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Canadas mergers and acquisitions market is one of the worlds most active and sophisticated, particularly in the mining, oil and gas, industrial products and real estate sectors. In choosing a Canadian law firm for a succession plan, clients look for not only legal expertise but also industry knowledge. The Mergers & Acquisitions (M&A) Group at Fraser Milner Casgrain LLP (FMC) is one of Canadas most experienced in the gold, metals and minerals, oil and gas, power, technology and real estate industries. Virtually every succession transaction involves negotiating tax aspects of the deal. The way tax laws are applied can sometimes be a dealbreaker, whether in complexmergers,managementbuyouts,orasaletothe next generation. The tax lawyers at Fraser Milner Casgrain LLP (FMC) creatively resolve tax issues, turning them from dealbreakers to dealmakers. We work closely with our colleagues in other practice areas, providing expert tax advice in all corporate and commercialtransactions.Ourexpertisecoversallsectors, from entertainment and international transactions, to realestate,miningandnaturalresources. TolearnmoreaboutFMC, initial public offering or reverse takeover) can be an attractive option, though it does involve giving up the advantagesofbeingaprivatelyheldcompany.

A Letter of Intent (LOI) serves to set out the ground rules of conduct between parties to a proposed transactioninvolvingthepurchaseandsaleofabusiness. This includes identifying factors which may later figure intothepurchase(thirdpartyconsents,boardofdirector or shareholder approval, Competition Act or foreign investment approvals or notifications,) and the timelines each party must follow in moving towards closing, such as the purchaser completing due diligence by a certain date or the vendor obtaining third party approvals by a certain date. In order to be effective, a LOI requires a minimum level of certainty with respect to fundamental business terms: parties, type/structure of the transaction,price(ortheprocessthroughwhichtheprice will be determined), and the property which is subject to thetransaction(i.e.sharesorassets). LOIs fall into two categories: binding and nonbinding. While nonbinding LOIs are true to their name in the broad sense, they often contain confidentiality, non disclosure, and/or standstill provisions which are intended to be binding on the parties either during an exclusivity period or even if the transaction does not close. Moreover, parties to nonbinding LOIs should be wary, as recent court cases in Canada have held that even LOIs which the parties believed to be nonbinding can give rise to legally enforceable obligations. Some commonoccurrencesofthisinclude: If there is a future dispute over the interpretation of the final executed binding purchase agreement which is related to the LOI, the LOI may be used to determinethecommonintentionoftheparties

There are a number of options open to plan for the succession of a business. The controlling shareholder may be bought out over time this can involve the controlling shareholders replacement by either a single replacement shareholder or a broader ownership group if no single replacement option exists. Another common route is the sale of the entire business (whether by sale of shares or assets) to a competitor or a complementary business. A similar alternative is to merge with a competitor or complementary business. Finally, dependingonitssize,takingacompanypublic(bywayof

If the parties intention was to be bound and the LOI contains all essential terms required for the particular transaction IfanLOIcontainslanguageakintoaformalagreementforexampleagreeduponoracceptance Itissettledlawthatanagreementtoagreeisnotenforceable.However,acommoninterpretationofanLOIisthat the parties are bound temporarily by the preliminary agreement which is to be replaced by the more detailed formal purchase agreement. The standard imposed by Alberta courts is that any LOI which merely records a futureintenttoenterintoacontractwillnotcreatealegallybindingrelationship.Itisthisstandardthatapartyto anonbindingLOImustkeepinmind.

The purchase price in the transaction is typically negotiated at the LOI stage, but this price usually based on financial statements provided during the period of negotiations is only a historical snapshot of the business at that point in time. However, the value of the business at the time of the closing of the transaction may have changed. As a result, the payment of the entire purchase price on the closing of the transaction may not suit the businessneedsofthepartiesandadjustmentstothepurchasepricemayneedtobemade. One mechanism used to adjust the purchase price is a working capital adjustment. Typically, a working capital target (or a range) is agreed to by the parties and after the actual working capital is calculated as at closing date (done by taking the companys current assets less its current liabilities), the purchase price is either increased or decreased(dollarfordollar)accordingtothedifferencebetweenthetargetworkingcapitalandtheactualworking capital as at the closing date. As it takes time to determine the actual working capital, this adjustment is typically done90to120days(orlonger)aftertheclosingdate. Alternatively, the purchase price may be dependent on the future earnings of the business over a period of time. Astheseearningswillnotbeknownatthetimeofclosing,aportionofthepurchasepriceisthenstructuredasan earnout.Thiscanbedoneinanumberofways: Future earnings compared to earnings at the same time in the previous fiscal year (i.e. month over month), with a percentage of any positive difference between previous earnings and current earnings paid to the vendor Atargetearningsfigureforaspecifiedtimeperiodisestablishedinthepurchaseagreementandthepurchaser then pays a percentage (or the entire amount) of the earnings which exceed the target (this could also be structuredasdifferentearningstargetsformultipleyearsafterclosing) Thevendoristoreceiveaspecifiedpercentageofgrossornetearnings,orgrossmargins,foraspecifiedperiod oftimeafterclosing Though this method may be attractive to vendors who are confident in their business, purchasers can be hesitant toemploythistransactionstructure.Forexample,anearningstargetmaybemetwhenitotherwisewouldnotbe as a result of extraordinary situations such as sales of assets out of the ordinary course of business or nonarms length transactions. It may also be the case that the purchaser attracts many new customers to the business after previous customers of the vendor have left. These factors, especially the former, may need to be specifically contemplatedinthepurchaseagreement.

Representations and warranties are a fundamental part of every purchase agreement and are typically heavily negotiated. Representations are statements of fact speaking to the past or present and warranties are guarantees that a fact is or will be true in the future. The purchaser will of course want the vendors representations and warrantiesasbroadaspossiblewhilethevendorwillseektonarrowthem. There are three common types of exceptions vendors use to reduce the scope of their representations and warranties.Thefirstoftheseistheknowledgequalifierwherebyavendorwilltrytolimititsrepresentationsand warranties to things falling within the actual knowledge of certain named individual vendors (the majority shareholders or management shareholders for example). In these cases the purchaser will almost always want knowledge to require the vendor to have made a reasonable inquiry into the matter or knowledge to include what a reasonable person, using reasonable care or diligence, should have known. This is termed constructive knowledge. For the sake of certainty, if the phrase to the knowledge of the vendor is included in the purchase agreement to qualify any of the vendors representations, the agreement should also include an interpretation sectionconcerningthemeaningofthephrase. A second common qualifier is the materiality exception. Adding a level of materiality to representations will protectavendorinthatimmaterialbreachesofthoserepresentationswillnotresultinabreachofthepurchase agreement and open up the vendor to liability. If the word material is left undefined in the purchase agreement it will be left to the parties to argue at a later date on a subjective level. However, in relation to the vendors disclosure regarding its agreements, commitments and expenditures, the word material is often defined based on a certain minimum aggregate dollar value, either on an annual basis or as a percentage of the purchase price. Thisallowsforanobjective,brightlinetest. A third manner of qualifying a vendors representations and warranties is for specific exceptions to disclosure (usually based on the results of due diligence by both parties) to be listed and described in schedules to the purchaseagreement(i.e.ExceptasdisclosedintheVendorsDisclosureSchedules,therehasbeenno.).

Indemnification clauses are included in purchase agreements to protect the purchaser from a breach of a representation or warranty of the vendor and specifically contemplate the vendors indemnification of the purchaser in these circumstances. Indemnification clauses are typically drafted to include both the direct losses that the purchaser may suffer as a result of a breach of representation and warranty and the losses the purchaser maysufferifathirdpartybringsanactionrelatingtoabreachofavendorsrepresentationorwarranty.

SurvivalPeriodofIndemnities The purchase agreement should include a survival clause expressly setting out the time period for which the vendors representations and warranties will last. After the expiry of that period (and provided there has been no breach of the vendors representation and warranty prior to that expiry date), the purchaser will no longer be entitled to seek indemnity from the vendor for a breach of a representation and warranty that occurs after that expiry date. Many general representations and warranties cannot be certified until postclosing such that a purchaser will generally not accept a survival period of less than one year after closing. Typical survival periods rangefrom1to3yearsafterclosing. IndemnificationBaskets Anindemnificationbasketistheminimumloss/damage(expressedindollars)thatmustbesufferedbyapurchaser forabreachofavendorsrepresentationsandwarranties(orthevendorsbreachofothercovenantsorprovisions of the purchase agreement) before the purchaser can recover damages from the vendor pursuant to the indemnification provisions in the purchase agreement. Vendors typically negotiate for baskets with a high value, whilepurchasersseekbasketswithalowone(ornobasketatall). Generally,therearetwotypesofindemnificationbaskets:(1)deductiblebasketsand(2)dollaronebaskets.Under a deductible basket provision, the vendor is only responsible for damages exceeding the basket amount. For example,iftherewasadeductiblebasketof$1,000andaclaimbythepurchaserof$1,500,thevendorwouldonly be responsible to pay the purchaser $500. Under a dollarone basket provision (also referred to as a first dollar basket), the vendor is responsible for all damages suffered by the purchaser once the purchasers damages reach the threshold.For example, if there was a dollarone basket of $1,000 and aclaim bythe purchaser of $1,500, the vendorwouldberesponsibletopaythepurchaserthefull$1,500oncethe$1,500thresholdwasreached. It is also possible to have a combination basket. In such a case, there is one figure for the minimum loss suffered and another for the threshold above which the vendor is responsible for indemnification. For example a combination basket could have figures of $10,000 and $5,000, where the vendor would not be required to indemnify the purchaser for losses until the minimum threshold of $10,000 was reached, and even at that point, wouldonlyberesponsibleforlossesinexcessof$5,000. IndemnificationCaps An indemnification cap sets out the maximum total amount of damages a purchaser is able to recover from the vendorundertheindemnificationprovisionsinthepurchaseagreement.Thepurchaserwillnegotiateforaslargea cap as possible (either unlimited (being no cap) or a cap up to the entire purchase price), while a vendor will want to limit the value of the cap as much as possible. Indemnification caps can either be expressed as a specific dollar amountorasapercentageofthepurchaseprice. Escrow Escrowisoftenusedasaformofcollateralorsecurityforthevendorspotentialindemnificationobligationstothe purchaser.Theescrowfunds(orholdbackfunds),typicallybeinganagreeduponportionofthepurchaseprice,are withheldfrombeingpaidtothevendoronclosingandaredepositedbythepurchaserwithanescrowagent(often the purchasers solicitors) into an interest bearing trust account at closing for a certain period of time (being the escrow period) often an equivalent time as the survival period of the vendors representations and warranties.

These escrow funds then serve to provide a form of protection to the purchaser for future indemnification claims, as the amount of its claims are then deducted from the escrow funds prior to any release of the escrow funds on thespecifiedreleasedateordates.

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