An M&A transaction does not always go as planned. Unfortunately, a transaction may fail at any time, including after the execution of a purchase agreement. For example, a buyer faced with financial uncertainty or a seller with a better opportunity may be hesitant to complete a transaction. However, if all of the conditions to closing in favor of both parties have been met, can one party seek specific performance and require the other party to close an M&A transaction even though the other party does not wish to proceed? The answer largely depends on a number of factors, namely:
- the applicable governing law;
- the contractual provisions;
- the practical challenges of implementation and enforcement.
Two legal regimes apply in Canada: civil law applies in the province of Québec with respect to property and civil rights matters and common law applies in the rest of the country. Subject to a few exceptions, which we will discuss below, while the granting of specific performance is discretionary under common law, it is a remedy to which an aggrieved party is entitled under civil law. The fundamental difference between the common law in Canada and the civil law of Québec with respect to the remedy of specific performance is that the aggrieved party under civil law does not have to establish the inadequacy of damages in order to claim specific performance.
As will be discussed below, notwithstanding these differences, similar considerations will apply in determining whether or not the remedy of specific performance is available or even desirable in the context of an M&A transaction.
Canadian Common Law
Remedies for breach of contract seek to put the aggrieved party in the position in which it would have been had the contract been performed. At common law, the remedy as of right for a breach of contract is an award of monetarydamages, on the basis that an aggrieved party can then use the monetary award to acquire a substitute for what it had originally bargained for. Specific performance is an equitable remedy, which can only be obtained if a court exercises its discretion to grant it.
A court will typically be inclined to exercise its discretion in favor of ordering specific performance if an award of monetary damages would be inadequate to place the aggrieved party in the same position in which it would have been had the agreement been performed. Some of the grounds upon which damages are normally considered inadequate include where (i) the subject of the agreement is unique, (ii) damages are difficult or impossible to calculate, or (iii) the party in breach of the agreement is not in a financial position to pay an award of damages.
In any case, even if damages are considered inadequate, specific performance may still be refused on other grounds, including where (i) the performance of the obligation would be difficult to supervise (for example, where, given the nature of the obligation, it would be difficult for a court to determine if the party is in compliance with the obligation), or (ii) the agreement contains an element of personal service.
Application of Common-law Rules to M&A Transactions
In the context of M&A transactions, Canadian common-law courts have shown a willingness to grant specific performance where they have concluded that damages would be inadequate. Some of the factors that will influence a court’s decision in determining whether specific performance is an appropriate remedy include: (i) whether the subject of the agreement is the sale of shares of a public company or a private company; (ii) in cases where a buyer is seeking specific performance, whether the buyer’s interest is purely financial; and (iii) whether it is the seller or the buyer that is seeking specific performance.
In the context of the sale of shares of a private company, courts have ruled that damages are normally considered inadequate on the basis that the shares are unique and a substitute asset is not readily available, and that the valuation of damages can be difficult. (See, for example, Newton v. Graham. The transaction consisted of the acquisition of the shares of a corporation operating a business in a rural community. The purchase price was $20,000). In the context of a sale of publicly traded shares, courts have suggested that the same arguments in favor of inadequacy are more difficult to make except where the consummation of the transaction would give the aggrieved party control or de facto control of the underlying business. (See I.M.P. Group Limited v. Dobbin. The buyer was the largest shareholder of the subject public company and required the shares relating to the disputed agreement to have effective control of the public company. The buyer successfully obtained specific performance of an oral agreement.)
Courts have also suggested that the type of buyer seeking specific performance may influence the availability of the remedy. In a recent Ontario Court of Appeal decision, Wallace v. Allen, a buyer was denied specific performance on the basis that it was a financial buyer and that the business to be purchased was therefore not unique for the buyer. (The Court of Appeal found that the parties who had only executed a letter of intent and had a draft purchase agreement, in fact, had a binding agreement. The subject matter of the transaction was the delivery of all of the shares of the four companies for a purchase price of $3,200,000.)
With respect to a seller seeking specific performance, it may be harder to claim that damages are inadequate, especially where the consideration for the sale of the business is money. An argument could be made that damages are inadequate for a seller, where (i) other buyers cannot be readily found; and (ii) there would be irreparable damage to the business being sold if there was a failure to consummate the transaction. For example, a failed transaction may lead to a perception that the seller’s business is struggling, which can give rise to issues with respect to employee, client and supplier retention and, in the case of a public company, put downward pressure on the trading value of the stock of the seller.
Also, specific performance in favor of a seller may be justified on the basis that if such remedy is available to one party, it should be available to the other (principle of mutuality).
Québec Civil Law
In Québec, specific performance is not a discretionary remedy and the aggrieved party is prima facie entitled to specific performance (see, for example, Varnet Software Corporation c. Marcam Corporation).
The general principles regarding remedies set out in Article 1590 of the Civil Code of Québec (the “Code”) provide, inter alia, that if one party to an agreement fails to perform its obligations without justification, the other party may,without prejudice to its right to obtain damages, choose amongst a number of remedies including specific performance.
The only impediment to an aggrieved party’s right to obtain specific performance is that the case has to “admit of it” (Article 1601 of the Code). This notion has been interpreted by courts in Québec as well as authors to mean that the specific performance remedy is not available where the performance of the obligation: (i) requires the personal service of the other party, though this prohibition does not usually apply where the other party is a corporation, (ii) has become impossible, (iii) would interfere with the rights of a third party, or (iv) would be difficult to supervise (see Gennium Pharmaceutical Products Inc. c. Genpharm Inc. and Charron c. Groupe santé Roy.)
Application of Québec Civil Law Rules to M&A Transactions
There is a limited number of reported cases in which the Québec courts have dealt with specific performance in the context of M&A transactions.
The cases that do exist involve relatively small and uncomplicated private target deals where one of the parties claimed that, despite the failure to sign a purchase and sale agreement, there was a binding agreement and specific performance ought to be granted. In most of these cases, the buyer petitioned the court for an action in “passage of title,” which is a form of specific performance typically used in real estate transactions and available in sale transactions pursuant to Article 1712 of the Code. (See for example 9153-1335 Québec Inc. c. Jems Investments (Quebec) Inc., which involved a transaction consisting of the acquisition of the shares of a corporation in the restaurant business. The purchase price was to be paid in cash and was less than $3,000,000. The issues regarding the action for passage of title specific performance, though discussed, were moot as the court did not find that the parties had an agreement. See also Kyriacou c. London, (QCCS), which was confirmed by London c. Kyriacou, (QCCA). The transaction consisted of the acquisition of the shares of two corporations, one of which was in the daycare business and the other owned the building in which the daycare was operated. The purchase price was less than $1,000,000. The action in passage of title was granted.)
Under civil law, if a seller sells the property that is the subject of a purchase and sale agreement to a third party, the buyer cannot seek specific performance, even where the third party has acted in bad faith. In such cases, the aggrieved buyer can only sue for damages (see Article 1397 of the Code). At common law, specific performance will not be refused for the sole reason that the shares or the assets have been sold to a third party. If such third party had prior notice of an agreement between a seller and an aggrieved buyer, specific performance can still be obtained by the aggrieved buyer. (See I.M.P. Group Limited v. Dobbin and Barrick Gold Corporation v. Goldcorp. Inc.)
There are certain practical considerations that one needs to take into account in determining whether specific performance is the desired remedy:
- Time required to get a judgment: Whether one is applying to a court of common law or civil law in Canada, it can take about two years before a final judgment on the merits for specific performance is obtained. Even where the suit is fast-tracked through the judicial system, the waiting period for a judgment to be rendered may make the remedy impractical.
- Financial state of buyer/seller: During such time as a judgment for specific performance is rendered, a buyer may lose its financing, which could mean that even if specific performance is granted it may be difficult to execute. A seller under financial distress may not have the financial leeway to wait for a judgment.
- Risk of the business:A buyer seeking specific performance will be relying on the seller to conduct the business during the waiting period and assumes the risk the business may not be in the state that the buyer expects at the time judgment is rendered. A buyer can seek an injunction to enforce the interim period covenants in the purchase agreement (to the extent they exist), but the performance would be difficult to supervise and a court may refuse to grant an injunction on that basis. (In Québec, a buyer would also need to obtain a temporary injunction to stop the sale of the shares or the assets to a third party for the reasons mentioned above.)
Remedy and Termination Clauses
Once the parties to a purchase agreement have considered the appropriate remedy for a failure to close the transaction, they may try to eliminate the risk of an unwanted remedy by expressly setting out the available remedies in the purchase and sale agreement. Termination provisions should also be reviewed carefully to ensure they are consistent with the intended remedies sought.
Specific Performance is the Remedy of Choice
Whether under the Canadian common law or Québec civil law, a party cannot force the performance of an agreement that has been properly terminated. Consequently, in circumstances where the parties want to keep the option of exercising the remedy of specific performance, they must ensure that the termination provisions in the purchase and sale agreement do not allow the defaulting party to terminate and do not allow automatic termination.
Where the agreement is governed by the laws of a Canadian common-law province, the parties may consider including a clause providing that they agree that damages would be inadequate in compensating for any breach of the agreement and that accordingly, a party may seek to enforce the performance of the agreement by injunction or specific performance. Though a contractual right to specific performance may not be conclusive or prevent a court from refusing to grant specific performance, it may still influence a court’s decision in favor of specific performance and even be considered an important factor. (See Height of Excellence Financial Planning Group Inc. v. Bergen). See also Robert J. Sharpe, Injunctions and Specific Performance, looseleaf (consulted on April 1, 2013), (Aurora, Ont.: Canada Law Book, November 2012).)
In contrast to Canadian common-law provinces, given a party’s entitlement to specific performance under the Code, where the agreement is governed by the laws of Québec and the parties wish to have the right to specific performance there is no need to include a specific contractual right to that effect.
Damages is the Remedy of Choice
Where the parties decide that the remedy of choice is damages and that specific performance should be excluded, they should review the termination provision to make sure that, if the non-defaulting party terminates the agreement, it still has a recourse in damages.
Where the agreement is governed by the laws of a Canadian common-law province, the parties may consider including a clause providing that they agree that damages are adequate in compensating any breach of the agreement and that, accordingly, a party may not seek to enforce the performance of the agreement by injunction or specific performance. Although a contractual prohibition to specific performance may be enforceable, a court under certain circumstances may choose to grant specific performance if a party asks for the remedy, despite the prohibition. (See for example, Romfo v. 1216393 Ontario Inc. and Le Soleil Hospitality Inc. et al. v. Louie et al. (BCSC) confirmed by Le Soleil Hospitality Inc. v. Louie (BCCA).)
Where the agreement is governed by the laws of Québec and the parties wish to exclude specific performance, given a party’s entitlement to it, the parties should consider including a clear and express clause excluding the right to demand specific performance. Such a clause should be enforceable given that article 1590 of the Code does not appear to be of public order.
Here are some conclusions that may be drawn:
- Seeking specific performance in the context of an M&A transaction in a common-law province in Canada may be more difficult than in Québec, unless the property has been sold to a third party, in which case specific performance will be impossible in Québec;
- This said, both common-law and civil-law courts will consider similar grounds in determining whether specific performance is appropriate and in the context of a complicated M&A transaction a court under either jurisdiction may be reluctant to grant the same;
- Once the choice of remedy is made, properly drafted termination and remedy clauses in the purchase agreement may lessen the risk of an undesirable remedy that can be imposed by the chosen Canadian legal regime; and
- The practical concerns resulting from the time that is required to obtain specific performance may render the availability of the remedy theoretical. That said, the availability of the remedy may prove to be useful as bargaining leverage in arriving at a quick settlement.