)

REPRESENTATIONS AND WARRANTIES

)

I. REPRESENTATIONS AND WARRANTIES

By obtaining a combination of broad and comprehensive

representations and warranties from the Vendor, the Purchaser is

attempting to ensure that it "gets what it is paying for".

It is suggested that the Purchaser investigate as thoroughly as

possible the subject matter of the Vendor's representations and

warranties prior to the closing. Simply put, it is easier to deal

with a problem before the Vendor has received its money than to

rely on representations and warranties once the transaction has

been completed. For example, if a Vendor has represented that

certain equipment leases of the Corporation are in good standing,

you may suggest that the Purchaser verify this fact by obtaining a

letter from the relevant lessor.

The agreement of purchase and sale should also provide for a list

of documents or other materials which are to be scheduled to the.

agreement, and a statement that such materials are incorporated in

the purchase and sale agreement by reference.

Materials which are ordinarily attached to the agreement are,

without limitation, the financial statements of the subject

Corporation, descriptions of any material contracts, insurance

policies and any leases in real property. Certain additional

closing documents (such as non-competition agreements, releases and

emploYment contracts) are also frequently so significant that the

terms are negotiated prior to the execution of the purchase and

sale agreement and copies are attached as schedules thereto.

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As a practical matter, it is often wise to schedule the foregoing

materials, together with other materials which, if described in the

main body of the agreement, would make the agreement too long and

tedious. For example, this may be the case where assets are being

described and the list of assets is extensive, or the formula for

determining the purchase price is long and complicated. In any

event, the combined use of representations and warranties together

with schedules is an effective way for the parties to thoroughly

define the terms upon which the transaction of purchase and sale is

being completed. After all, representations and warranties provide

the traditional means by which a Purchaser confirms it's

assumptions about the business being purchased. As a result,

however, representations given by a Vendor tend to be quite

extensive.

A. LIMITATION - "ACTUAL KNOWLEDGE"

As many of you will have experienced, there are times when the

Vendor attempts to limit the scope of its representations to actual

knowledge of the facts represented. This limitation naturally

poses a problem for a Purchaser due to the fact that the Purchaser

must, in order to recover damages from the Vendor, first·

demonstrate that a misrepresentation has occurred and then

demonstrate the state of the Vendor's knowledge at the time the

representations were given. On one hand, while the Vendor's

position in seeking a "knowledge" limitation is understandable, the

fact remains that the representations and warranties are being

utilized in order to protect the Purchaser from risks which the

Purchaser does not wish to assume, notwithstanding any state of the

Vendor's knowledge. It is also true to say that, as between the

Vendor and Purchaser, it is the Vendor who should have greater

familiarity with the business and, therefore, should bear the risk.

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In those circumstances where the Vendor protests that it would be

unreasonable for the Vendor to provide a warranty going beyond the

Vendor's state of actual knowledge, then the Vendor should be

asked, at the very least, to qualify their knowledge based

representations and warranties as being made "after due inquiry".

For corporate Vendors, analysis may also be necessary to determine

at what levels (e.g. officers, directors, senior managers) in the

Corporation knowledge is deemed to be known by the Vendor.

As a practical matter, "state of actual knowledge" limitations

should in most cases be restricted to representations about

threatened proceedings and to those representations regarding

absence of defaults on the part of third parties or the compliance

by third parties with material contracts of the business.

The foregoing is not intended to imply that the Vendor's

representations must always be completely unqualified. To begin

with, Vendor's will be reluctant to give absolute representations

in some cases, due in large part to the fact that breach of a

representation or warranty will, given a properly structured

purchase and sale agreement, permit the Purchaser to void the

transaction prior to completion. This is the case because the

truth and correctness.of representations and warranties is usually

made a condition precedent to the closing of the transaction.

Most Vendors do not want to be held up at closing because of some

non-material representation which is found to be "technically"

inaccurate. As a result, practical negotiation of representations

and warranties will frequently lead to a number of compromises in

which "materiality" qualifications are written in to limit the

absolute warranties sought by a Purchaser. There are times when

the materiality concept is specifically defined within the terms of

the agreement ( for example, either by means of some dollar

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reference or linking the representation with the ability (or

inability) of the Purchaser to properly conduct the business in the

event such representation has proven not to be true). More

commonly, however, the term "material" is intentionally left

undefined to be interpreted in the particular context of the

agreement.

In an asset purchase agreement (as opposed to a share purchase

agreement), representations and warranties are more commonly

confined to the business being acquired and there are, relatively

speaking, fewer representations required from the Vendor in such

circumstances.

B. "WRAP-AROUND" REPRESENTATION

As you will see when reviewing the accompanying precedent

materials, most representations and warranties deal with specific

subj ect matter. Frequently, however, lawyers may encounter a

representation in the form of a comprehensive statement similar to

the following:

"None of the representations or warranties herein containan untrue statement of material fact or omit to state anymaterial fact necessary to prevent the representationfrom being materially misleading to the Purchaser seekingfull information regarding the subject matter of thistransaction."

Another variation of the foregoing "wrap around" representation is

to the effect that the Vendor "knows of no fact not otherwise

disclosed in the agreement, which would be material to a buyer of

such a business".

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) The former type of provision is viewed by many counsel as being

reasonable, but the latter should, arguably, be viewed as

unacceptable. The second type of representation is objectionable

since it makes all of the specific representations redundant in

cases where the parties have carefully negotiated and modified

their representations and warranties. The effect of such a wrap

around statement is to nullify all the limitations and

qualifications which have been carefully negotiated. The former

provision is more appropriate because it is intended to ensure the

Purchaser that none of the statements made by the Vendor will

result in the Purchaser being mislead due to the omission to state

some other relevant fact. For example, a representation might

indicate that the Vendor is duly licensed, which might be true.

However, it could also be relevant to know that the Vendor's

licence is about to be rescinded unless significant capital

expenditures for environmental compliance purposes are made.

C. "REPRESENTATION" VERSUS "WARRANTY"

As already stated, most purchase agreements will clearly stipulate

that the Purchaser's obligations to complete the transaction are

conditional upon the representations and warranties being "true and

correct" on the date of closing, with the same effect as if made on

and as of that date. Finally, other provisions (to be discussed

later on) extend the duration of the warranties beyond closing for

a specified period of years.

The effect of all of the foregoing is that, if it is discovered by

a Purchaser prior to the closing that one of the statements of fact

presented by the Vendor is untrue, the Purchaser under the terms of

the agreement can be relieved of its obligation to complete the

transaction. On the other hand, the statements of fact are also

described as "representations" and "warranties". If one of them of

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a material character is found to be untrue after the closing of the

transaction and within the "survival period", the Purchaser will be

entitled to claim damages.

Needless to say, there is a reason for utilizing both

"representations" and "warranties". A representation is a

statement as to existing facts. A warranty is a term of the

contract, a breach of which entitles the innocent party to a

remedy.

One case which illustrates the meanings of these terms (and

emphasises the importance of a "survival" clause in an acquisition

agreement) is discussed in the Aird & Berlis publication Business

Acquisition Agreements: An Annotated Guide. The case is that of

Richview Construction Co. Ltd. v. Raspa (1975), 11 O.R. (2d) 377.

In that case, the Ontario Court of Appeal dealt with an agreement

of purchase and sale for a vacant lot in a residential subdivision.

The agreement contained the following provision:

"It is understood and agreed that this is a vacant lotand that the Purchaser has the privilege to erect asingle family dwelling on plans approved by the Boroughof Etobicoke. Being a fully serviced Lot •••• "

After the transaction had been closed, the Purchaser discovered

that the Lot was not fully serviced. The Purchaser sued for

damages for breach of contract. On page 380, the Court stated:

"The clause is to be read as if it said, on this point:

)

'It is understood and agreedis a fully serviced Lot.'

that this

How is such a provision to be characterized, in terms ofcontract law? Different results follow if it is a "mere

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representation", a "collateral warranty", a "collateralcontract", or a "term of the contract". These are termsused in various of the decided cases, and not always -­according to the textwriters and commentators -- withaccuracy and precision.

It is small comfort, at this stage, to recognize that noproblem would have arisen if the Offer to Purchase hadread:

, The Vendor warrants that this is a fullyserviced Lot, and agrees that this warrantyshall survive the closing of the sale' .•.. "

In dealing with the issue of "representation" versus "warranty", at

page 382 the Court stated:

"In my view, the clause here in question is not a 'mererepresentation'. Such a representation, if madeinnocently « i . e.) without fraud) gives no· cause ofaction for damages after closing although it turns out tobe untrue . . . .

To elevate a 'mere representation' to the category of a'warranty', it is not enough to show that the statement,originally made orally, has been included in the writtencontract. Such inclusion simply puts it beyond disputethat the representation was made . • • •

What is required to lead a Court to construe a provisionas a warranty has been expressed in a number of ways. InWaxman v. Yeandle, at page 376 O.R., p. 479 D.L.R. Roach,J .A., said:

'In order to succeed in this action, thePlaintiff . would have to prove that theDefendants contracted with him that therepresentation was true and that in the eventit is turning out to be untrue, they wouldindemnify him against loss that might therebybe occasioned to him.'

At p. 377 O.R., pp - 479 - 80 D.L.R., he stated:

'I am unable to conclude from the languageused in the paragraph in question that it was

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the intention of the paragraph to constitute awarranty. A person can be made liable if hewarrants the truth of a representation, but itmust be made abundantly clear that thewarranty was in fact given. '"

As you will note, the Court concluded in the Richview case that,

although the clause in question constituted a warranty, the

warranty did not survive the closing of the transaction and the

Purchaser therefore had no remedy. To summarize, therefore, the

Vendor's representations and warranties will, after closing, be the

only source of effective remedies for the Purchaser and, if they

are incomplete or otherwise do not address any matter which is

discovered after closing and materially affects the value of the

purchased shares or assets, the Purchaser, in the absence of fraud,

will be left without remedy. The Purchaser will, in such a case,

likely be paying you a visit.

D. POSITION AND OBLIGATIONS OF LEGAL COUNSEL

Given the foregoing, each solicitor must recognize that the

representations and warranties are intended to accurately state the

Purchaser's expectations and the relevant state of affairs of the

business. Exceptions are frequently stated in schedules, many of

which will not be finalized until well after the first draft of the

agreement has been delivered.

Frequently, the first draft of the purchase agreement (which is

almost always drafted by the Purchaser's solicitor), will

constitute a "fishing expedition" or present the Purchaser's "high

water mark" for finalizing the transaction. Naturally, counsel

should advise any Purchaser that it should have some expectation

that the final draft of the Vendor's representations will not match

up with the initial draft, and representations will have to be made

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the subject of exceptions. As a result, the solicitor for the

Vendor and the Vendor must carefully review the representations for

accuracy and carefully state (frequently utilizing the schedules)

any necessary exceptions. The Vendor's counsel must make it known

to the Vendor that a false representation has consequences, and if

discovered prior to closing, will permit the Purchaser to avoid its

obligation to conclude the transaction. It may also expose the

Vendor to liability for damages for misrepresentation, both before

and after closing.

Problems with the Vendor's representations may often be discovered

and should be addressed frankly and openly between the parties.

The content of the Vendor's representations often affects the price

which the Purchaser is willing to pay for the purchased shares or

assets.

The initial draft of the purchase agreement may, or may not, follow

a letter of understanding between the parties. However, due

diligence has usually progressed to a point where the Purchaser and

Vendor are at least satisfied that there is a transaction to be

completed. Since the first draft is often designed to meet the

needs of the Purchaser and not the Vendor, a decision must be made

by Purchaser's counsel in conjunction with the Purchaser about the

"even handedness" of the first draft. On one hand, a first draft

which "leans hard" towards the benefit of the Purchaser is natural.

However, most of us have had the experience of reviewing the first

draft and finding little to connect its terms and provisions with

the economic terms already negotiated between the parties. In

addition to that, it frequently does not represent the basis upon

which the agreement is actually finalized. The risk that

Purchaser's counsel may run is that the initial draft can destroy

trust and confidence which the Vendor and Purchaser, as business

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people, have carefully nurtured between themselves. This, in turn,

could destroy the entire basis of the transaction.

Notwithstanding the foregoing, however, the Purchaser's counsel is

obligated to provide the best representation for the Purchaser

possible. As a result, there may be no substitute for Purchaser's

counsel taking the first draft of the purchase agreement and

carefully reviewing the same (and the potential for any negative

impact thereof as between the two parties) with the Purchaser.

This may result in the ability of the Purchaser to both provide

reasonable qualifications during the initial draft or, at the very

least, provide the Purchaser with the opportunity to discuss the

matter with the Vendor prior to delivery of the first draft to the

Vendor's counsel.

The precedent materials provided herein have been drafted from the

position of the Purchaser, setting forth terms which we would

expect the Purchaser might wish to see in an agreement. You

should, when preparing an initial draft, operate on the assumption

that if the Vendor objects to certain clauses, those objections

will be dealt with in the negotiations between the parties by the

appropriate amendments, qualifications or deletions. The

precedents accompanying this material have assumed that the

Shareholder of the Vendor is a party to the agreement and will

jointly and severally make the representations and warranties and

give certain covenants with the Vendor. The Vendor's counsel must

understand that, in these circumstances, the Shareholder is taking

on personal liability for a number of matters, and that, in the

absence of a sale, the vast majority of such matters would not have

otherwise imposed any personal obligation.

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E. ANALYSIS OF REPRESENTATIONS AND WARRANTIES - SHARE PURCHASEAGREEMENT PRECEDENT

* Note: Much of the commentary in this section is drawn from or

based on information found in Business Acquisition Agreements: An

Annotated Guide by Aird & Ber1is (1992, Canada Law Book Inc., 240

Edward Street, Aurora, Ontario, L4G 3S9)

1. 3.1(1) Corporate Authority and Binding Obligation

Closely held corporations frequently restrict the ability of

Shareholders to transfer shares, either in their Articles or in

some other manner. These transfer restrictions may range from

requiring the approval of the majority of the Board to requiring

certain Shareholder approval. Unanimous shareholder agreements

also frequently provide for rights of first refusal and other

restrictions on transfers.

In addition, it is possible that the sale of shares (or assets)

constitutes all or substantially all of the assets of the Vendor

Corporation. In such circumstances, both the Canada Business

Corpora~ions Ac~ and The Business Corpora~ions Ac~ (Saskatchewan)

require approval for the sale by a "special resolution" of the

Shareholders. In closely held corporations, this approval can

usually be easily obtained on or before closing.

2. 3.1(2) - No Other Purchase Agreements

This representation assumes that a careful review of the corporate

records of the Corporation (including its financial statements) has

been completed. Again, a review of any shareholder agreements

checking for rights of first refusal, options to purchase or other

rights available to shareholders other than the Vendor must be

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completed. At times, there are also other material contracts which

have granted option rights, rights of first refusal, etc. to

contracting parties including, franchisors and licensors of the

Corporation.

3. 3.1(3) - Contractual and Regulatory Approvals

The precedent put forward here contemplates a schedule which will

contain a list of necessary consents or regulatory approvals to be

obtained or fulfilled by the Vendor. Many standard contracts (such

as leases), require the consent from a third party prior to a

change in control of the Corporation. This is also the case in

respect of most standard financing arrangements licensing and

franchise agreements. In addition, some businesses are statutorily

regulated and the governing statute imposes consent requirements or

other approvals. Common examples of these are businesses requiring

environmental permits for operation, liquor licences or any

business where one of the employees/shareholders is required to a

maintain professional standards or licences.

4. 3.1(4) - Status, Constating Documents and Licences

While the precedent paragraph provided in relation to this heading

is a good "opening volley", additional adjustments or disclosures

are almost always necessary.

5. 3.1 ( 5) - Compliance with Constating Documents, Agreementsand Laws

The precedent provision in this case may often be the subject of a

materiality limitation by the Vendor, particularly since a minor

violation would put the Vendor offside in subparagraph 5(c). In

large transactions, it is not unusual to spell out the definition

of material. This may be done by means of financial remedies or,

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) alternatively, the accumulated cost of certain remedies not

exceeding a particular dollar threshold.

6. 3.1(6) - Corporate Records

All of us will have seen a form of representation like this at some

point in time. It is also fair to say that it is seldom absolutely

correct. The manner in which a Vendor may wish to limit this

representation or warranty is important, however, since improper

corporate actions may well go to the entire root of the contract.

(For example, if the subject matter of the agreement is shares and

the same have not been validly issued). As such, the Purchaser's

counsel should not easily accept "knowledge" as the basis for many

aspects of this representation by the Vendor.

7. 3.1(7) - Authorized and Issued Capital

8. 3.1(8) - Shareholders Agreements. Etc.

Closely held Corporations which have more than one Shareholder

frequently do have some form of Shareholder Agreement containing,

at the very least, a buy-sell provision. There may also be special'

voting arrangements in place. In that case, the parties could

consider appending the Shareholder Agreement. However, the issues

raised by the agreement must be dealt with and be clearly

understood between the respective counsels. For example, if a

right of first refusal or option exists, will a waiver be obtained

or will the right of first refusal process actually be followed?

The latter solution may involve a considerable delay in most cases

which will not be acceptable to a Purchaser. In other

circumstances, the Vendor may arrange to have the Shareholder

Agreement terminated immediately prior to closing of the

transaction or to be amended effective on closing.

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9. 3.1(9) - Financial Statements

The importance of the financial statement representation cannot be

overstated. It has also been correctly pointed out that even

audited statements are nonetheless statements of the Vendor, and

not the auditors. The law is not yet abundantly clear on the

obligations of auditors to a Purchaser, even in circumstances where

the auditors knew or ought to have known that the statements would

be presented to and relied upon by a Purchaser in finalizing the

transaction.

Whether or not the statements are audited, a Purchaser is entitled

to a representation that they have been completed in accordance

with generally accepted accounting principles and that they

presently fairly the financial position of the Corporation and the

results of its operations. There may be circumstances where more

detailed representations about specific items in the financial

statements are also of vital importance to a Purchaser ( for

example, matters dealing with collectibility of accounts

receivable, etc.).

10. 3.1(10) - Financial Records

With respect to financial records, the Vendor will frequently want

some limitation in terms of materiality. This will, as always,

amount to a risk distribution as between the parties.

11. 3.1(11) - Liabilities of the Corporation

A clause such as that found in the precedent agreement is common.

The Vendor is given the opportunity to specifically list in

schedules any liability exception known to the Vendor. As to

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whether or not the representation would be limited to the "best of

the knowledge" of the Vendor is, again, a subject of risk

allocation as between the Vendor and Purchaser. This may be

capable of finalization, again, by means of some materiality

threshold. However, as Purchaser's counsel, your client will not

be impressed with your drafting capabilities in the event that a

large undisclosed liability arises after completion of the share

purchase transaction, notwithstanding that the same was not "within

the knowledge" of the Vendor.

12. 3.1(12) - Indebtedness

The indebtedness representation in the precedent agreement is

particularly aimed at long-term debt less the amount of "short-term

debt" falling due within one year.

13. 3.1(13) - Absence of Certain Changes or Events

14. 3.1(14) - Commitments for Capital Expenditures

As you will note from a review of the foregoing representation in

the precedent material, the same requires an extensive review by·

the Vendor. You will note that the representation contains certain

"exception" wording, usually to the effect of activities which have

been carried on or incurred "in the ordinary course of the

business". Aird & Berlis in Business Acquisition Agreements - An

Annotated Guide provide an interesting comment with respect to the

meaning of this type of exception. In other parts of the

agreement, you will also find wording referring to the "routine

daily affairs of the Business", as an added exception. In

comparing the phrase "the ordinary course of the routine daily

affairs of the Business" with the wording "the ordinary course of

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the Business", Aird & Ber1is indicate that the difference in

phraseology is best explained by an example, namely:

"The purchase by a Corporation of, say, a new plant siteand the commencement of a construction of a plant thereonmight well be characterized as being in the ordinarycourse of the Business even if it involved theexpenditure of many millions of dollars, it being thenature of corporations to expand their Businesses. Suchan expansion could never, however, be characterized asbeing in the ordinary course of the routine daily affairsof the Business. By the same token, the replacement ofa motor in a forklift would be both in the ordinarycourse of the Business and in the ordinary course of theroutine daily affairs of the Business."

15. 3.1(15) - Dividends and Distribution

While this representation, as drafted in the precedent agreement,

can often be made, there may be exceptions where the Purchaser is

intending to pay a certain dividend on the purchased shares prior

to closing, or a redemption of shares may be necessary in respect

of a class or series of shares prior to closing of the transaction.

16. 3.1(16) - Tax Matters

As you will note, the representation dealing with "governmental

charges" and the related tax implications thereof is extensive.

Take note also of subsection 3.1 (16)( g) which specifically sets out

in the agreement tax related items such as paid up capital, non­

capital losses, adjusted cost bases, etc. These are, of course,

not items which would be found in the financial statements of the

Corporation. However, this information which provides the future

basis for taxation of the Corporation may be extremely important to

some purchasers. (For example, natural resource corporations have

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"resource pools" for tax purposes which may be of considerable

importance to the Purchaser.)

17. 3.1(17) - Litigation

The Vendor often attempts to take the position that the last

sentence of this representation should be qualified by wording "to

the best of the Vendor's knowledge". This is, as always, a matter

of risk allocation between the parties. One solution again may

relate to a materiality threshold which will quantify the ultimate

damages to be sustained by a Purchaser, in the event of a breach of

this provision, while providing a "safe zone" within which the

Vendor may operate "unmolested".

18. 3.1(18) - Environmental Matters

As you will note, the precedent contains a very extensive prov~s~on

dealing with environmental matters. Nonetheless, this entire area

is one which Purchaser's counsel must take seriously and, at the

very least, have taken efforts in order to fully inform clients.

Clients are frequently well aware of the concept of environmental

risk (as are their Bankers!).

If the environmental representations provide disclosure of

particular concerns, the manner in which those are dealt with may

be of vital importance. I recall working on a major transaction

which, as a result of the initial representations and warranties

dealing with environmental matters, resulted in the completion of

the asset and real property purchase but the "severance" of certain

portions of the real property from the purchase and sale

transaction. The Purchaser was, in turn, granted certain easement

rights and indemnities (related to the severed areas). On the one

hand, the transaction was completed. On the other hand, the Vendor

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was left in the circumstance where the Purchaser, albeit a new

joint venture partner, was left sharing in none of the associated

historical risks in respect of the environmental contamination and

clean up. That agreement also required fairly detailed schedules

to describe the various treatment facilities, tailings ponds and

other related facilities.

Again, a Vendor may be seeking materiality thresholds or financial

caps on environmental representations. Clearly, some businesses

are more environmentally sensitive than others. I f the business is

clearly of an environmentally sensitive nature, my recommendation

would be that the parties conduct an environmental audit and that

the same be completed prior to closing. Recently, I have seen a

number of transactions virtually "derailed" as the result of

environmental concerns which, at the end of the day, were not well

founded. Nonetheless, all parties (particularly Purchasers, their

solicitors and financial backers) want a strong representation and

indemnity in relation to environmental matters and/or independent

third party evidence that the environmental status of the business

is "clean".

The agreement must also provide for general access and testing

clauses, examination of the records and assets of the Purchaser,

and environmental audit and remedial work clauses. The matter of

cost sharing of such audits and any remedial work required is also

a matter of negotiation. Remedial work, in most cases, will fall

upon the Vendor or will permit the Purchaser, in certain

circumstances, to void the agreement ab initio.

19. 3.1(19) - Title to Assets

20. 3.1(20) - Deposit Accounts and Safety Deposit Boxes ofthe Corporation

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21. 3.1(21) - Accounts Receivable

Needless to say, the Bankruptcy of a major customer of the Vendor

Corporation during the "interim period" between signing of the

purchase agreement and closing could well permit the Purchaser to

avoid the obligation to close. That event is clearly beyond the

control of the Vendor and is not predictable. Nonetheless, the

Vendor should clearly understand the effect of representations

dealing with accounts receivable. Furthermore, qualification by

materiality may also be considered in these circumstances.

22. 3.1(22) - Inventory

Any obsolete inventory which falls outside the "reasonable

allowance" for obsolete inventory should be specifically excepted

from the representation. Purchasers are often concerned about

their ability to utilize inventory in the ongoing operation of the

business following closing.

23. 3.1(23) - Real Properties

Depending on whether the Vendor owns real property or not, one of

the sample clauses contained in this subsection of the precedent

agreements will be useful from the Purchaser's perspective.

Representations may also be requested concerning compliance by the

Vendor with agreements affecting the real property in relation to

governmental authorities, easements, rights of way, suppliers of

utility services, etc. In addition, the representation that the

construction of all buildings and the occupancy thereof is in

accordance with validly issued building permits and occupancy

requirements is advisable.

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The status of any leases granted to third parties in respect of

property is also important. If there are no leases, tenancies or

rights of occupancy, this should be confirmed. If any such leases

or other obligations exist, representation should be made to the

extent that there is no default in relation thereto. Provision may

be made for appropriate estoppel certificates from each tenant or

third party. Finally, confirmation that any mortgage or other

financing is not in default should also be obtained.

24. 3.1(24) - Leased Premises

Matters dealing with validity of leases and confirmation that no

breach has occurred in relation thereto will normally be dealt with

by means of an estoppel certificate from the Landlord. The same

should be available on closing. Again, a number of leases contain

provisions dealing with change of control, which may have to be

dealt with prior to closing.

25. 3.1(25) - Work Orders and Deficiencies

Depending on the use of buildings located on real property or the

use of leased premises, specific representations may also be

requested in relation to such matters as elevator or escalator

operations, disposal units, or other licences required to operate

in buildings and related facilities in good standing.

26. 3.1(26) - Condition of Properties and Equipment

This representation again is important from the Purchaser's

perspective, but should be carefully analyzed from the Vendor's

perspective. Matters in relation to building structure could be

expanded in order to include exterior weather walls, exterior doors

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and windows, foundations, footings, parking lots, access roads,

etc.

27. 3.1(27) - Leases of Personal Property

28. 3.1(28) - Intellectual Property

There are circumstances where intellectual property is truly the

major asset of value owned by the Corporation being purchased. If

that is the case, certain other specific representations may be

necessary. A representation is also included in the precedent

dealing with hardware and software being free from viruses. A

check should be run by a Purchaser in relation to computer viruses

as soon as possible following closing.

29. 3.1(29) - Subsidiaries and Other Interests

If the Corporation does own subsidiaries, then representations in

the agreement should be tailored accordingly. This may also

include financial statements being prepared on a consolidated basis

and individually for each corporation.

30. 3.1(30) - Partnerships or Joint Ventures

31. 3.1(31) - Customers

32. 3.1(32) - Restrictions on Doing Business

33. 3.1(33) - Guarantees, Warranties and Discounts

Each of the foregoing representations could be costly to the Vendor

(and any Shareholder guaranteeing the accuracy thereof) if they are

untrue. The existence and amount of guarantees, warranties and

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discounts are directly related to a price which the Purchaser is

prepared to pay. The Vendor is obligated to disclose any special

extended product warranties which a customer has been able to

extract, as well as prepaid repair contracts or goods delivered on

consignment.

34. 3.1(34) - Licences, Agency and Distribution Agreements

35. 3.1(35) - Outstanding Agreements

36. 3.1(36) - Good Standing of Agreements

As they currently stand, the foregoing represent onerous

representations on the part of the Vendor. The Vendor will usually

attempt to modify the same in respect of material adverse affects

on the Corporation and its business operations.

37. 3.1(37) - Employees

The representation calls for a fairly detailed explanation of

employee remuneration and other aspects of employment. With

respect to employees who might be on workers' compensation, a

further representation may be necessary with respect to their right

to return to employment with the Corporation. The confidential

aspect of some of the information contemplated by this schedule may

call for the same to be delivered separately from the actual

purchase and sale agreement, upon finalization.

Clearly, Purchasers through acquisition of shares, will acquire all

of the liabilities for termination, severance payments, statutory

or otherwise. The information called for in the schedule helps a

Purchaser to better understand and estimate the potential limits

within which they may be operating. In some circumstances, these

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can be significant costs related to operation of an ongoing

business. There are times when the cost of certain termination or

severance may be agreed to between the Purchaser and the Vendor and

for which the Vendor would agree to share in with the Corporation.

38. 3.1(38) - Employment Agreements

Any exceptions to this representation should be very explicit. For

example, employees with written contracts of employment or special

oral arrangements may be in a position to enforce rights as against

the Corporation on a change of control not otherwise capable of

enforcement in respect of common law contracts where the contract

is one of an indefinite hiring.

39. 3.1(39) - Labour Matters and Employment Standards

40. 3.1(40) - Employee Benefits and Pension Plans

41. 3.1(41) - Insurance

Most of us are familiar with provisions dealing with insurance

whereby the Vendor Corporation indicates that it is carrying

insurance of a type which a prudent person carrying on a similar

business would maintain. However, a Vendor may well take the

position that it will simply provide its insurance coverage to the

Purchaser, who can determine whether the Purchaser, as a reasonably

prudent person, wishes to obtain additional insurance coverage.

42. 3.1(42) - Non-Arm's Length Matters

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43. 3.1(43) - Government Assistance

For some Corporations, government assistance programs can be of

significant value and there may be circumstances when otherwise

forgivable loans or grants may have to be repaid. Finally, there

may be adverse tax consequences in respect of such programs in

certain circumstances.

44. 3.1(44) - Compliance with Laws

As you will note in the draft agreement, more specificity may be

required in order to properly deal with the statutes which impact

more on the Vendor's operations than "laws of general application".

45. 3.1(45) Vendor's Residency

As most solicitors are aware, if the Vendor is a non-resident of

Canada within the meaning of the Income Tax Act (Canada), then

either the Vendor must deliver to the Purchaser a certificate

pursuant to s. 116 of the Income Tax Act (Canada) doing away with

the need for a holdback or, alternatively, the Purchaser will be

required to withhold one third (1/3) of the purchase price and

forward it to the Receiver General for Canada on behalf of the

Vendor. Competent tax advice is required in these circumstances.

46. 3.1(46) - Copies of Documents

47. 3.1(47) - Disclosure

As discussed earlier, the last representation (dealing with failure

to state any material facts) may be a representation found rather

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) onerous on the part of the Vendor. The Vendor again will attempt

to limit this by means of knowledge.

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SURVIVAL OF WARRANTIES

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I. 4.2 - SURVIVAL OF WARRANTIES BY THE PURCHASER

As noted from earlier discussions, it is important that

representations and warranties be clearly indicated as surviving

the closing of the transaction. The period of "survival" time will

be a matter of negotiation between the parties. More importantly,

rather than having a general survival clause" lumping" together the

longevity of all representations and warranties for one specified

period of time, it may be better (although more work) to break out

representations which will survive for certain periods of time.

For example, there should be no time limitation on certain

representations, such as one which represent that the shares being

purchased have been duly allotted and issued.

On the other hand, certain less material representations may fall

by the wayside within a year or two following closing since the

Purchaser will be in a position to determine the accuracy thereof

within such time frame.

Vendors may also attempt to place dollar limits on claims for

breaches of warranty. Again, Purchasers may be prepared to live

underneath a certain threshold number. This again is always a.

matter of negotiation as between the parties. Another issue arises

whether a Purchaser should be entitled to claim all damages if the

minimum level of damages has been exceeded « i •e.) if the threshold

is $20,000, does damage amounting to $20,001 give the Purchaser the

right to collect $1 or the entire $20,001 amount?)

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INDEMNIFICATION

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I. INDEMNIFICATION

You will note from a review of the accompanying precedent that an

indemnity provision usually consists of two parts -- an indemnity

for damages suffered by the Purchaser (the "supplementary

indemnity") and an indemnity against liabilities incurred by the

Purchaser to third parties (the "third party indemnity").

A. THE SUPPLEMENTARY INDEMNITY

It is standard practice to include an indemnity clause as

supplemental to the representations and warranties in both the

asset and share purchase agreements.

An action on an indemnity is an action to enforce a contract, not

an action for damages for breach of a contract. That distinction

may have important consequences. A person who wants to use an

indemnity clause (the "indemnitee") incurs responsibilities to the

person giving the protection (the "indemnitor") that may be

onerous. The indemnitee has to preserve the indemnitor's rights to

any security that the indemnitee may have, and any rights of action

that may be available to recover from a third party the amount that.

the indemnitor has had to pay. Rights of indemnity may be lost if

the indemnitor is not given prompt notice of the claim. The terms

that the parties have agreed to for the procedure under the

indemnity clause may turn out to be very restrictive.

The desirability of or need for a general supplemental indemnity

should, like every clause in the agreement, be carefully reviewed

and the benefits and risks assessed.

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B. THIRD PARTY INDEMNITY CLAUSE

In many asset purchase agreements the line between the third party

indemnity and the supplemental one may not be clear. After an

asset purchase, the Purchaser may be liable, for example, as the

owner of the land, for the costs of an environmental clean-up which

can be traced to the Vendor's conduct. The Purchaser may have a

remedy under either an appropriate warranty or an indemnity from

the Vendor. A right of indemnity for this claim would be closer to

a "true" indemnity than in the case of the supplemental indemnity,

even though there is also a warranty that there are no outstanding

environmental risks or claims. In this situation, a claim under

the indemnity functions as a true indemnity, measuring the

indemnitee's loss by the amount required to meet the third party

claim, rather than an amount as damages.

In all cases where a third party indemnity claim may be made, it

will be very important to the parties to decide who controls the

litigation. There is obviously no single answer, and perhaps no

simple answer. What is important is that the parties deal with

their concerns expressly.

Normally, limitation periods of 12 to 24 months are agreed upon

with some longer time period applicable to tax warranties tied to

the expiry of reassessment periods. It is important to provide

that these periods not be extended by any waiver by the indemnified

party of the time limited for reassessment given to the taxing

authorities by the indemnified party without the consent of the

indemnifying party. There may also be a further exception for tax

fraud, for which there is liability to reassessment without

limitation as to time.

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Sometimes the Purchaser's rights of indemnification will be limited

to claims in excess of a certain minimum dollar level. It is

important to clarify whether this minimum requirement is

effectively a threshold amount or a deductible amount. It is the

former then, subject to claims totalling at least that minimum

amount, indemnification may be obtained for all claims, including

those below the threshold. On the other hand, if it is a

deductible amount, the only claims which may be recovered are those

in excess of the minimum « i . e.) the deductible becomes a risk

assumed by the Purchaser). A deductible is probably inappropriate

where the representations have been qualified by materiality

provisos.

As regards the concept of a threshold, the underlying principle is

that there has to be a sufficient dollar amount of claims to make

it worth the time and effort of the parties to determine and adjust

for them. Once that level has been reached, however, the right of

recovery should, arguably, apply to all claims and not just those

in excess of the minimum amount.

It is sometimes contended that the right to indemnification flows

as a matter of law from the breach of a contract and it is

therefore unnecessary to provide for them in express terms. That

point is, at best, debatable, and hence the Purchaser should

insist, and reasonably so, that he be entitled to this level of

protection. Additionally, indemnity provisions commonly establish

the mechanics and the time within which claims are to be asserted.

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GENERAL PROVISIONS

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I. GENERAL PROVISIONS

Almost invariably, clients do not want to deal with or even read

the provisions of an agreement that are grouped under a heading

such as "General" or "Miscellaneous". The comment you may hear is

that "it is just boilerplate" and "let the lawyers handle it".

Clients, and perhaps many lawyers, seem to think that such

provisions are "standard" and therefore do not warrant much

attention.

Contrary to what the client might think, general prov~s~ons can, in

certain circumstances, become very important. A client resident in

Saskatchewan and needing to give notice to another party resident

in British Columbia on the last day of a notice period might be

very appreciative when she/he finds out that counsel has drafted

the notice provision to include notice by telecopy which can be

effected on the last day of the notice period. A client resident

in Saskatchewan wishing to commence legal proceedings against

another party resident in Quebec might likewise be appreciative if

the agreement provides that the courts of Saskatchewan will have

exclusive jurisdiction to deal with any litigation arising out of

the agreement.

It is because of the importance that these general provisions can

have (and because clients too often consider them to be "standard"

and not worth the effort to read), that counsel must be diligent

and ensure that careful thought is given to these provisions in the

context of the agreement in which it is contained.

A. FURTHER ASSURANCES

The obligation of any party under a further assurances clause

should not be limited to what is reasonably required to give effect

to the agreement and should not obligate a party to act simply.I

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because, in the opinion of the other party, it may be desirable to

do so.

Sometimes, in a sale agreement (especially a sale of assets), it is

prudent to provide that, in respect of any assets which, for any

reason (usually the failure to obtain some outstanding third party

consent), are not effectively conveyed at the closing, the Vendor

will continue to.hold such assets in trust pending their effective

transfer.

B. REMEDIES CUMULATIVE

This provision is of particular importance to the Purchaser, who

may need to "stack" their claims for damages or indemnities. The

aspects of this clause dealing with non-waiver are dealt with later

in this paper.

C. NOTICES

A property drafted Notice clause should apply not only to formal

notifications given under the agreement but all communications

given under the agreement such as approvals, delivery of'

certificates and the like required or permitted to be given under

the agreement.

It is wise to provide for modes of delivery in addition to mail,

such a personal delivery (including couriers) and telecopier. In

certain circumstances, notice by telex or telegram might also be

appropriate; however, these methods are becoming outdated. As

regards electronically transmitted communications, it may be useful

to provide that they are to be confirmed by a signed original,

mailed or sent not later than 24 hours or 48 hours after the

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original transmission. With regard to notifications by mail, it is

useful to include a postal interruption clause.

For certainty, it is helpful to include deeming provisions as to

the date on which the notice is deemed to have been given and

received for the purposes of the agreement by the various methods

permitted under the agreement. As regards personal delivery, these

should be confined to being effected on business days or, if

delivered on a non-business day, it should be deemed to have been

received on the next following business day. As regards personal

delivery to be effected on a Corporation, it is quite common to

specify that delivery is to be made to a responsible officer or

employee of the company to whom the notice is being given, to

ensure that it is not misplaced or lost in the corporate

bureaucracy. The notice clause should contain provisions

permitting any party to change its address by giving notice to such

effect to the other parties.

Parties often specify that copies of all communications are to be

given to counsel, so that what are essentially legal communications

will get prompt attention by legal counsel.

Where various methods of giving notice are permitted, it is

desirable to include appropriate data together with the address of

each of the parties to facilitate communications by those methods,

as for example, proper postal and delivery addresses and telecopy

numbers and the name (or titles) of any individual or corporate

officials to whose attention such communications are to be sent.

D. TIME

The purpose of a "time is of the essence" provision is to preclude

a court exercising its equitable jurisdiction to award days of

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grace or a reasonable time for the performance of a time stipulated

obligation. Such a provision is probably also important in respect

of counsel's opinion concerning the enforceability of a contract in

accordance with its terms.

E. INTERPRETATION

For the sake of clarity and ease of drafting, it is useful to

include an interpretation provision, although it is also quite

common to include such provisions with the "Definitions" at the

beginning of the agreement.

F. CHOICE OF LAW AND JURISDICTION

Choice of law clauses are usually believed to have some effect on

what rules "govern" the rights and obligations of the parties under

the contract.

However, if the court where the litigation occurs considers that

the statutory or common law rules of that place apply to the

contract irrespective of the parties' intention, then those rules

apply whatever law may have been chosen by the parties. For

example, no clause in a Saskatchewan contract will avoid the

application or effect of The Securities Act, 1988 (Saskatchewan) if

a court thinks that the Act applies. Generally speaking, no choice

of law clause will prevent the court from applying the rules that

it believes apply to all contracts. A choice of law clause is a

guide to the interpretation of the contract and will not override

the substantive law of the jurisdiction where the action is

brought.

A choice of jurisdiction clause is more likely than a choice of law

clause to ensure that one set of provincial rules rather than

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another is applied to a contract. Choice of jurisdiction clauses

are of two types: exclusive and non-exclusive. Examples of each

are as follows:

(a) Non-Exclusive Choice of Jurisdiction Clauses

"The Parties agree that any dispute arising under this agreement

may be brought in the courts of Saskatchewan."

OR

"Should any dispute of any kind arise under this agreement or any

question in respect of the interpretation, validity, termination or

non-termination of this agreement, or any renewal thereof, the

parties agree to submit to the jurisdiction of the courts of the

Province of Saskatchewan."

(b) Exclusive Choice of Jurisdiction Clause

"This agreement is subject to the exclusive jurisdiction of the

Courts of the Province of Saskatchewan."

A clause similar to the exclusive jurisdiction clause above was

held by the Saskatchewan Court of Appeal to confer exclusive

jurisdiction on the Ontario courts and to prevent a Saskatchewan

dealer from suing Volkswagen Canada in Saskatchewan. See E. K.

Motors Ltd. v. Volkswagen Canada Ltd., [1973] 1 W.W.R. 466.

It is likely that, at least as between parties of equal bargaining

power, the courts will enforce a choice of jurisdiction clause,

even if it means that a local plaintiff is denied a forum where it

does business. No harm is likely to be done by the inclusion of a

choice of law clause with a choice of jurisdiction clause,

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particularly with an exclusive choice, but the choice of law clause

is probably unnecessary: the choice of law will be inferred from

the choice of jurisdiction. It would be unwise to choose a law

that is not the law of the place chosen as the place for

litigation. Such a choice could force the client to incur the

expenses of proving the foreign law.

Some care must be taken before a choice of jurisdiction clause is

inserted in a contract. First, such a clause may be a much more

contentious bargaining issue than a choice of law clause since the

impact on possible litigation costs may be significant. Second,

the choice made must be consistent with the nature of the agreement

and the likely needs of the client. Considerations of where it

would be convenient for the client to sue must be known and kept in

mind. It would, for example, probably be a mistake to have any

choice of jurisdiction clause in an agreement imposing restrictions

on competition within Canada «i.e.) a non-competition clause wide

enough - and justifiably so - to prevent competition in Canada).

The Purchaser in such a situation may need an injunction and there

may be serious limits on the effectiveness of an injunction

obtained in Saskatchewan in controlling the activities of a

defendant in British Columbia. In addition, the evidence of the

harm flowing from the defendant's activities may be most easily

shown in the place where it is acting in violation of the non­

competition clause. A choice of law clause in such an agreement

would be unlikely to override any provincial limits on the

availability of the remedy sought or the standards of public policy

to be applied by the court before which the action is brought, and

may simply add to the complexity of any action.

In G & E Auto Brokers v. Toyota Canada Inc., [1980 13 B.L.R. 33,

the parties agreed to submit all disputes to the courts of the

Province of Ontario exclusively. In that case, the alleged breach

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) of contract occurred in British Columbia and the Plaintiff brought

its action in that province. However, the British Columbia court,

giving effect to the agreement, stayed the action, even though it

acknowledged that it has an overriding discretion not to do so if

it considers that there is good reason to permit it. The exclusive

identification of the courts of one jurisdiction place a heavy onus

on a party contending that the courts of another place ought to

have jurisdiction. In Westcoast Commodities Inc. v. Yehia (1985),

30 B. L. R. 107, the court was satisfied that the circumstances

warranted allowing an action upon a contract, under which the

parties expressly submitted to the jurisdiction of the Illinois·

courts, to proceed in British Columbia courts. In that case,

however, there was no purported conferral of exclusive jurisdiction

on the Illinois court.

G. COUNTERPARTS

It is customary to include a provision for the execution of the

agreement in counterparts. This facilitates the execution of the

agreement in different locations.

H. EXPENSES

It is usual to provide in a purchase agreement that each party is

solely responsible for the payment of its own costs and expenses.

You may wish to modify the application of this provision in the

event that the agreement is not completed by reason of the failure

of one party to perform its obligations under the agreement. In

such a case, the other party's main damage may be its out-of-pocket

expenses incurred in connection with gearing up for the

transaction.

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I. FINDERS/BROKERS

The matter of a brokerage fee is also often dealt with in the

representations and warranties where it is customary for the

parties to provide mutual representations to one another as to the

absence of any involvement by brokers or finders in connection with

the transaction which would expose any of the parties to the

payment of such a fee.

J. ASSIGNMENT

It is customary to impose a restriction on a contracting party's

right of assignment. Most often this restriction is conditioned on

obtaining the other party's consent, which consent is not to be

unreasonably withheld. Sometimes an exception is created for

transfers to affiliates and, in such cases, it is customary to

condition such transfer upon the affiliate executing an assumption

agreement and to provide that both the transferring party and the

affiliate are thereafter jointly and severally liable for the

performance of the obligations of the transferring party. In order

for the restriction to be comprehensive, it should extend to the

whole or any part of any rights, benefits or obligations of the

transferring party under the agreement.

The enurement clause usually recognizes these restrictions by

containing language such as:

"Subject as aforesaid, this agreement shall enure to thebenefit of and be binding upon the successors of theparties hereto and their permitted assigns."

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K. ENTIRE AGREEMENT

The main purpose of an "entire agreement" clause is to exclude any

possible application of the prior agreements, discussions or

communications which the parties may have had concerning the

subject matter which is not included in the agreement itself.

However, it should be made clear that any agreements which are

contemplated by the agreement in question, such as any that are

schedules to it, and any other documents which are

contemporaneously delivered with it, are to be preserved and not

rendered ineffective by this wording.

L. AMENDMENT

It is customary to state that no purported amendment of the

agreement will be effective unless it is in writing and executed by

the parties.

M. NON-WAIVER

It is customary to state that any waiver of a breach of the

contract must be in writing and that a particular waiver of a given

breach does not constitute any sort of continuing waiver with

respect to similar or other breaches o·f the agreement.

N. SEVERABILITY

It has become customary to include a severability provision in most

agreements on the basis, presumably, that the parties would prefer

to have most of their agreement upheld, even if some one part

(usually a readily identifiable portion such as a non-competition

clause or a penalty provision of some sort) is subsequently held to

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be legally defective or invalid for some reason. There may,

however, be some provisions so fundamental to the agreement that

they should be excluded from the appliance of this provision.

O. EXTENSION OF TIME AND EXCUSABLE DELAY

It is unusual to include a "force maj eure" provision in normal

commercial agreements which do not provide for the construction or

delivery of something. However, on the theory that the concept of

excusable delay is valid ( although not with respect to the

performance of obligations which are purely financial),

consideration may be given to including such a provision.

"Excusable delay" is itself a matter of definition. Generally, it

is defined in terms of a delay which results in a circumstance

beyond the reasonable control of the party, which was not caused by

its own default and which was not avoidable by the exercise of

reasonable effort or foresight by the party. Such a definition

would also include delays caused by the ordinary unlikely force

majeure events such as "riots" and "earthquakes". Where an

excusable delay provision is included in the contract and is

applicable in a particular instance, the contract should provide

that the time for performance will be extended by a period of time

equal to the duration of the excusable delay.

P. INTERPRETATION NOT AFFECTED BY PARTY DRAFTING AGREEMENT

As you will note in the precedent agreement, (see the last sentence

of section 1. 6 ), wording may be inserted in counter the "contra

proferentum" rule of agreement interpretation and replace it with

what is more appropriate in modern share purchase agreements that

have been negotiated between the parties. However, it is important

to note that such a clause will only be effective if a Court is

convinced that it is appropriate not to apply the contra

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proferentum rule in the first place. While it is fair to say that

Canadian Courts are generally inclined to hold commercially

sophisticated and legally advise parties to negotiate an agreement

for the terms of those agreements, even such a clause will not be

a guarantee.

Q. JOINT AND SEVERAL OBLIGATIONS

If the Vendor and Shareholders (or any other related party) are to

be obligated along with the Vendor Corporation, it is important to

clearly provide that the obligations of the parties are, unless

otherwise stated, are intended to be joint and several.

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