Material Adverse Effect (MAE) Clauses In Canada: What U.S. Counsel Needs To Know

I. INTRODUCTION

THE recent decision in Fairstone v. Duo Bank is an important addition to Canadian M&A jurisprudence.¹ This is especially the case regarding Fairstone's "material adverse effect," or "MAE" analysis, being the first detailed Canadian MAE decision in almost 20 years. The case has therefore attracted a large amount of commentary in Canada, the spotlight shinning even brighter given the dispute's grounding in the widespread economic disruptions resulting from the COVID-19 pandemic.

Much of this commentary centers on summarizing the guiding principles articulated in Fairstone, including as derived from the more developed body of Delaware MAE caselaw the court heavily cites. However, comparatively less attention has been paid to Fairstone's complicated relationship with Canadian MAE caselaw. So too has comparatively little attention been paid to how the decision departs from and conflicts with the Delaware MAE caselaw on which it otherwise heavily relies.

This article focuses on these less explored areas. What emerges is that Fairstone raises multiple unresolved and problematic issues not apparent from the face of the decision. The discussion is organized into four sections. Section II provides a brief overview of MAE clauses in M&A agreements. Section III summarizes the five Canadian cases cited by Fairstone during its MAE analysis. Section IV is a deep dive into Fairstone. We first review the court's MAE analysis. We then compare Fairstone's approach to its Canadian and Delaware counterparts.

Three critical revelations result. First, Fairstone departs from its Canadian and Delaware MAE siblings in several significant respects. Second, such departures overlap to a significant extent. Third, as a general matter, Fairstone neither signals that it is making such departures nor explains its reasons for doing so. Overall, the outcome is that Fairstone charts an unusual and uncertain path between Canadian and Delaware MAE caselaw of which U.S. and Canadian counsel should be aware and take caution.

For certainty, it is prudent to make clear what this article does not address. It does not provide a detailed examination of the multiple ways Fairstone closely follows Delaware MAE caselaw; this is uncontroversial and self-evident from the decision. Nor does the author purport to opine on what Canadian MAE law should be. Rather, the goal is to assist fellow practitioners in understanding Fairstone's complex relationship with Canadian and Delaware caselaw, including in light of the decision's silence regarding its departures from such caselaw as well as the multiple interrelated, unresolved, and problematic issues raised by this uncharted course. Finally, given that the U.S. is by far the largest source of foreign investment into Canada,² this confusion will be of particular interest to U.S. counsel with a cross-border practice.

II. MAE CLAUSES: A BRIEF OVERVIEW

MAE clauses are ubiquitous in corporate purchase and sale agreements, including share purchase agreements ("SPAs") and asset purchase agreements ("APAs"). Their basic purpose is to "permit the buyer to avoid the closing of the deal if a material change has occurred in the financial condition, assets, liabilities, business, or operations of the target firm."³ Put in layman's terms, MAE clauses act as an escape hatch for the benefit of the buyer, allowing them to back out of the transaction where the target suffers a severe blow to its business.

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Footnotes

1. Fairstone Fin. Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397 (Can.).

2. According to Statistics Canada (a department of the federal government), in 2019 direct investment from the U.S. into Canada was $455.1 billion and represented 46.7% of overall foreign direct investment into Canada. See STATISTICS CANADA, FOREIGN DIRECT INVESTMENT, 2019 (2020), https://www150.statcan.gc.ca/n1/daily-quotidien/200717/ dq200717b-eng.htm.

3. Albert Choi & George Triantis, Strategic Vagueness in Contract Design: The Case of Corporate Acquisitions, 119 YALE L.J. 848, 854 (2010).