The deal has closed and the shares have transferred. However, the agreement notes the possibility of a post-closing price adjustment for adjustments discovered before a deadline, but there is no adjustment formula or mechanism in the agreement. How should this process unfold?
The Saskatchewan Court of Appeal recently considered this question when it upheld a trial decision that found no adjustments were warranted in the case of Niebergal v QHR Technologies Inc., 2020 SKQB 327 (Trial Decision) and 2022 SKCA 85 (Appeal Decision).
QHR and Clinicare
In this case, the purchaser, QHR, issued promissory notes in partial payment for its shares of Clinicare as set out in a share purchase agreement (“SPA”). Following the close, QHR eventually advanced adjustments pursuant to a price adjustment clause (“PAC”) to the effect that none of the amounts in the promissory notes remained owing. This amounted to an approximate 20% reduction in share value from the amount negotiated in the SPA (which was based on an agreed base price plus certain assets minus certain liabilities subject to adjustment).
The trial judge interpreted the PAC such that the negotiated share value in the SPA, and consequently the amounts in the promissory notes, remained the same and owing to the sellers without adjustment. The parties tendered a great deal of evidence over the three-week trial in relation to the validity of each of the many adjustments QHR advanced. There was further argument whether the SPA, properly interpreted, allowed for the adjustment of assets in addition to liabilities. However, the trial judge disposed of the issue by concluding the adjustments had not been properly communicated by a deadline set out in the SPA.
The negotiated assets and liabilities were incorporated into schedule C of the SPA. The PAC was contained in a note at the bottom of Schedule C immediately below a list of outstanding liabilities. Apart from that notation set out below, the SPA did not provide a mechanism or formula for adjusting the purchase price payable for the shares:
Any Price Adjustment per Clause 1.1 (c) and 2.2 if made due to underestimating the liabilities set out above shall be made only to the extent that the underestimate is greater than $75,000 and is discovered before 1 February 2010.
Trial Findings and Appellate Approval
The trial judge concluded:
(a) Adjustments were confined to liabilities and did not include assets, as QHR argued. Further, the adjustments had to be “discovered” as of February 1, 2010 (about two months post-closing).
(b) The term “discovered” in this context required that documented evidence of necessary adjustments had to be communicated no later than February 1, 2010.
QHR communicated on the eve of the deadline it “believed” that “balance sheet adjustments” existed and it planned to conduct an audit in that respect. QHR provided no calculations or other material information about the nature or amount of any adjustments. The information arising from the audit and the amount and nature of the claimed adjustments came almost four months after the February 1 deadline. QHR argued its approach was consistent with the dictionary definition of “discovered” – “to become aware of.”
The Court of Appeal found no error with the trial judge’s interpretation requiring meaningful communication in addition to mere discovery. QHR’s interpretation did not fit within the contextual circumstances, which included the fact the key personnel within QHR had previously held key positions within the seller. QHR and Clinicare operated in a small industry and QHR had acknowledged on multiple occasions that it knew Clinicare and its numbers inside and out. Multiple rounds of due diligence and negotiations had taken place and the post-closing time period for adjustments was short, consistent with an objective contemplation that the scope of adjustments should be narrow; certainly nothing that accommodated a lengthy audit process.
Commercial Certainty and Reasonableness
The principles of certainty of essential terms also anchored the trial decision. The trial judge referred to a number of authorities for the principle that “Price is both one of the most important and essential terms in any share purchase agreement along with the number of shares and the closing date.” He then cited authority that the essential terms of a contract must exist with a “reasonable degree of certainty.” There must be “a concluded bargain” that “leaves nothing to be settled by agreement between the parties.”
Adjustment clauses have been found acceptable where they “specify how the adjustments are to be determined.” Without such a mechanism, the Courts may find a lack of agreement due to uncertainty, as the B.C. Court of Appeal did in Rana.
It is also acceptable to agree for a third party to make a final determination regarding post-closing adjustments. In News Marketing Canada Corp. v De LeCamp, the agreement articulated an extensive process with defined terms for Adjusted Working Capital and requirements for computations to be done in accordance with GAAP. Objections and disputes were to be determined by an independent auditor. However, failure to strictly follow the detailed process resulted in a finding that no adjustments could be pursued.
More typically, the party pursuing an adjustment seeks a relatively small change. In Equitable Trust Company v Lougheed Block Inc., the Alberta Court of Appeal held that a requested adjustment of 1.13% of the total purchase price ($340,704 of a $30,150,000 transaction) was not permissible in the absence of clear wording permitting such an adjustment. The provision in that case merely said “subject to the usual adjustments.”
Courts have been reluctant to adopt interpretations that result in a significantly different negotiated contract price. In Western Financial, the Manitoba Court of Appeal assessed competing interpretations of a SPA that contemplated “bump payments” in subsequent years. The Court did not favour an interpretation that dramatically added to the purchase price when the reasons for negotiating the bump provisions did not appear to be engaged:
There is no dispute that the purpose of the bump calculations was to compensate the plaintiffs for any increase in HED’s earnings by comparing EBITDA on the bump calculation date to EBITDA on a previous date. However, the trial judge’s construction of the 2009 SPA would require the 2006 equity to be added back into the valuation, resulting in an additional bump payment to the plaintiffs on the first bump calculation date in excess of $3.3 million regardless of whether EBITDA had changed. It is highly unlikely that the parties would have structured the transaction in such a way.
In making this decision, the Court took into account the following surrounding circumstances: “the aim and genesis [of the agreement]; the extensive negotiations which resulted in a comprehensive share purchase agreement; the sophistication of the parties; and the involvement of professional advisors.” All of these factors combined to suggest it was not mutually intended that the contract could change by such a wide margin through the bump provisions in these circumstances.
In the QHR decision, the sellers similarly argued that experienced businesspersons would not agree to subject themselves to an uncertain process premised on the belief of one party that there might be adjustments upon further investigation. It is widely recognized that “the importance of commercial certainty in commercial relations and the protection of the reasonable expectations of parties to commercial contracts cannot be overemphasized.”
The sellers also argued it was completely reasonable that documentation of the discovery and a precise articulation of an actual adjustment calculation was required. The agreed-upon tight timeframes and narrow nature of what could be adjusted did not align with QHR’s assertion that a declaration of a general belief that some adjustments existed at the deadline thereafter allowed them unlimited time to seek unlimited adjustments for all of Schedule C.
The trial judge agreed:
 The interpretation QHR urges me to adopt is not commercially reasonable in this context because, in my opinion, it does not make good business sense – the lodestar for divining the meaning of a commercial contractual instrument. Nor is it consistent with the factual matrix of this contract which indicated the parties desired that this transaction be completed expeditiously and without undue delay.
The trial judge also noted the interest rates in the promissory notes rapidly escalated if payment was not provided soon after the close. This was further contextual evidence of a compact adjustment process. Since no adjustments were warranted, no exceptional circumstances existed to circumvent the contractual rate of interest and QHR’s misrepresentation counterclaim was dismissed. The Court ordered payment of the full amount remaining under the promissory notes plus accrued interest of 25% per annum to the date of judgment.
Post-closing price adjustment provisions should be avoided wherever possible. If they are required, the what, when, where and how of the adjustment process should be clearly delineated. That process must then be strictly adhered to if it is to be relied upon to make any adjustments.