M&A and Private Equity Bulletin: Insights from the Fairstone-Duo Bank Decision on the Effect of MAE/MAC Provisions Amidst the COVID-19 Pandemic

The Ontario Superior Court of Justice (the “Court”) recently released its decision in Fairstone Financial Holdings Inc. v Duo Bank of Canada (“Fairstone”), which has been the first decision in Canada to address the applicability of invoking material adverse change (“MAC”) or material adverse effect (“MAE”) provisions, commonly found in M&A and corporate finance transaction documents, in the context of the COVID-19 pandemic.[i]

Background of the Fairstone Decision:

Duo Bank of Canada (“Duo”) was set to acquire Fairstone Financial Holdings Inc. (“Fairstone”) by way of a share purchase agreement signed on February 18, 2020 with a scheduled closing date of June 1, 2020. Between the signing of the agreement and the date of closing, the COVID-19 pandemic swept across the globe and had a significant impact on the business and operations of Fairstone.

On May 27, 2020, just days before closing, Duo notified Fairstone that it did not intend to close the transaction, asserting that an MAE had occurred since the signing of the purchase agreement and that Fairstone’s response to the pandemic breached its covenant to operate the business in the “ordinary course”.

The Court had to decide whether, amidst the global pandemic, the buyer would be able to abandon the transaction by relying on the MAE provision and the allegation that the effects of COVID-19 had met the threshold of an MAE on the target’s business, or would be ordered to specifically perform the contract.

The Court found that the effects of the COVID-19 pandemic did not constitute an MAE which would allow Duo to rescind the agreement. As such, Duo was ordered to perform its obligations and close the transaction.

The Analysis:

The Applicability of the “MAE Provision”

The Fairstone purchase agreement contained a specific provision indicating that no MAE shall have occurred between the date of signing and the date of closing. Duo sought to rely on this provision to abandon the transaction, arguing that the COVID-19 pandemic constituted a MAE, and therefore, gave it the right to terminate the agreement. Fairstone, on the other hand, asserted that the effects of the COVID-19 pandemic fell within the scope of the specified MAE carve-outs.

In its analysis, the Court adopted the widely used definition of an MAE from established Delaware jurisprudence, requiring the alleged MAE, interpreted from a purchaser’s reasonable view to be:

(i)     an unknown event or effect,

(ii)    a threat to the overall earnings potential, and

(iii)   of durational significance.

The Court concluded that the COVID-19 pandemic satisfied all three of the required criteria. However, the MAE was also defined so as to exclude effects that were caused by:

(i)     worldwide, national, provincial or local emergencies;

(ii)    changes in the markets or industry in which Fairstone operates; or

(iii)   the failure of Fairstone to meet any financial projections.

The Court held that Fairstone met its evidentiary burden and established that all three carve-outs did in fact apply. In its analysis of these carve-outs, the Court recognized that:

(i)     the carve-out on “emergencies” applied despite the absence of the word “pandemic” as a contemplated event;

(ii)    Duo was in a position to negotiate a number of mechanisms to protect itself, including defining the specific amount of deterioration in specified financial matters or structuring the purchase price as an earn out contingent on maintaining specific financial benchmarks, but it did not; and

(iii)   the fact that other markets or industries may be experiencing the same changes does not in any way diminish the fact that there is a change in Fairstone's market or industry.

The Court further held that Fairstone was not disproportionately affected by the pandemic compared to others in the same market or industries in which it operates. Therefore, there was no MAE as defined by the Fairstone purchase agreement.

The Court reiterated that contracts are to be read as a whole and not as a series of unrelated, standalone provisions. As such, while Duo argued that it was to be awarded “the protections for which they bargained”, the Court did not agree that these alleged protections were in fact bargained for.

While the Court noted that MAE provisions are not generally designed to protect purchasers against changes in market timing, a carefully drafted purchase agreement can include features that protect purchasers against these types of uncertainties. The purchase agreement in dispute contained no such features, and therefore, the purchaser could not rely on these protections.

Factors that Constitute “Ordinary Course of Business”

The Court also rejected Duo’s argument that it should not be required to close because Fairstone had not continued to operate the business in its ordinary course between the date of signing and closing of the share purchase agreement.

The ordinary course covenant required Fairstone to act in a manner that is consistent with its past practices. Duo contended that Fairstone: (i) made changes to its branch operations model, (ii) made changes to its collections process by offering extensive deferment programs, (iii) changed its employment policies, (iv) changed its expenditures, and (v) changed its accounting methodology.

On the facts, there was no evidence that Fairstone was operating any differently than other companies in the industry in light of the COVID-19 pandemic. The Court noted that Fairstone’s conduct was pursued in good faith for the purpose of continuing business, and that the changes it implemented were in response to systemic challenges that the pandemic posed for the entire economy, not just Fairstone specifically. The Court further noted that the changes Fairstone undertook would neither have long-lasting effects nor impose any additional obligations on the purchaser.

Key Takeaways and Insights for Future Deals:

As a result of the Fairstone decision, the Court set out several principles to guide contractual interpretation and drafting, and more specifically, the use of MAE and ordinary course provisions for M&A participants.

This decision:

(i)     exemplifies how an analysis of MAE provisions will be highly dependent on the particular facts and context of a transaction;

(ii)    reiterates that contracts are to be read as a whole and that courts will look at the surrounding circumstances and language of the agreement to determine the intention of the parties; and

(iii)   demonstrates that courts are hesitant in expanding provisions to include protections that have not explicitly been negotiated, especially where the parties are highly sophisticated.

The Fairstone decision serves as a reminder to M&A participants, including both vendors and purchasers, that MAE provisions and ordinary course covenants must be carefully drafted in order to ensure that the intentions of each party is fully reflected in a commercial agreement such that the parties receive the protections for which they have bargained. As such, the Fairstone decision affirms that market and operational risks contemplated by dealmakers during the negotiation stage should be revisited carefully when it comes time for purchase agreements to be drafted by lawyers in order to alleviate deal uncertainties arising from the closing process of an M&A transaction.

For more information about the article or any related topic, please contact Vincent Ho.


[i] Fairstone Financial Holdings Inc. v Duo Bank of Canada, 2020 ONSC 7397.