirmatory due
diligence
• Vendor’s desire to limit investigation
– If due diligence is broad and Puchaser discovers problem,
Purchaser walks
• Limited reps and warranties = greater due diligence
– Required because likely no claim against Vendor if problem
arises

19. Conditions Of Closing
• All reps, warranties and covenants must be true or
performed – what if they aren’t?
• Vendor does not want Purchaser to be able to walk away
if there is a minor breach
• Breach must be material
• Define “materiality”
– If possible in a monetary amount
– Tied to amounts agreed upon prior to making indemnity claim
• Consequences of waiver of breach
– Right to sue or no right to sue

20. Failure To Satisfy Conditions Of Closing
• Where unmet, allow the Purchaser to rescind the
agreement without any liability
• Vendor liability upon rescission
• Vendor does not want to be liable unless matter
was reasonably capable of being performed
– E.G. loss of customer

21. Use of Best Efforts
• To ensure covenants, agreements, et cetera are
fulfilled at closing
• Take all actions within control and best efforts in
respect of matters beyond control
• For Vendor:
– Use of “reasonable commercial efforts” reduces cost
– If “best efforts” is used, define it to exclude
extraordinary expenditures

22. Jurisprudence on “Best Efforts”
• Atmospheric Diving Systems Inc. v. International Hard
Suits Inc. (1994), 89 B.C.L.R. (2d) 356:
– it imposes a higher obligation than a “reasonable effort”
– it means taking all reasonable steps and leaving no stone
unturned
– it includes doing everything known to be usual, necessary and
proper – may not be economically viable
– it is not boundless
– commercially reasonable is an economic test: namely, does not
need to be done if it does not make sense financially

23. Representations and Warranties
• Subject of lengthy negotiations between counsel
• Certain basic reps and warranties are normally
uncontroversial:
– due organization, due power and authorization, no conflicts with
laws, all governmental and other consents obtained, legally
binding obligations, all approvals obtained and maintained, no
litigation and compliance with applicable laws
• Given the numerous types of legal entities that exist, use
generic language like “organization” rather than
“corporation” to capture all forms

24. Specific Representations and Warranties
• Deal specifically with the maker or its business
• Risk-shifting reps and warranties
• Used in share sale, credit agreement, or asset sale
• ‘Vendor friendly’ versus ‘Purchaser friendly’
• In credit agreements, must remain true throughout term
of loan facility
• In purchase agreements, the length of the term of the
truthfulness can be negotiated

25. Risk Transfer Techniques
• Liability of Vendor:
– ‘absolute’ versus ‘material’ or ‘best of knowledge’
– Key: who bears the risk of an unknown problem
• Use a fair approach to expedite negotiations
• Purchaser’s reps and warranties are generally limited – exception
exists where Vendor financing provided
• Watch out for Vendors who attempt to avoid giving detailed reps and
warranties
• Due diligence in lieu of reps and warranties may be inadequate
where purchaser dues not understand the business

26. ‘Best of Knowledge’
• Vendor should seek to define this term:
– restricted to the actual knowledge of designated
senior officers
• Purchaser should be resist ‘best of knowledge’:
– If used, it should compel representatives to conduct
diligent inquiries
• For corporations, determine whose knowledge

27. Knowledge qualifiers
• Shifts risk to Purchaser
• e.g. “to the best of the knowledge of the Vendor,
there are no hazardous substances on the lands
that form part of the purchased assets”
• Often an unwarranted transfer of risk – who
should bear risk for unknown liability?

28. Knowledge Qualifiers
• Consider whether the risk being transferred is
acceptable
• Resist fundamental risks:
– title to assets
– existence of encumbrances
• ‘after due inquiry’

29. Materiality
• Used in conjunction with words such as change, effect,
affect, default
• The threshold for materiality can be used to transfer risk
• Often defined as a monetary amount
– sometimes materiality cannot be quantified in dollars (E.G. loss
of licence)
– aggregating of small breaches
• Defining materiality gives certainty to levels of disclosure

30. Material Adverse Changes
• Used in conjunction with conditions precedent,
reps and warranties, covenants, and events of
default
• Tension between quantitative and qualitative
material adverse changes
• Overly-broad clauses may be found void by a
court for ambiguity

31. Material Adverse Changes
• Carve-outs for Vendor:
– short term changes
– political or market change
– natural disasters/terrorism/sabotage
– changes resulting from the agreement itself
– disclosed matters
– changes in GAAP/ASPE
– failure to meet earnings estimates
– changes in industry
– requests by governmental authorities

32. Material Adverse Change (MAC)
• Invoking a MAC clause:
– mixed law and fact
– objective and subjective standard applied
– depends on the knowledge of the party invoking the
clause
– make sure definitions in loan agreement and
purchase agreement are the same, where financing
obtained

33. Ordinary Course or Business
• Vendor may limit risk by excluding from reps and
warranties matters in “the ordinary course of
business”
• If so, only abnormal matters are caught by the
reps and warranties
• Typical wording
– “except as may arise in the ordinary course of
business”

34. Covenant to Disclose Misrepresentation
• ‘no ambush’ clause
– Purchaser reps that it has not become aware of any
circumstances which would constitute a breach by the Vendor
– Allows Vendor to fix problem or establish that the Purchaser
made no reliances
• A Purchaser should avoid such clause
– SWAT team
– Purchaser may not have enough facts to fully understand
consequences
– Disputes over who knew what

35. Pricing
• General rule:
– The more risk the Vendor retains, the higher the
purchase price.
– Receiver sales are ‘as is’, so the price is often very
low

36. Use of Disclosure Schedules
• Numerous schedules attached to the agreement:
– Vendor discloses material facts
– Vendor discloses exceptions to otherwise absolute
representations and warranties
– Vendor discloses no litigation which has been
commenced against the corporation
– e.g. ‘Except as set out in Schedule “B” there are no
encumbrances against the purchased assets’

37. Use of Disclosure Schedules
• Time consuming, so not popular with Vendors
• However, it is advantageous to Vendor:
– Reduces risk of Purchaser seeking indemnifications later –
Vendor should consider making over-disclosure
• Vendors find completing schedules onerous, so they
sometimes take shortcuts
• Use cross-references or language that disclosure in one
schedule qualifies other schedules or other disclosures

38. No Failure to Disclose Representation
• Purchasers often use an all-encompassing
representation and warranty
• Problem: highly risky for Vendor
• Solution:
– qualify it with knowledge or materiality
– specifying that an objective standard applies
– except matters such as projections or judgment calls

39. Absence of Change in Events
• A rep and warranty that there are no changes in
the business since the date of the financial
statements
• These clauses are common in purchase
agreements
• Clause should be qualified:
– Vendor is not responsible for general economic
conditions or in conditions in the industry
– MAC exceptions

40. Multiple Parties
• Ensure that reps and warranties are specific to a
particular Vendor
• Agreements often miss this point
• Take great care to review the wording of each
rep and warranty

41. Bring Down Certificate
• A certificate that the reps and warranties are true at the
closing date
• Risk for the Vendor that, if not true, a claim can be made
by the Purchaser for breach
• Put in exception that they will be true “except as set forth
in a closing certificate” to allow for change
– then no breach
– Purchaser then forced to waive or not close

42. Survival of Reps and Warranties
• Most agreements specify that the reps and
warranties will survive the closing for a period of
time
• This is a significant risk for the Purchaser as it
loses ability to sue after the survival period
expires

43. Survival of Reps and Warranties
• Purchaser should seek no time limit for the titles,
corporate existence, fraud, misrepresentations
• Purchaser should seek extended time limit for
tax liabilities, interest, or penalities

44. Indemnities
• Carefully worded indemnity can add significant
protection for the Purchaser
• At common law, there is no liability for damages
that are too remote
• Negate common law duty of mitigation

45. Indemnities
• Indemnities often provide indemnification for
actual legal expenses
• Prudent Vendor will take steps to soften the
effect of the indemnity

46. Indemnities
• Carve outs:
– Punitive and aggravated damages
– indirect damages
– loss of profits
– insurance
– tax benefits result
– Purchaser could reasonably have mitigated
– Recovery from third parties

47. Limiting Vendor’s Liability
• Consider limiting the Vendor’s liability to a maximum
amount:
– FMV
– Vendor not liable for any amount in excess of the difference
between the purchase price to be paid by the Vendor and the fair
market value of the Purchased Assets (other than goodwill)
• Limit the indemnity to reps and warranties under the
purchase agreement or documents delivered at closing
• Limits only apply to reps and warranties not covenants
• Establish deductibles

48. Limiting Vendor’s Liability
• Purchaser should ensure that limitations on
liability only apply to breaches of reps and
warranties
• Purchaser should ensure the indemnity states
the following:
– any breach of a rep or warranty is deemed to be
suffered by the Purchaser, dollar for dollar

49. Thresholds, Caps and Deductibles
• Deductibles ensure that the Vendor is not liable
for de minimis claims
• Tipping Basket: if the threshold amount is
reached, Purchaser can claim for all loss
suffered
• True Deductible: the Vendor receives the first $X
free, and the Purchaser’s claims are limited to
those in excess of $X

50. Double Dipping
• Basket clauses are a risk allocation matter
• Purchaser should ensure that the Vendor does
not double dip
• Double dipping occurs where there is both
basket clause and reps and warranties qualified
by materiality

51. Conclusion
• Lawyer’s primary role is to minimize risk
• Do not be afraid to question commonly used
documents
• Success will be heavily dependent on the client’s
bargaining position

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53. Q&A
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54. Stay in Touch
Thank you for joining us!
Verona Thibault
President, SEDA
@saskecdevassoc
@growourregion
verona.thibault@seda.sk.ca
306-384-5817
Glen Lekach
Miller Thompson, LLP
glekach@millerthompson.com
306.347.8322