Canada: Material Contract Review For Lending Transactions

A borrower's material contracts can have a significant impact on a lending transaction. These contracts affect the rights and obligations of the borrower, the value of the borrower's assets and overall financial performance of the business and potential restrictions on the ability of the lender to enforce against those assets.

Review of the borrower's material contracts is often the most important aspect of the due diligence process because they have an effect over these fundamental aspects of lending transactions.

This article sets out a brief methodology for approaching the review of material contracts.

Why is a particular agreement being reviewed?

The borrower will likely have many written agreements with third parties. It is likely not necessary, practical or even possible for a lender to review all of those agreements. Similarly, lenders must recognize that locating and putting forward copies of contracts for the lender to review may represent a significant time commitment or logistical challenge for the borrower. A decision therefore needs to be made as to which agreements the lender wishes to focus on.

Typically, the consideration of agreements will be limited to those that are 'material' to the borrower. The loan agreement will often contain a definition of "material contract." In any event, the determination as to whether an agreement is material will usually include the following factors:

  • what is the 'value' of the contract? (i.e. product volume? monetary value? per cent of overall business?)
  • will the agreement remain in place after the closing of the loan? (in the other words, is it an agreement that is being terminated contemporaneously with the new loan; for example, the documentation relating to any indebtedness being refinanced using the proceeds of the new loan)
  • can the agreement, if terminated, be replaced with an arrangement with a different third party, on similar terms and within a reasonable time period?
  • does the agreement relate to an asset which is key to the business (for example, a key piece of equipment or important license for software or other intellectual property, necessary to run a material part of the business)?

Practically speaking, the loan agreement, officer's certificate, information certificate or other documentation provided as part of the due diligence process will typically include a list of material contracts. From that list the lender can then decide which agreements are to be reviewed.

Another practical consideration is the cost associated with the contract review. This raises the question of who will do the review? For a particular contract, if the lender is only interested in certain business points (for example, price, specific volume discounts) it will likely be more cost-effective for the lender to conduct the review of that particular agreement, rather than engaging the assistance of legal counsel.

Restrictions on ability to liquidate inventory?

An important consideration is the impact that certain agreements may have on the ability of the lender to realize on the borrower's inventory in the event of an enforcement.

A key question is whether the agreement requires, upon termination (which typically would be triggered by an insolvency or similar event), that the borrower return any goods supplied by the counterparty. And, more importantly, if such a provision exists, it will be important to note the stipulated price (relative to the liquidation/market value price) and whether the return of goods is automatic or optional for the supplier.

There may be other restrictions in the agreement which could impact the ability to liquidate inventory (for example, geographical restrictions on sale) which will need to be considered in the context of the lender's analysis of the value of the borrower's assets in any liquidation scenario.

When does the agreement terminate?

The determination of when the agreement will terminate may also be an important consideration.

If the agreement specifies a particular termination, the initial question will be whether this date extends beyond the term of the new loan (or any reasonably anticipated extensions or renewals).

A somewhat obvious, although useful point to note is that it should be confirmed whether the agreement is actually still in force; often agreements will be tabled that have expired without renewal but the counterparties to the agreement may be dealing as though the agreement remains in force.

The agreement may terminate on insolvency (or similar event) which will be relevant as the lender's enforcement would therefore trigger the termination. Similar, the agreement may terminate on a change of control which may be relevant depending on the structure of the transaction.

Intellectual property issues

The intellectual property used by a borrower will often represent a significant aspect of the business.

If the agreement deals with the licensing by the borrower from a third party of specific intellectual property, there may be important implications for an enforcement scenario.

Consider a situation where the borrower licenses a trademark from a third party and that licensed branding is used in the packaging of the product. If there are restrictions on the ability of the borrower to use that trademark in the event of an insolvency, realizing on that borrower's inventory becomes much more complicated and difficult.

Can the contract be assigned?

The lender's enforcement analysis may contemplate the sale of the business or parts of the business as a going concern in order to maximize the lender's realization (as opposed to simply liquidating the assets). In this event, the ability of the lender to assign certain contracts may be important. For example, in a construction financing, the ability or inability to assign any third party contractor or other related construction contracts would be relevant to the lender.

Industry specific issues?

There may be industry specific issues related to the business which involve specialized legislation that may require consideration in the context of the material contract review. For example, where the contract is with a government body and relates to certain fees to be paid to the government, there may be priority liens in favour of the government for any unpaid fees which the lender should be aware of. Similarly, the contract may relate to security granted in favour of a third party financier. In both cases, a priority agreement may be necessary, a reserve considered or other alternatives contemplated to deal with any issue.

Errors in the agreement to be corrected?

The contract review often discloses errors that should be corrected. For example, is the agreement in the names of the correct parties (for example, are the correct legal names used)? Was the agreement signed by all parties?

The due diligence process may represent a good opportunity to have these deficiencies corrected.

Counterparty consent/agreement

The results of the contract review may suggest that the lender should attempt to obtain the counterparty's consent or specific agreement with respect to certain circumstances.

For example, the lender may ask the counterparty to consent to any future assignment by the lender in connection with an enforcement (which would otherwise be prohibited). Or perhaps the counterparty will agree to waive any restrictions that would apply to goods supplied to the lender to permit the lender to liquidate assets. Obviously, the potential alternatives will depend on the specific issues involved and on the leverage that the borrower may have to bring the counterparty to the negotiating table, as well as the importance that the lender may place on obtaining an agreement.


Material contract review is often a crucial aspect of the lender's due diligence process. This process involves balancing the potential impact a borrower's contract may have with the time and resources required to effectively review the document. This article has attempted to illuminate some important factors for lenders to take into account when performing this balancing exercise.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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