Canada: Earnout Trends: One Small Step For Good Faith, A Few Minor Tweaks For Earnouts?

Earnout arrangements typically involve post-closing obligations on the part of the buyer, who now owns and likely operates the purchased business or assets. This post, the third in our earnout series, takes a look at how the Supreme Court of Canada's November 2014 decision in Bhasin v Hrynew, — a case concerning the role of honesty and good faith in the common law of contract – might affect earnout provisions in future.

Bhasin: Good faith and honest performance in contract law

In Bhasin, the Supreme Court of Canada held that good faith is an "organizing principle" within Canada's common law of contract. What that means, basically, is that good faith is not in itself a general rule of contract law, but rather a principle that underlies and informs a range of narrower common law doctrines that have traditionally required the exercise of good faith in certain limited types of contractual performance. Examples include the good faith obligations that arise in certain relationships, such as "insurer-insured", as well as those that have been held to apply in certain situations, as in the case (for example) of a contract whose central purpose would be frustrated if one side did not endeavour in good faith to obtain a required permit.

One of the key holdings of Bhasin, however, is that, from time to time, the organizing principle of good faith may generate new good faith duties in addition to those that are already recognized. While the court repeatedly emphasized that any new good faith duties would have to evolve by means of gradual and incremental steps, the fact remains that its decision in Bhasin indicates that the range of good faith obligations in Canada can be expected to expand over time.

That gradual expansion began in Bhasin itself, with the court's decision to take the "incremental step" of introducing a duty of "honest performance" into Canadian common law. The duty of honest performance requires that parties not lie or otherwise knowingly mislead their counterparties about matters directly related to the performance of a contract. It creates what the court called a "minimum standard of honesty" – "minimum" because it does not rise to the level of a duty of loyalty or a duty of disclosure. However, while it may not be as onerous as a fiduciary duty, the new duty of honesty, as far as it goes, will be difficult to avoid. There appears to be no way to contract out of it, although the court did state that it can be limited by express contractual language – a point addressed in greater detail in our earlier general discussion of the Bhasin case.

Bhasin and earnouts: short-term effects

One immediate effect of Bhasin is that an argument that a typical1 earnout arrangement has been breached as the result of a lack of good faith can potentially be founded on one or both of the following doctrines of Canadian common law:

  • One of the "good faith" duties that, even before Bhasin, was recognized in certain limited situations. A typical earnout may be found to fall within one or more of the generic situations in which a good faith duty of performance has traditionally been recognized, e.g. the situation (mentioned above) in which one party has been left with the discretion to decide how best to achieve an essential element of the contract and must therefore exercise that discretion in good faith. A typical earnout arrangement will often arguably involve exercises of discretion by one party, particularly with respect to the buyer's decisions about how that business should be operated during the earnout period. As a result, a buyer may have to exercise that discretion in good faith. This does not represent a change in the law, of course, as these more narrowly focused "good faith" duties existed prior to Bhasin.  For clarity, we should also note that a typical earnout would not likely fall into any of the categories of relationship that typically attract good faith duties, e.g. employer-employee, franchisor-franchisee or insurer-insured relationship.
  • The duty of honest performance created in Bhasin. Post-Bhasin, the common law duty of honest performance would apply to the performance of an earnout, as it generally would to all provisions of any commercial contract. A buyer that is operating a purchased business post-closing should accordingly refrain from misleading or lying to a seller about the actions it is taking or intends to take in respect of the earnout.

Bhasin and earnouts: long term2 effects

The Supreme Court of Canada states in Bhasin that, over time, new manifestations of the organizing principle of good faith may be recognized by Canadian common law courts. While any such growth will be gradual and incremental, it is certainly possible that earnouts will be affected by it over the long term. At this point, no one can know precisely which additional good faith obligations will evolve in Canadian common law (or when) but in the specific context that we are considering here, it may be helpful to look briefly at how the doctrine of good faith has been applied to U.S. earnouts. There are two reasons that U.S. jurisprudence is of interest:

  • There is currently no Canadian case law that deals with good faith obligations in the context of an earnout; and
  • The Supreme Court of Canada recognized in Bhasin that there is a need (and indeed a reasonable expectation) that Canadian common law in this area will become more consistent with the law of U.S. jurisdictions and Quebec, which are common law Canada's leading trading partners. In those jurisdictions, good faith obligations have generally been more liberally applied than has hitherto been the case in the common law provinces of Canada. 3

While we cannot deal in any great depth with the U.S. experience here, it should suffice to note that the following situations – in which U.S. courts have applied good faith duties to the performance of earnouts – may be harbingers of how courts in Canada might deal with similar issues in the coming years:

  • A buyer reorganizing the purchased business in a way that diverts sales and strips resources from the purchased business. 4
  • A buyer entering into a joint venture with a competitor of the purchased business.5
  • A buyer substituting its own products for those of the purchased business 6 or refusing to accept new opportunities generated by the purchased business. 7
  • A buyer reducing output of one of the purchased business' more profitable products to prioritize sales of the buyer's incumbent products and changing the name and branding of the products of the purchased business. 8

Moving forward: some general principles

To sum up, general principles that are associated with a duty of good faith (as extracted from Bhasin, other Canadian good faith case law and, to an extent, from U.S. sources) and which may prove to be applicable to the performance of a typical earnout arrangement include the following:

  1. A party must:
    • act honestly;
    • exercise its discretion reasonably and for the intended purpose;
    • refrain from acting strategically to evade its contractual obligations; and
    • not act arbitrarily, unreasonably or in a manner that eviscerates the main objective of the contract.
  2. In assessing whether a party breached any of its good faith obligations, consideration will generally be given to:
    • the reasonable and legitimate expectations of the parties;
    • the express terms in the contract; and
    • the particular facts and context of the individual case.
  3. In addition, where a form of conduct occurs in the context of an earnout that is arguably unjust or unfair, but which does not fall under any existing good faith doctrine, it should be borne in mind that Bhasin could potentially ground the recognition by the court of a new good faith duty to refrain from such conduct.

Conclusion: further thoughts

In the negotiation of an earnout provision, buyers typically seek to expressly limit good faith obligations, most notably including obligations to take action to maximize the earnout. While the duty of honesty established in Bhasin v. Hrynew appears primarily to target lying and deliberate deception, the fact that this new duty cannot be entirely disclaimed may need to be considered in the drafting of some earnouts. As well, buyers would likely bargain to broaden the scope of, and discretion in, their operational decisions relating to the purchased businesses, which could engage good faith duties arising out of the established category of discretionary contracts. Sellers – whose negotiating focus is typically on imposing specific obligations, actions and limitations that apply to the operation of the business post-closing – are not as likely to be affected by these types of obligations post-closing. However, to balance the concerns of each party, in addition to careful drafting, a little "good faith" may be required.


1 In the majority of cases, an earnout is structured so that the buyer will operate, or at least control and oversee the operation of the purchased business post-closing. It is this scenario that is referred to as a "typical" earnout arrangement.

2 Until we see how enthusiastic Canadian courts turn out to be with respect to the recognition of new good faith duties, it will be difficult to know how long the "long term" is likely to be.

3 The Bhasin decision also specifically refers to the good faith requirement in §1-302(b) of the Uniform Commercial Code, which has been adopted in almost all U.S. jurisdictions.

4 Interwave Technology, Inc v Rockwell Automation, Inc 2005 U.S. Dist. LEXIS 37980 (E.D.Penn.); Kuchera v Parexel International Corporation, 719 F. Supp. 2d 121 (D. Mass. 2010); TWA Resources v Complete Production Services, 2013 Del. Super. LEXIS 319.

5 LaPoint v AmerisourceBergen Corporation, 2007 Del. Ch. LEXIS 131 (Del. Ch.), aff'd 956 A.2d 642 (Del. 2008).

6 Jaqueline T. Hodges & HRC Solutions, Inc. v. Reasonover, 2008 US Dist LEXIS 12254 (N.D. Ga.).

7TR McClure & Co v TMG Acquisition Co, 1999 U.S. Dist. LEXIS 13676 (E.D. Penn.); in Sonoran Scanners, Inc v PerkinElmer, Inc, 585 F.3d 535 (1st Cir. 2009), a duty of good faith was breached when the buyer refused to use reasonable efforts to generate new business opportunities as stipulated in the earnout contract.

8 Horizon Holdings, LLC v Genmar Holdings, Inc, 387 F.3d 1188 (10th Cir. 2004). See also other U.S. cases, such as: Airborne Health, Inc v Squid Soap, LP, 984 A.2d 126 (2009 Del. Ch.); Winshall v Viacom International, Inc, 55 A.3d 629, (Del. Ch. 2011); Ferguson v Lion Holding, Inc, 478 F. Supp. 2d 455 (S.D.N.Y. 2007); Agilysis, Inc v Gordon, 2008 US Dist LEXIS 99553 (N.D.OH.); Rubin Squared Inc v Cambrex Corp, 2007 U.S. Dist. LEXIS 62861 (S.D.N.Y.), aff'd 2009 U.S. App. LEXIS 6244 (2d Cir. N.Y., Mar. 25, 2009); Rumis v Brady Worldwide Inc>, 2007 U.S. Dist. LEXIS 37190 (S.D. Cal.); Starr v Firstmark Corp, 2013 U.S. Dist. LEXIS 128361 (E.D.N.Y.); Keene Corporation v. Bogan, 1990 U.S. Dist. LEXIS 220 (S.D.N.Y.); Wagner v. JP Morgan Chase Bank, 2011 U.S. Dist. LEXIS 24518 (S.D.N.Y.);Fireman v. News America Marketing In-Store, Inc, 2009 U.S. Dist. LEXIS 91236 (D. Mass.).

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions