Overview and Key Practical Takeaways
Earnouts have seen more frequent use in Canadian private M&A in recent years.1 Even so, earnout rulings in Canada remain relatively rare compared to such jurisdictions as Delaware. The February 2025 decision of the Ontario Superior Court of Justice (Commercial List) in Project Freeway Inc.2 is therefore noteworthy and provides valuable guidance for Canadian M&A. It also raises complex questions.
Our key practical takeaways from the decision include:
- The court held that the earnout's acceleration clause had not been triggered by two post-closing financing transactions.
- The court read the earnout's terms as striking a balance between the seller's right to the potential earnout payments and the buyer having "operational freedom" to run the target as it saw fit so long as it did not impair the earnout.
- Even though the definitive share purchase agreement (SPA) included an "entire agreement" clause, the court considered the terms of an earlier, non-binding letter of intent (LOI) and the seller's pre-closing knowledge the post-closing financings might occur.
- Earnouts have been a key M&A tool during uncertain economic times to mitigate buy-side risk while also optimizing the seller's view of the target's value. Ambiguous drafting can create risk for both sides.
Our detailed insights follow. For Fasken's comprehensive guide to earnouts, see Earnouts in Private M&A: Negotiation, Drafting and Strategy. For more Fasken M&A thought leadership, visit our Capital Markets and M&A Knowledge Centre and subscribe.
The Dispute in Brief
Project Freeway arose from the acquisition of a manufacturer of plastic injection and molded products with facilities in Canada, the U.S. and Mexico. The purchase price was a cash payment of US$165,000,000 and an earnout for a maximum amount of US$26,461,000.
The earnout period was two years and contemplated three possible payments based on the target's post-closing financial performance. The earnout also included an acceleration clause that would be triggered should the buyer "directly or indirectly" divest a "material portion of the assets" of the target business in "one or a series of transactions" to any third party without the seller's prior consent.3
The SPA was signed on December 21, 2022 and the transaction closed on March 1, 2023. Shortly afterwards, the buyer completed two financing transactions without the seller's approval:
- First, a series of sale and leaseback transactions whereby the target's land and buildings were sold for gross proceeds of approximately US$97.9 million and leased back to the business for continued operation (the "SLB Transactions").4
- Second, a factoring arrangement whereby the target's accounts receivable were assigned to a bank in exchange for advanced payment on those receivables (the "Factoring Arrangement").5
The first earnout period expired in August 2023, and in November 2023 the buyer notified the seller that the first earnout target had not been met. Following various correspondence between the parties' counsel, the seller applied to the court seeking a determination the SLB Transactions and Factoring Arrangement had triggered the earnout's acceleration clause.
The Seller's Arguments
The seller argued the acceleration clause was a "complete code" that established a "bright line test" for whether acceleration was required.6 Specifically, that on a "plain reading" the clause set a "clear and unambiguous" standard whereby, if a "material portion" of the target's assets were transferred to a third party, acceleration was triggered.7 To this end, the seller submitted that it was manifest that the SLB Transactions and Factoring Arrangement involved a "significant" portion of the target's assets, noting specifically that the value of the SLB Transaction alone was US$97.9 million, being "approximately 59% of the purchase price under the SPA".8
The Buyer's Arguments
The buyer conceded that the SLB Transactions and Factoring Agreement were transfers of target assets to third parties that occurred without the seller's consent. However, the buyer argued that the seller's interpretation did not give appropriate meaning to the clause's materiality qualifier. The buyer argued that "material" did not "simply mean big or expensive".9 Rather, it must "mean something within the context" of the earnout.10 As such, the buyer argued that something was only "material" if it impacted the target's performance and, by extension, the pursuit of the earnout.11 Accordingly, the buyer argued this standard was not met by the SLB Transactions and Factoring Arrangement given they were "ordinary financing steps" that did not have "any impact" on the target's business other than to "generate extra cash".12
The Court's Analysis
The court relied, as had both parties, principally on the Supreme Court of Canada's ruling in Sattva.13 The court summarized that, per Sattva, the SPA must be "read as a whole" giving its words their "ordinary and grammatical meaning", and that the court should adopt a "practical, common-sense approach" as it tried to "ascertain the objective intent of the parties".14 The court also stressed that the SPA should be interpreted in a manner that "accords with sound business principles" and avoids a "commercially absurd result".15
The court agreed with the buyer that it should "examine the purpose" of the earnout "in light of the SPA as a whole."16 In doing so, the court saw the earnout as striking a balance between, first, the seller's right to the potential earnout payments, and, second, the buyer having "operational freedom" to run the target business as it saw fit "as long as it does not impair" the pursuit of the earnout.17
This interpretation was supported by, among other things,18 two other SPA clauses. First, a subclause that stipulated the earnout did not restrict the buyer from consolidating any of the target's facilities with any of the buyer's facilities so long as appropriate adjustments were made to tracking product lines for the earnout's calculation.19 Second, a qualifier to the acceleration clause stating it did not limit the buyer's right to "complete mergers, amalgamations or other internal reorganizations".20 The result was that the court agreed with the buyer that the word "material" as used in the earnout meant material to the earnout.21 This also meant it would be "commercially absurd" for the buyer to be allowed to "close and consolidate facilities" and "complete mergers and other internal reorganizations" but not "engage in ordinary course financing transactions."22
It was therefore "difficult to see" how the SLB Transactions and Factoring Arrangement were "material" to the earnout.23 In the court's words:
"I agree with the submission of the [buyer] that the [SLB Transactions] and the [Factoring Arrangement] are ordinary course financing steps that did not impact the operation of the business. Following the close of the [SLB Transactions], and the close of the factoring agreements, the [target] business continued to operate in the same place, with the same equipment, employees, and customers as the day prior to the close of these financing transactions. The only thing that changed under the [SLB Transactions] was the legal ownership of the sites. The only thing that changed under the [Factoring Arrangement] was that the [buyer] was able to realize more quickly on its receivables."24
The court also repeated that this outcome honoured the "purpose" of the earnout, being a "balance" between the buyer's "operational freedom to run the business as it sees fit as long as it does not impair" the pursuit of the earnout.25
Additional Considerations
Two additional considerations informed the court's ruling. First, a non-binding LOI that the parties had executed two months prior to the SPA. Second, that the seller had knowledge of, and assisted with diligence in respect of, the potential financing transactions prior to closing.
The Non-Binding LOI
The court agreed with the buyer that Sattva allowed it to consider the LOI for the "purpose of ascertaining background facts at the time the SPA was entered into."26 Key here was that an LOI exhibit set out certain principles intended (at that time) to govern the earnout. These contemplated that acceleration would occur should the buyer sell the target business or fail to follow the SPA's operating covenants "in a manner which materially impairs the ability of the Seller to earn Earn-Out Payments..."27 As such, and even though the acceleration clause in the definitive (and binding) SPA was phrased differently, the court took the LOI to reinforce the buyer's argument that a "material portion of the assets" in the eventual earnout clause objectively meant "assets of the Business that would be material to the Earn-Out."28 The court did so even though the SPA included an "entire agreement" clause that specifically referenced the SPA having superceded the LOI and the LOI being of no more force and effect.
The Seller's Knowledge of the Financing Transactions
An ancillary ground of the court's reasoning was that the seller had, prior to closing, knowledge of the possibility of the financing transactions occurring, but did not object to them until after being notified the first earnout target had not been met. This awareness on the seller's part flowed from site visits the seller facilitated for representatives of the eventual counterparty to the SLB Transactions. The court also stated it was "notable" that the same two senior executives of the seller that were aware of these site visits were among the five people whose knowledge constituted the seller's knowledge under the SPA.29 For the court, under Sattva, this helped in "ascertain[ing] the objective intent of the parties" regarding the meaning of the materiality qualifier.30
Key Practical Takeaways
The Project Freeway ruling is not particularly long. There is, nonetheless, a lot to unpack. Our key practical takeaways are:
- The court applied a purposive interpretation to hold the earnout's acceleration clause had not been triggered by two post-closing, "ordinary course" financings involving the sale of more than half of the business' assets.31 This hinged on the court's interpretation of the acceleration clause's "materiality" qualifier. Whereas the seller interpreted this as meaning significant in terms of the value of the assets, the court agreed with the buyer that "material" should be interpreted as significant in terms of the pursuit of the earnout (i.e., the target's business performance). This approach differs somewhat from how other Canadian courts have previously interpreted materiality qualifiers in M&A disputes.32 Parties employing materiality qualifiers should therefore appreciate that the significance of such qualifiers may be heavily context-dependent.33 In this case, the court relied both on reading the earnout provisions as a whole as well as the earnout principles included in the earlier, non-binding LOI.
- The court saw the earnout as striking a balance between the
seller's right to the potential earnout payments and the buyer
having "operational freedom" to run the target as it saw
fit so long as it did not impair the pursuit of the earnout. As
with the "materiality" qualifier, the court's
analysis flowed from reading the earnout as a whole as well as the
terms of the earlier LOI.
- Regarding the court's reading of the earnout as a whole, the types of other clauses it relied on – being carveouts preserving the buyer's ability to engage in certain operational matters – are not uncommon in earnouts. The ruling may therefore caution sellers to approach the drafting and/or inclusion of such carveouts more carefully so as not to grant the buyer more operational freedom than intended.
- Regarding the court's reliance on the terms of the earlier LOI, the court rejected the seller's argument that the SPA's "Entire Agreement" clause precluded consideration of the LOI, even though the Entire Agreement clause expressly referenced the LOI being superseded and of no force and effect.34 This raises complex issues regarding inconsistent M&A caselaw involving entire agreement clauses.35 We will therefore be publishing a separate Fasken insight on this aspect of Project Freeway.36
- The court gave weight to the seller's pre-closing knowledge of the possibility of the financing transactions. Among other things, the court stated:
"If there was a concern that the full earn-out may be triggered when the [buyer] proceeded with these ordinary course financing transactions, presumably one of the sophisticated parties or counsel would have raised it."37
Project Freeway therefore cautions sellers against delaying raising any issues they may have regarding the pursuit of the earnout with the buyer, including but not limited to any acceleration clause and its triggers. Here, a seller will want to avoid giving any indication it is acquiescing to any post-closing conduct or events regarding the target's business that could arguably be offside the buyer's post-closing covenants or acceleration clause triggers. Project Freeway may also caution sellers toward negotiating for more post-closing information rights regarding the business as it impacts the earnout. We will also be publishing a separate bulletin on this aspect of Project Freeway (i.e., the court's reliance on the seller's pre-closing knowledge in connection with the materiality qualifier).38
Footnotes
1. See the most recent ABA Canadian Private Target M&A Deal Point Study, released in February 2025, where earnouts appeared in 31% of the deals in the study's sample, as compared to 16% of deals in the 2018 study, 17% in the 2016 study, and 25% in the 2014 study.
2. Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 (CanLII) [Project Freeway]. – https://www.canlii.org/en/on/onsc/doc/2025/2025onsc1048/2025onsc1048.html?resultId=809935cf25194a94a1d1edf77f2a664e&searchId=2025-05-06T15:32:28:847/672c278107a14b6693e53e03801e6fa5
3. See Project Freeway at para. 33.
4. In a sale and leaseback transaction the seller's commercial real estate is sold to an investor and the seller executes a long-term lease (in this case, 20 year leases with 10 year renewal terms) with the new property owner.
5. As noted below, the court (at para. 32) held the buyer had submitted "unchallenged evidence" the two transactions had "no impact" on the target's performance or the earnout calculation.
6. Project Freeway at paras. 37 and 39.
7. Project Freeway at paras. 37-38.
8. Project Freeway at para. 38.
9. Project Freeway at para. 46.
10. Project Freeway at para. 46.
11. Project Freeway at para. 46.
12. Project Freeway at para. 43. The court elsewhere (para. 32) noted the buyer had submitted "unchallenged evidence" the two transactions had "no impact" on the target's performance or the earnout calculation.
13. Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53 (CanLII), [2014] 2 SCR 633 [Sattva]. – https://www.canlii.org/en/ca/scc/doc/2014/2014scc53/2014scc53.html?resultId=86446548fd6f4d2881b32b4a37731b1e&searchId=2025-05-06T16:30:35:565/795c7bf1aeab4343a3f3d66c81d5a24f
14. Project Freeway at para. 34, citing Sattva at paras. 47-50.
15. Project Freeway at para. 34, citing Weyerhaeuser Company Limited v. Ontario (Attorney General), 2017 ONCA 1007 (CanLII) at para. 65.
16. Project Freeway at para. 47.
17. Project Freeway at para. 48.
18. See "Additional Considerations" below.
19. Project Freeway at para. 54.
20. Project Freeway at para. 54.
21. Project Freeway at para. 53.
22. Project Freeway at para. 54.
23. Project Freeway at para. 56.
24. Project Freeway at para. 56.
25. Project Freeway at para. 56.
26. Project Freeway at para. 51.
27. Project Freeway at para. 52.
28. Project Freeway at para. 53.
29. Project Freeway at para. 55. Note, however, that the knowledge definition to which the court refers is expressly tied to the seller's representations and warranties and not to the SPA generally.
30. Project Freeway at para. 57.
31. This result may come as a surprise to many transaction lawyers given that, on a strict reading of the acceleration clause, the trigger was any "material" asset transfer.
32. See Fasken, Private M&A in Canada: Transactions and Litigation (LexisNexis, 2024) at §3.05[4]. – https://www.fasken.com/en/knowledge/capital-markets-mergers-acquisitions/private-mergers-and-acquisitions-in-canada
33. It may therefore be worthwhile, in some cases, for M&A parties to consider spelling out more clearly the intention behind a materiality qualifier's use.
34. Project Freeway at para. 50, citing Ontario First Nations (2008) Limited Partnership v. Ontario Lottery and Gaming Corporation, 2021 ONCA 592 (CanLII) at para. 62: "An entire agreement clause alone does not prevent a court from considering admissible evidence of the surrounding circumstances at the time of contract formation." – https://www.canlii.org/en/on/onca/doc/2021/2021onca592/2021onca592.html
35. See Fasken, Private M&A in Canada: Transactions and Litigation (LexisNexis, 2024) at §3.06[5].
36. Visit Fasken's Capital Markets and M&A Knowledge Centre and subscribe. – https://www.fasken.com/en/knowledge/capital-markets-mergers-acquisitions
37. Project Freeway at para. 55 (emphasis added).
38. Visit Fasken's Capital Markets and M&A Knowledge Centre and subscribe. – https://www.fasken.com/en/knowledge/capital-markets-mergers-acquisitions
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