In a recent Ontario decision, the court addressed the impact of the COVID-19 pandemic on a commercial transaction after one party tried to use the pandemic as a reason to terminate the deal.
Party Attempts to Terminate Transaction in Wake of COVID-19
On February 18, 2020, Fairstone Financial Holdings Inc. and its subsidiaries signed a share purchase agreement with the Duo Bank of Canada pursuant to which Duo agreed to purchase Fairstone’s business. Closing was scheduled for June 1, 2020.
However, on May 27, 2020 Duo advised Fairstone that it would not be closing on June 1 as planned. Duo took the position that four covenants in the share purchase agreement allowed it to avoid closing: the material adverse event covenant, the ordinary course covenant, the amortization event covenant and the access to information covenant.
Duo claimed that the first three covenants had been triggered by events that occurred or were expected to occur as a result of the COVID-19 pandemic. As such, Duo took the position that it was entitled to terminate the transaction.
In response, Fairstone brought an application for specific performance.
Relevant Terms of the Share Purchase Agreement
The material adverse event covenant– In the share purchase agreement, Fairstone covenanted that no material adverse effect should have occurred between the date of signing and the date of closing. In the agreement, material adverse effect was defined so as to exclude effects that were caused by:
- worldwide, national, provincial or local emergencies;
- changes in the markets or industry in which Fairstone operates; or
- the failure of Fairstone to meet any financial projections.
The ordinary course covenant– The ordinary course covenant required Fairstone to act between signing and closing in a manner that was consistent with its past practices and that was in the ordinary course of normal day-to-day operations, to the extent it was lawfully able to do so.
The amortization event covenant– Pursuant to the amortization event covenant, Fairstone agreed, among other things, that its losses within its loan portfolios would not exceed a certain trigger point.
The access to information covenant – The access to information covenant required Fairstone to furnish Duo with such financial and operating data as was reasonably necessary for Duo to consummate the transaction.
Court Orders Specific Performance
First, the court found that, while a material adverse effect did occur as a result of the COVID-19 pandemic, the three carveouts from the material adverse effect clause took Duo’s complaints outside of the scope of the clause, stating:
“Here the adverse effect was clearly caused by the pandemic which falls into the definition of the first carveout. In addition, the changes of which Duo complains are changes to the entire market and industry in which Fairstone operates. They are not changes unique to Fairstone. Third, Duo’s fundamental complaint is that Fairstone failed to meet the projections contained in its financial plan. The first two carveouts have the added nuance that they apply only to the extent that Fairstone has not been disproportionately adversely affected relative to other persons in the industries or markets in which Fairstone operates. I have concluded that Fairstone has not been disproportionately affected.”
With regard to the ordinary course covenant, the court found the steps Fairstone had put into place after the pandemic had been declared were consistent with steps it had put into place during past recessions and/or were steps that one would expect a business to put into place as part of its ordinary course operations during a recession. The court stated that, to the extent that Fairstone had taken steps that it had not taken in the past, it had been required to do so by law. As such, the court held that Fairstone’s behaviour fell within ordinary course operation principles.
Addressing the amortization event covenant, the court stated that the issue turned on whether, in the language of the agreement, a circumstance had existed that “would reasonably be expected to result in an amortization event .” The court held:
“The short answer to Duo’s complaint is that simply because a financial model might project an amortization event does not mean that it will occur. The whole point of obtaining those projections is to enable management to recalibrate the business to avoid the projected amortization event from ever occurring.”
Finally, the court dismissed Duo’s complaints under the access to information covenant, finding that they amounted to a fishing expedition and an attempt on Duo’s part to not close.
The court therefore concluded that none of the material adverse effect, ordinary course, amortization event or access to information covenants had been breached and none provided Duo with any basis for refusing to close the transaction.
As a result, the court ordered Duo to perform the share purchase agreement and close the transaction.
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