Written by Gary Solway, Munaf Mohamed, Q.C., John Mercury, Michael Mysak and Paul Romaniuk
A private M&A purchase agreement customarily includes extensive representations and warranties and indemnification provisions. Post-closing, if the buyer alleges a breach of those provisions claiming significant damages, and the seller disputes that allegation, that dispute could end up before the courts for resolution.
One such recent court decision is the Alberta Queens Bench case of NEP Canada ULC v MEC OP LLC, 2021 ABQB 180 released April 1, 2021. The case provides some useful lessons for participants in private M&A transactions in Canada. The Court found that the private equity-backed seller had purposefully lied, or told half-truths, about its compliance with certain regulatory obligations associated with oil field assets, thereby committing fraud. In its disclosure schedule, the vendor repeatedly represented there were "potential" issues of non-compliance when they knew the issues were actual and substantial. The Court awarded almost $200 million in damages, including more than $120 million for loss of opportunity. The decision is under appeal. Bennett Jones1 represented the successful buyer/plaintiff in the acquisition and the litigation.
In 2010, the buyer developed a business strategy under which it would acquire previously developed oil and gas fields, use its expertise to workover existing wells and drill new wells to increase production and resell the investment within three years. This was memorialized at the time in various "waterfall" models and contemporaneous documents.
In June 2011, the buyer agreed to purchase oil field assets within Alberta from the seller through the purchase of all shares in a subsidiary of the seller. In accordance with the buyer's business strategy, it planned to resell the expanded oil field assets by 2014.
Not long after the transaction had closed, the buyer became aware of many regulatory non-compliance issues with the oil field assets. The buyer was required to close a third of its production and use its reduced cash flow to remedy these non-compliance issues, which effectively prevented the buyer from reselling the assets by 2014. Instead, due to remediation efforts and related financing delays, the buyer could not feasibly sell the assets until 2016—by that time the price of oil and the value of the assets had dropped significantly.
The following is a list of 10 key takeaways from this litigation for parties involved in M&A transactions:
1. Court Litigation Takes Time
Although the buyer was successful at trial, nearly 10 years passed from the closing date of the transaction until the Court determined the merits of the dispute. Further, each side has appealed portions of the decision, meaning it may not be finally resolved for a significant time. The purchase agreement did not contain an arbitration clause. Arbitration is typically a speedier alternative as it follows a directed process and is more likely to result in a final decision as parties often agree to limit any appeals of the arbitrator's decision. For private equity and venture capital participants, where IRR and MOIC metrics are extremely important, a speedy and definitive resolution can be the most important concern. However, arbitration may not be appropriate for every situation.
2. Unwelcome Publicity
This decision against the seller is public. In addition to finding the seller engaged in fraud and attempted to use "word weasel terminology" to hide its knowledge of liabilities, the Court made a number of factual findings potentially harmful to the seller's reputation. Unlike courts, arbitrations are generally private and allow the parties to ensure the dispute, and in this case the determination of fraud, to remain confidential.
3. Discovery Reveals All
Canadian litigation permits each party to obtain access to all of the other party's records relevant and material to the dispute, including emails. Emails have a tendency, as they did in this case, to reveal telling and unhelpful dialogue between executives of the seller as they negotiated the transaction. For instance, it was the discovery of emails which revealed that the seller was aware of "potential" regulatory liabilities. Further, while key executives of the seller denied knowledge of the regulatory liabilities, the Court imputed knowledge to these key executives as they had repeatedly received emails discussing these regulatory liabilities and the Court did not believe that the executives had not read them (in particular as the executives had requested they be copied on such emails). There is not much that can be done to protect emails from discovery in Canadian courts, other than privileged communications with legal counsel in certain circumstances. As a result, those working on an M&A transaction should be careful with their email and other document retention practices. For example, if an executive does not intend to read the emails he or she is copied on, he or she should ask to be removed from the circulation list to avoid imputed knowledge.
4. Seller's Limited Access to Records and Personnel
As most of the records and personnel go with the acquired company or business, the seller will have difficulty accessing them. Typically, there are provisions in the purchase agreement dealing with seller's access to records post-closing, but the seller will not control the records and therefore will not be able to access these records as conveniently and fully as they otherwise would be able to. Accessing personnel will be more difficult and may require them to be called as witnesses, which has its own hazards.
5. Executives of Seller Become Executives of Buyer
The executives who conducted the sale for the seller frequently become employees of the buyer. They will often be required to act as witnesses in the litigation, which is likely to be a time consuming process and a distraction to these executives, which is harmful to the buyer. Further, the buyer does not want to be suing its key executives or making them testify in awkward situations that could potentially be publicly reported. In this decision, the Court noted the difficult position of senior employees of having to admit to participating in the deception of the buyer—their current employer. The retention of former seller executives creates additional concerns if they were owners (e.g., shareholders/option holders) of the acquired business, as the executives will also potentially be on the hook for damages. Representation and warranties (R&W) insurance can be helpful in these situations as it will reduce the potential personal liability of the executives/sellers. However, R&W insurance does not generally apply where there is fraud. R&W insurance also will not stop the executives from becoming involved in litigation where the insurer disputes liability.
6. Legal Privilege Not Seller's
Privilege is the right of a person to be able to speak freely with his or her lawyer without risk of that discussion being disclosed in court or otherwise. It is easy to forget who the beneficiary of that protection is. In a decision related to this case2, the Court found that the privilege belonged to the acquired company, which the buyer now controlled, and therefore the seller could not assert privilege in the communications between the acquired company and its legal counsel. Preserving seller privilege in these circumstances can be addressed through appropriate provisions in the purchase agreement.
7. Fraud Trumps Everything
The Court determined that the seller's fraud rendered inapplicable the purchase agreement's caps and limitations on types of damages available. The Court held that a party who makes fraudulent misrepresentations to induce the counterparty to enter into the contract cannot rely on exculpatory or limitation clauses to protect themselves from their wrongful conduct. As a matter of public policy, the Court found it would be contrary to equity to allow the seller to escape liability for the false remarks simply because they, while withholding crucial truths or actively making mendacious comments, inserted into the contract a clause that shields it from legal ramifications.
8. Scope of Potential Damages is Broad
The Court awarded the buyer damages to compensate the plaintiff with respect to the oil field assets being worth less than represented due to associated liabilities, and for the loss of opportunity to resell the oil field assets while the price of oil remained high. The Court found that the seller's fraud had deprived the buyer of the opportunity to resell the oil field assets in accordance with the timeframe in its business plan. In this case, the seller was aware of the buyer's business plan. While a clause limiting damages might typically be useful to protect the seller, the finding of fraud here rendered any such clause inapplicable, as noted above.
9. Knowledge Can Be Imputed
The buyer was required to prove that the seller's key personnel responsible for the transaction (the persons of knowledge) knew about the undisclosed liabilities, either through actual knowledge or through imputed knowledge due to the executives' recklessness towards those liabilities. Through the use of documents discovered in the litigation process, the buyer was available to convince the Court that persons of knowledge, including key, senior seller executives had actual knowledge of such liabilities or were reckless regarding the representations on them, despite express denials of knowledge by these executives during oral testimony. Some representations and warranties in the purchase agreement were expressly qualified by the knowledge of the seller executives, after due inquiry. The Court held that the seller executives had willfully failed to make the necessary inquiries.
10: Oral Conversations, Actions and Other Extrinsic Evidence
Things parties say and do in the course of the negotiations may end up later harming them. In this case, oral representations made by the seller executives were used to prove the seller's deceit and breach of its duty of good faith. The Court may consider testimony made by the parties providing a recollection of past oral conversations, subject to the rule against hearsay. In this case, the buyer brought evidence that the seller had orally represented that there were no hidden liabilities that were undisclosed in the disclosure schedules. This evidence formed part of the Court's finding that certain of the seller executives actively mislead the buyer, amounting to breaches of the duty of good faith and forming part of the seller's fraudulent misrepresentations. In most cases, parties will use an entire agreement clause to oust the consideration of any oral representations. However, generally-worded clauses of this nature are not likely effective in the case of fraudulent misrepresentation, or where a party otherwise makes specific representation contrary to the party's duty of good faith. As a result, it may be difficult to escape oral statements that are knowingly misleading, even if these oral representations are not reproduced in the purchase agreement.
This case demonstrates some of the many issues that should be considered in the drafting of purchase agreements in Canada. Understanding how these issues are dealt with by Canadian Courts can assist counsel in drafting purchase agreements to eliminate, as much as possible, the issues identified in this case.
Bennett Jones' public and private M&A practice spans all industries, and particularly those that drive the Canadian economy, such as energy: oil and gas and renewables, mining, consumer products, technology, utilities, agribusiness, financial services and cannabis, among others. Gary Solway and John Mercury act on behalf of buyers and sellers in M&A corporate transactions. Munaf Mohamed, Michael Mysak and Paul Romaniuk act in M&A litigation matters.
1.Munaf Mohamed, Q.C. and Michael D. Mysak of Bennett Jones represented the buyer/plaintiff in the litigation.
2.NEP Canada ULC v MEC OP LLC, 2013 ABQB 540. For further information, see our previous blog post on this topic, NEP ULC v MEC Op Co LLC: A Cautionary Tale for Corporation Counsel.