A recent decision from the Ontario Court of Appeal highlighted the legal pitfalls associated with imprecise contract drafting. In Project Freeway Inc. v. ABC Technologies Inc. (Freeway), the Court examined how to interpret an ambiguous earn-out clause in a share purchase agreement.
For parties involved in transactional matters, this ruling provides a crucial takeaway: when resolving contractual ambiguities, courts will examine the broader underlying context.
Background
The dispute in Freeway arose due to ABC Technologies Inc. and Project Freeway disagreeing over the meaning of an earn-out clause. The clause served two functions: it structured earn-out payments and outlined conditions that would lead to an immediate payment of the maximum earn-out. One condition that would set off this accelerated payout was the unauthorized sale of material portions of the assets to a non-affiliated buyer.
Project Freeway claimed that after closing, ABC Technologies Inc. conducted two unauthorized transactions involving the asset, and triggered the maximum earn-out provision. In contrast, ABC Technologies Inc. maintained that activating the clause required a material impact on earn-outs, and their transactions had no such effect.
The Courts’ Approach to Ambiguous Contracts
The Ontario Court of Appeal engaged in a contextual analysis to interpret the ambiguous earn-out clause. This required a careful examination of the ordinary and grammatical meaning of words, while applying a common-sense approach. Through this analysis, the Court determined that the earn-out clause aligned with ABC Technologies Inc.’s position. By linking the material impacts in the clause to earn-out payments, the Court prioritized the avoidance of commercially absurd outcomes.
Importantly, the Court also confirmed that the non-binding Letter of Intent (LOI) could be considered when interpreting the final agreement. The Court rejected Project Freeway’s claim that the “entire agreement clause” in the share purchase agreement precluded consideration of prior agreements such as the LOI. Instead, the Court agreed that previous agreements can help clarify the parties’ intentions when contract language is unclear.
Finally, the Court’s decision factored in surrounding circumstances like the parties’ conduct after the transaction was closed. Evidence showed that despite being aware of ABC Technologies Inc.’s transaction, the principals at Project Freeway chose not to raise any concerns. This lack of response further undermined Project Freeway’s argument that these transactions were of material concern.
Why Buyers and Sellers should Care
This case offers valuable insight into drafting effective agreements and individual clauses. By using clear and direct language, parties can accurately reflect their intentions in their commercial dealings. Careful drafting also avoids ambiguity that could distort or invalidate clauses essential to facilitating transactions.
When dealing with unclear contract terms, courts will also analyze various contextual factors to determine a party’s intention. This may include reviewing non-binding agreements like an LOI, which further underscores the importance of precise drafting practices across all documents.
Another aspect courts will consider is the conduct of parties, particularly after closing. This highlights a critical need for parties to fully understand and act in accordance with the terms of their contract. By aligning their actions with these terms, parties can demonstrably reinforce their commercial intentions if litigation ever arises.
For businesses negotiating acquisitions or earn-out arrangements, this case is a crucial reminder about the importance of clear drafting. The use of precise language from the start can help avoid costly disputes down the line.
Surabhi Kulshrestha, LPP Student