The Quebec Court of Appeal's decision in Francoeur v. 4417186 Canada Inc., 2013 QCCA 191, provides a cautionary tale on the dangers of entering into a share purchase agreement and subsequently closing a share purchase transaction, without ample due diligence.
The one-sided apportionment of risk
The Francoeur share purchase agreement (the "SPA"), which was signed by parties the court characterized as "fierce competitors", contained the following key provisions.
- The purchaser acknowledged that (a) until closing, it did not have access to certain "key documents" held under seal, (b) it had not undertaken any due diligence, and (c) it accepted the risks in the circumstances.
- The material under seal included a list of golden parachute arrangements with key employees.
- The closing was conditional on various terms that could be waived by the purchaser.
- Prior to the closing, the target company's president had the power to make decisions in the ordinary course of business, but was precluded from signing contracts valued in excess of $100,000.
- The seller's representations and warranties were limited to those expressly stipulated in the SPA.
- The purchaser had limited indemnification rights in the case of misrepresentations by the seller.
The target company's pre-closing activity
On the same day that the SPA was signed (but before closing), the target company's president announced the departure of its vice-president. Soon thereafter, the target company negotiated a settlement (the "Disputed Agreement") with the vice-president specifying, inter alia, that the vice-president would transition to a new position at a reduced salary (albeit more than the $100,000 limitation imposed in the SPA) for 12 months. In exchange, the vice-president waived all recourse against the seller in relation to his termination.
Post-closing: The purchaser's remorse
The purchaser, after reviewing the documents under seal, took the position that the vice-president was not entitled to (a) a golden parachute because he was not an employee of the target company when the transaction closed, or (b) payments pursuant to the Disputed Agreement.
Predictably, the vice-president sued the target company (which at this point was owned by the purchaser). Also predictably, the purchaser sued the seller and the former president for indemnification, alleging that the seller fraudulently concealed the target company's golden parachutes from the purchaser and secretly concluded a sham transaction to convey an entitlement to which the vice-president had no right.
The Quebec Court of Appeal
The Quebec Court of Appeal reversed the trial judge's finding that the Disputed Transaction was invalid and the vice-president had no entitlement to the golden parachute. Among other things, the Quebec Court of Appeal held the following.
- The golden parachute was not fraudulently hidden from the purchaser. As the transaction's closing was not assured, it was reasonable for the target company to protect confidential information from its competitor. The purchaser assumed all risks associated with conducting no due diligence.
- In any event, the SPA could not alter the vice-president's entitlement to a golden parachute. The purchaser acquired the target company in a share transaction that left the company intact and therefore responsible for valid pre-closing agreements entered into by the company.
- The SPA permitted the former president to negotiate the Disputed Agreement even though its value was in excess of the $100,000 limitation imposed in the SPA. Until closing, the former president was charged with running the business. The SPA's limitations did not alter the target company's duty to provide the vice-president with a proper notice of termination or a financial equivalent due to his dismissal. Moreover, the Court found the former president's actions reasonable as the transaction's closing was not assured and it was in the target company's best interests to lock up a key employee for 12 months.
- The former president and seller were not liable to the purchaser even if they had misrepresented facts relating to the vice-president's dismissal. In the SPA, the purchaser waived any right it might have had to take legal action based on such a misrepresentation.
The Three Takeaways
In circumstances where due diligence is short-circuited for business reasons, a purchaser should:
- be reminded that in a share transaction, the purchaser acquires the good, the bad and the ugly from the target company, subject to protections negotiated in the share purchase agreement.
- consider negotiating:
- for the disclosure of proprietary information subject to a confidentiality agreement;
- a rigorous indemnification clause to specifically account for risks that the purchaser is unwilling to assume (that said, seeking indemnification from the seller may require costly litigation); and
- a retention amount to be held in trust until an appropriate period post-closing.
- reconsider the risks and benefits of acquiring the target company without appropriate due-diligence – of course, targeted due-diligence from qualified and trusted legal advisers is always recommended, subject to business priorities.
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