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LOIs in M&A: Is New Boilerplate Needed After a Recent Ontario Ruling?

Fasken
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Overview

Capital Markets and Mergers & Acquisitions Bulletin

Overview and Key Practical Takeaways

“Entire agreement” clauses are integral to M&A. Given the extensive negotiations between buyers and sellers, M&A parties rely on “entire agreement” clauses – in pursuit of deal certainty – to ensure the terms of the definitive purchase agreement supersede all earlier discussions and deal documents. 

For these reasons, the recent ruling of the Ontario Superior Court of Justice (Commercial List) in Project Freeway is noteworthy. In particular, even though the acquisition agreement’s “entire agreement” clause specifically stated that it superseded an earlier, non-binding letter of intent (the LOI), the court still looked to the terms of the LOI in deciding an earnout dispute. 

Our key practical takeaways include: 

  • The parties disputed whether the acceleration clause of a three tranche earnout was triggered by two post-closing financings. 
  • When deciding how to apply a “materiality” qualifier in the definitive acceleration clause, the court consulted the much briefer discussion of acceleration in the LOI. 
  • Given the “entire agreement” clause specifically referenced the LOI, the ruling raises a key question: what more can M&A parties do to reduce the risk of a court relying on preliminary deal documents in a dispute arising under the definitive agreement? 
    • We consider two options. First, include additional boilerplate in the LOI stating the parties cannot rely on the LOI in any future dispute under a subsequent definitive agreement. Second, add additional language to the “entire agreement” clause in the definitive agreement to a similar effect.
  • Based on the court’s ruling, M&A parties must appreciate there is no guarantee a court would consider its discretion confined by such clauses.

Our detailed insights follow. For Fasken’s insights on the earnout analysis in Project Freeway, see here. For further discussion of “entire agreement” clauses in M&A, see Fasken, Private M&A in Canada: Transactions and Litigation (LexisNexis, 2024). For more Fasken M&A thought leadership, visit our Capital Markets and M&A Knowledge Centre and subscribe.  

The Importance of “Entire Agreement” Clauses in M&A

The fundamental aim of an “entire agreement” clause is deal certainty. As recognized by the Ontario Court of Appeal (ONCA), the goal is to “lift and distill the parties’ bargain from the muck of the negotiations.”

This is especially important in M&A for several reasons. In particular, M&A negotiations often involve (1) seller roadshows and other presentations to prospective buyers, (2) preliminary deal documents such as term sheets, LOIs, and confidentiality and non-disclosure agreements, (3) multiple external advisors and workstreams (e.g., financial and legal), and (4) extensive due diligence and document disclosure (e.g., confidential information memorandums, virtual data rooms, and due diligence questions and answers). 

M&A parties therefore include “entire agreement” clauses to ensure commercial and legal certainty over the exact deal struck, i.e., to guard against either buyer or seller later attempting to rely on matters previously discussed but which were subsequently altered or did not survive the negotiations to be included in the definitive acquisition agreement. 

The “Entire Agreement” Clause Ruling in Project Freeway

At issue in Project Freeway was what meaning to give to a “materiality” qualifier in the earnout’s acceleration clause. This clause provided that acceleration would be triggered if the buyer divested a “material portion of the assets” of the target business without the seller’s consent. 

The seller argued “materiality” meant significant in terms of value. The buyer argued something was only “material” if it impacted the target’s performance and thus the pursuit of the earnout. The court preferred the latter interpretation, and one of the three pillars of its analysis was that the buyer’s reading was supported by the brief discussion of earnout acceleration in the LOI. 

The seller argued the court was precluded from considering the LOI by the acquisition agreement’s “entire agreement” clause. The court disagreed. Citing ONCA precedent, it explained: 

An entire agreement clause alone does not prevent a court from considering admissible evidence of the surrounding circumstances at the time of contract formation.

The court was prepared to consider the terms of the LOI, on the basis that the LOI terms were “objective evidence of the parties’ intentions at the time of the definitive agreement.” This was the case even though the “entire agreement” clause explicitly referenced the earlier, non-binding LOI. The clause read: 

This Agreement, the Disclosure Letter and the other Transaction Documents and the other agreements, documents and other instruments contemplated to be delivered by the Parties pursuant hereto, constitute the entire agreement among the Parties with respect to the transactions contemplated by this Agreement, and supersede all prior agreements, understandings, negotiations and discussions, whether oral or written, of the Parties with respect to such transaction, including the Letter of Intent, except for the Non-Disclosure Agreement, which shall terminate and have no further force and effect upon the Closing…

The court also noted, and was clearly influenced by, the following factors: (i) the acquired business had not achieved the first tranche of the earnout payment, (ii) the financing transactions in question had no adverse impact on the acquired business’s performance, and (iii) the seller had been aware of the likelihood of one of the financing transactions pre-closing, but only objected to them when it learned that the first earnout target had not been met.     

Has Canadian M&A Been Here Before? Yes and No

Some M&A parties and practitioners may be surprised by this result. The court’s approach appears to directly contradict the parties’ express instruction in the “entire agreement” clause and thereby also overlooked the critical role the clauses play in M&A. However, this is not the sole instance of a Canadian court refusing to be restrained by an "entire agreement" clause in an M&A dispute.

The most notable previous occurrence is the ruling of the Alberta Court of Appeal (ABCA) in IFP Technologies. The dispute was over the extent of rights acquired in an oil and gas asset exchange. The plaintiff argued it had acquired an interest in all oil and gas production from the lands, whether of a primary (i.e., conventional) or enhanced (i.e., steam-assisted) nature. The respondent argued the plaintiff’s rights were limited to enhanced production. 

An earlier memorandum of understanding (MOU) between the parties clearly supported the plaintiff’s position. But the trial court agreed with the respondent that the “entire agreement” clause in the subsequent, definitive asset exchange agreement precluded reliance on the MOU. The ABCA reversed. It relied on the ruling of the Supreme Court of Canada (SCC) in Sattva, which had not yet been issued at the time of the trial court’s decision. The ABCA held the “entire agreement” clause did not preclude consideration of the factual matrix – including the MOU – to assist in determining the “genesis and aim” of the transaction, which greatly corroborated the plaintiff’s interpretation. 

Comparing Project Freeway and IFP Technologies 

This does not mean the “entire agreement” rulings in Project Freeway and IFP Technologies are precisely aligned. Their principal commonality is that they both relied on the SCC’s ruling in Sattva emphasizing the importance of a contract’s factual matrix. Also notable is that neither court acknowledged the particularly important role played by “entire agreement” clauses in M&A. 

By comparison, notable contrasts between the rulings can be drawn. Primary among these is that, while in Project Freeway the parties disputed the meaning of a single word in a single subclause (i.e., the import of a “materiality” qualifier,) in IFP Technologies the court faced a “serious dispute” as to the very “nature and extent” of the bargain. This caused the ABCA to consult the earlier MOU in search of the “genesis and aim” of the transaction, a concern not similarly stressed in Project Freeway. Second, the MOU in IFP Technologies expressly stated the parties intended to finalize a more definitive agreement based on the MOU’s terms. It is unclear whether the LOI in Project Freeway included any similar language. Third, while the “entire agreement” clause in Project Freeway expressly referenced the LOI, the “entire agreement” clause in IFP Technologies did not expressly reference the MOU. 

It remains to be seen whether a future Canadian court will put any weight on these differences between the two rulings if faced with a similar debate.  

Key Practical and Potential Drafting Takeaways

Prominent Canadian scholars have described “entire agreement” clauses as “one of the most confusing areas of the law of contractual interpretation in Canada,” stating that “it is difficult to predict in any particular case whether an "entire agreement" clause will be enforced or not.”

Project Freeway adds to this complex body of caselaw. On the one hand, the court consulted the LOI in pursuit of what the parties objectively intended by including the “materiality” qualifier in the earnout’s acceleration clause. On the other hand, the court appears to ignore the parties’ objective intent as evidenced by their express reference to the LOI in their “entire agreement” clause. 

What are M&A parties to do going forward? Two options might be considered: 

  1. Include additional boilerplate in the LOI stating that the parties cannot rely on the LOI in any future dispute under a subsequent definitive agreement. 
  2. Add additional language to the “entire agreement” clause in the definitive agreement to similar effect.

Put differently, to guard against a similar result as occurred in Project Freeway, new and improved boilerplate language may be sensible. For example, even otherwise non-binding preliminary documents such as term sheets, LOIs and MOUs often include basic and binding legal provisions addressing, for example, (1) governing law, and (2) dispute resolution. To this could be added a brief clause to the effect of option (A) above. The subsequent definitive agreement could then adopt option (B) above.  

That said, M&A parties must appreciate there is no guarantee a court would consider itself confined by such clauses. Sattva grants wide discretion to consider the factual matrix. Therefore, although precluded from forming part of the definitive agreement by an “entire agreement” clause, preliminary deal documents such as LOIs may nonetheless remain fair game for a court in determining the parties’ commercial objectives at the time they entered into the definitive agreement. 

The situation is similar to other clauses that seek to steer the court’s discretion, such as M&A parties expressly agreeing to the remedy of specific performance upon a breach of the acquisition agreement. M&A parties should therefore not assume that preliminary deal documents become entirely irrelevant upon the execution of a definitive agreement that contains an "entire agreement" clause. On the other hand, the inclusion of the additional clauses suggested above could help in convincing a court to reduce the weight placed on preliminary deal documents should a dispute later arise.

Contact the Authors

For further detail, please contact the authors.

Contact the Authors

Authors

  • Brad Moore, Partner | Litigation and Dispute Resolution, Toronto, ON, +1 416 865 4550, [email protected]
  • Doug H. Scott, Partner | Mergers & Acquisitions, Corporate/Commercial, Toronto, ON, +1 416 943 8823, [email protected]
  • Brendan Sawatsky, Partner | Corporate/Commercial, Calgary, AB, +1 403 261 5506, [email protected]
  • Gesta A. Abols, Partner | Co-Leader, cross border and international practice, Toronto, ON, +1 416 943 8978, [email protected]
  • Elyse Ardiel, Partner | Corporate/Commercial, Toronto, ON, +1 416 865 5159, [email protected]
  • Melissa Cook, Partner | Capital Markets, Mergers & Acquisitions, Calgary, AB, +1 403 261 8499, [email protected]
  • Alexandra Lazar, Partner | Mergers & Acquisitions, Montréal, QC, +1 514 397 5238, [email protected]
  • Kareen A. Zimmer, Partner | Mergers & Acquisitions, Financial Services Regulatory, Vancouver, BC, +1 604 631 4775, [email protected]
  • Paul Blyschak, Counsel | Corporate/Commercial, Calgary, AB, +1 403 261 9465, [email protected]

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