CANADA Law and Practice Contributed by: Grant McGlaughlin, Sean Stevens and Claire Gowdy, Fasken
6.8 Allocation of Risk Private equity buyers are not sympathetic to assuming risks related to a business before they become own - ers, instead adopting the principle of “your watch/our watch” for all matters. However, risk allocation can be more tempered in a competitive auction process and, depending on the nature or extent of diligence con - ducted and the comfort level, with (or pricing adjust - ment in light of) known risks. Sellers in Canadian private equity transactions seek to limit liability through: • the use of materiality thresholds and knowledge qualifiers in providing representations and warran - ties; • the application of baskets and deductibles (ie, imposing minimum thresholds that must be obtained before out of pocket); • shortened durations for representations and war - ranties; and • reducing the cap on indemnification. The duration of representations and warranties in a non-insured deal typically ranges from 12 to 24 months (with carve-outs for tax, fraud, environmen - tal or specific representations such as fundamental representations, which can have a longer period). Fol - lowing US trends, where fundamental representations used to be provided for an indefinite term, these too are restricted in time, although often longer than the general duration for other representations. As a result, sophisticated private equity purchasers have sought to expand the definition of fundamental representa - tions beyond what was covered historically (share ownership and authority to sell) to include core zones of risk, such as intellectual property, with varying lev - els of success. However, in a sellers’ market, as was seen during the pandemic, the success of such an approach was more limited. Indemnification provisions in private M&A in Cana - da range anywhere between 10% and 100% of the purchase price, and may even go uncapped. After a move towards US-style 10% and lower caps in the early 2020s, recent reports have shown a significant increase in caps, with the average at approximately 64% of purchase price.
private transactions. The height of the sellers’ market in 2021 saw many private equity sponsors required to provide limited guarantees and equity commitment letters to support break fees being demanded by sell - ers. Where such provisions are accepted, it tends to be in a privatisation context and countered with a reverse break fee (or, at a minimum, a reimbursement of expenses clause). Reverse break fees do arise if the transaction is condi - tional on financing, thereby limiting the private equity firm’s exposure if financing does not take place. Many private equity sponsors have been required to provide equity commitment letters and limited guarantees to secure a prospective acquisition. In a friendly public take-private transaction, a reverse break fee is typically payable to the purchaser in con - nection with the exercise of a fiduciary out by the tar - get board for a superior proposal. 6.7 Termination Rights in Acquisition Documentation Purchase agreements structured as two-step (sign and then close) transactions typically provide for ter - mination in the case of: • mutual agreement; • termination by the buyer (provided the buyer is not in default of its obligations) where the obligations of the seller cannot or have not been satisfied by an outside date; and • termination by the seller (provided the seller is not in default of its obligations) where the obligations of the buyer cannot or have not been satisfied by an outside date. The failure to obtain regulatory or government approv - als, third-party consents or appropriate financing are the most frequent obligations triggering these termina - tion rights. A typical longstop date (or “outside date”, in Canadian terms) is set on a case-by-case basis, taking into account the anticipated level of complex - ity of obtaining regulatory approvals (if any) and any other closing deliverables (such as required consents, necessary pre-closing transactions, etc).
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