Stikeman Elliott represented the sellers of Fairstone Financial in the first case in which a Canadian court has ordered specific performance of a major M&A deal and the first Canadian case to consider the impact of COVID-19 on an acquisition.

The COVID-19 pandemic has led to a notable increase in actual and contemplated M&A litigation, as buyers under acquisition agreements signed before the pandemic consider their obligations to close and sellers seek to compel performance. At issue in these cases are two key contractual risk allocation mechanisms widely used in acquisition agreements: material adverse effect (“MAE”) clauses and interim covenants requiring the target business to operate in the “ordinary course”.

On December 2, 2020, Justice Markus Koehnen of the Ontario Superior Court of Justice – Commercial List ordered specific performance of the acquisition of Fairstone Financial Holdings Inc. (“Fairstone”) by Duo Bank of Canada (“Duo Bank”). Following this decision, the transaction closed on January 4, 2021.

The Fairstone decision represents multiple notable firsts in Canadian M&A litigation. It is the first decision by a Canadian court: ordering specific performance of a major M&A transaction; interpreting a complex MAE clause including carve-outs for risks assumed by the buyer; interpreting an ordinary course covenant in an acquisition context; and considering whether a buyer was entitled to refuse to close an acquisition due to the impact of COVID-19 on the target business.


The Fairstone acquisition

On February 18, 2020, Duo Bank entered into an agreement (the “Agreement”) to purchase the shares of Fairstone, Canada's largest consumer finance company, which has been in operation since 1923 and has over $3 billion in assets. The parties anticipated that closing would occur on June 1, 2020, with an outside date of August 14, 2020.

Duo Bank alleges failure of closing conditions

On April 1, 2020, Duo Bank took the position that the COVID-19 pandemic might already have resulted or would result in a MAE, breach of the ordinary course covenant, and an “Amortization Event” under the securitization facilities Fairstone used to fund its business. Eventually, on May 27th, Duo Bank advised that it would not close the transaction, but did not terminate the Agreement.

Fairstone immediately commenced an application on the Commercial List in Toronto, seeking specific performance of Duo Bank's obligation to close the transaction. In response, Duo Bank commenced its own proceeding seeking a declaration that it was not required to close the transaction as well as damages for alleged breach of a covenant to provide Duo Bank with all information reasonably necessary for closing.

The Decision

Justice Koehnen concluded that the closing conditions were met: Fairstone had not experienced a MAE or operated outside of the ordinary course, and no Amortization Event was reasonably expected to result. Each of these conclusions is summarized below.

No Material Adverse Effect Due to COVID-19

The Fairstone decision is the first interpretation by a Canadian court of a MAE clause with a commonly used three-part structure, which:

  1. places the risk that a material adverse effect will occur prior to closing on the seller;
  2. carves out various events or effects that do not constitute a MAE, allocating these risks to the buyer; and
  3. re-allocates some of the carved-out risks to the seller, but only to the extent that they have a materially disproportionate adverse impact on the target business compared to others in the same industry or markets.

The decision first addresses the burden of proof to establish that a MAE had occurred, which was a matter of first impression in Ontario law. The court held that the burden shifts between the parties: the onus is on the buyer to prove that a MAE has occurred; on the seller to prove that any carve-outs apply; and on the buyer to prove materially disproportionate impact on the target.

Material adverse effect on loan originations

In the first part of the analysis, this decision offers the clearest articulation to date by a Canadian court as to what constitutes a material adverse effect. The court adopted the prominent definition of the Delaware courts that a MAE is an effect (i) that is unknown to the parties at the time of signing the acquisition agreement, (ii) which threatens the overall earnings potential of the business, and (iii) which occurs in a durationally significant manner.

The court also addressed two issues of timing with respect to the determination of a MAE:

  • First, it was appropriate to determine whether a MAE had occurred or was reasonably expected based on the information available on the outside date by which the transaction was expected to close.
  • Second, how far into the future courts should look to see if a MAE is expected to arise would depend on the circumstances of the case. For instance, where a purchaser is acquiring a cyclical business and by the time of closing can foresee a recession within two years, it would not be appropriate to allow the purchaser to avoid the transaction.

Applying these principles, the court concluded that the pandemic had a material adverse effect on Fairstone's business:

  1. While the parties were aware of the pandemic at the time of entering into the Agreement, its effect on Fairstone's business was unknown at the time.
  2. Fairstone had experienced year-over-year decreases in loan origination, including due to credit tightening, which were a threat to the earnings potential of the business.
  3. The effect was durationally significant, as it would reasonably be expected to continue into 2022.

Multiple carve-outs applied

The court concluded, however, that three carve-outs applied:

  1. A carve-out for failure to meet forecasts or estimates precluded any reliance on Fairstone's failure to meet its pre-pandemic annual operating plan and projections.
  2. A carve-out for “worldwide, national, provincial or local conditions or circumstances” broadly allocated systemic risks to the buyer. The carve-out specifically captured “emergencies” or “crises.” Both aspects of the carve-out clearly included the pandemic, despite the lack of express reference to “pandemics.”
  3. A carve-out for “changes in the markets or industry” also excluded the effects of COVID-19 on Fairstone, as those effects were part of a general change to the consumer lending market.

The court further concluded that neither the COVID-19 emergency nor the related changes in the market or industry had had a materially disproportionate adverse impact on Fairstone relative to others in the industries or markets in which it operates. As a result, there was no MAE entitling Duo Bank to refuse to close.

Pandemic Responses Were Ordinary Course

The court also rejected the buyer's argument that Fairstone's responses to COVID-19 materially breached its covenant to operate in the ordinary course. While previous cases have considered the meaning of “ordinary course” in a variety of other legal contexts, this decision is the first Canadian judicial consideration of the concept in the context of an acquisition.

As an essential business, Fairstone had been permitted to and did keep its branches open and its branch employees working on-site throughout the pandemic. Fairstone had, however, made adjustments to operations in response to the pandemic, which included:

  • controlling access to premises to maintain social distancing;
  • brief closures of a small number of branches;
  • implementing a nationwide program that allowed customers to defer payments;
  • giving employees extra leave days and a daily pay premium; and
  • decreasing marketing and other expenditures by 10% relative to budget.

The court held that the purpose of ordinary course covenants is to ensure that the business the buyer pays for at closing is essentially the same one it agreed to buy, and to mitigate the moral hazard of sellers self-dealing between signing and closing.

The court rejected the buyer's arguments that Fairstone's pandemic response measures were outside the ordinary course:

  1. The court rejected the argument that actions taken in response to unusual circumstances or financial difficulties were outside the ordinary course. Such actions could be ordinary course provided that they were responses to systemic circumstances rather than to difficulties specific to the target. This interpretation achieved the fundamental purpose of ordinary course covenants, which is to protect the purchaser against company-specific risks and moral hazards, but not against the risk of market timing.
  2. The court rejected the argument that Fairstone could not operate in the ordinary course in the extraordinary circumstances of the pandemic. This conclusion was supported by the exclusion of emergencies from the MAE clause, which indicated that the parties did intend the transaction to close even in an emergency.
  3. The court rejected the argument that Fairstone's pandemic responses were not “consistent with the past practices” of Fairstone, as the ordinary course covenant required. This contractual wording required Fairstone's conduct to be “consistent” with past practices, not identical to them. Operational changes consistent with Fairstone's actions during past economic contractions, or which allowed Fairstone to continue its normal day-to-day consumer lending business, were consistent with past practices.

The court concluded that Fairstone's pandemic response measures were not outside the ordinary course, as Fairstone's business remained the same, and any changes were made in response to systemic challenges, not challenges unique to Fairstone; were made in good faith for the purpose of continuing the business; were consistent with what other businesses were doing across Canada; and had no long-lasting effects.

The court also held that Fairstone was entitled to rely on an exception permitting it to operate outside of the ordinary course with Duo Bank's prior written consent, which could not be unreasonably withheld. Fairstone had not sought Duo Bank's consent prior to adopting pandemic response measures because it took the position that it was operating within the ordinary course. The court agreed but held, in the alternative, that if any steps taken by Fairstone were outside the ordinary course, it would have been unreasonable for Duo Bank to withhold consent.


The Fairstone decision considers the interpretation of two risk allocation mechanisms commonly used in acquisition agreements – MAE clauses and ordinary course covenants – and their application to the extraordinary circumstances of the COVID-19 pandemic. The decision provides guidance that:

  • Even if the definition of a MAE does not expressly allocate the risk of epidemics or pandemics, other common carve-outs can capture pandemic risk. These may include carve-outs for general market changes, systemic conditions or circumstances or emergencies.
  • The Ontario court defined “material adverse effect” consistently with past Delaware cases as an effect unknown to the parties at signing that threatens the overall earning potential of the target in a durationally-significant manner.
  • Businesses may operate in the ordinary course even in the extraordinary circumstances of the pandemic. Changes to operations made in response to the pandemic may be consistent with ordinary course conduct, provided that they have no long-lasting effects on the business. Buyers may not be able to reasonably withhold consent to pandemic response measures that are short term, commonplace, and taken for the purpose of maintaining the business.

Stikeman Elliott represented Fairstone and its principal sellers, investment vehicles advised by J.C. Flowers and Värde Partners, with a litigation team led by Eliot Kolers and Danielle Royal and a corporate team led by John Leopold, Warren Katz, and Kevin Custodio.  

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.