The transaction was completed and the shares were 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 addressed this issue when it upheld a trial decision that no adjustment was warranted in the case of Niebergal v QHR Technologies Inc.2020 SKQB 327 (First instance decision) and 2022 SKCA 85 (Appeal decision).

DSQ and Clinicare

In this case, the buyer, QHR, has issued promissory notes in partial payment for its shares of Clinicare, as stipulated in a stock purchase agreement (“SPA”). Following the closing, QHR eventually advanced adjustments under a price adjustment clause (“PAC”) to the effect that none of the amounts of the promissory notes remained due. This equated to a reduction of approximately 20% in the value of the stock from the amount traded in the SPA (which was based on an agreed cost base plus certain assets less certain liabilities subject to adjustment).

The trial judge interpreted the PAC such that the value negotiated on the part of the SPA, and therefore the amounts of the promissory notes, remained the same and due to the sellers without adjustment. The parties presented extensive evidence during the three-week trial regarding the validity of each of the numerous adjustments advanced by QHR. There was further discussion about whether the SPA, properly interpreted, allowed adjustment of assets in addition to liabilities. However, the trial judge decided the issue by finding that the adjustments had not been properly disclosed within the time period prescribed by the SPA.

Assets and liabilities traded have been incorporated into Schedule C of the SPA. The PAC was listed in a footnote to Schedule C immediately below a list of outstanding debts. Other than as noted below, the SPA has not provided any mechanism or formula for adjusting the purchase price payable for the shares:

Any price adjustment in accordance with clause 1.1(c) and 2.2, if made due to an understatement of the liabilities set out above, will only be made to the extent that the understatement is greater than $75,000 and is discovered before February 1, 2010.

Trial findings and approval on appeal

The trial judge concluded:

(a) The adjustments were limited to liabilities and did not include assets, as argued by QHR. In addition, the adjustments were to be “discovered” by February 1, 2010 (approximately two months after closing).

(b) The term “discovered” in this context required that documented evidence of the necessary adjustments be provided no later than February 1, 2010.

QHR communicated on the eve of the deadline that it “believes” that “balance sheet adjustments” exist and that it plans to conduct an audit in this regard. QHR has provided no calculations or other material information about the nature or amount of the adjustments. The information resulting from the audit as well as the amount and nature of the adjustments claimed arrived almost four months after the February 1 deadline. QHR argued that its approach was consistent with the dictionary definition of “discovered” – “to take cognizance of”.

The Court of Appeal found no error in the trial judge’s interpretation requiring meaningful disclosure in addition to mere discovery. QHR’s interpretation did not fit the contextual circumstances, which included the fact that key QHR personnel had previously held key positions within the Vendor. QHR and Clinicare operated in a small industry and QHR had repeatedly acknowledged 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 consideration that the scope of adjustments should be narrow; certainly nothing that allowed for a lengthy verification 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 of any contract for the purchase of shares with the number of shares and the closing date”.[1] He then cited the authority that the essential terms of a contract must exist with a “reasonable degree of certainty”.[2] There must be “a concluded deal” which “leaves nothing to be settled by agreement between the parties”.[3]

Adjustment clauses have been deemed acceptable when they “specify how adjustments are to be determined”.[4] Without such a mechanism, the courts could conclude that there was no agreement due to uncertainty, as the British Columbia Court of Appeal did in Rana.

It is also acceptable to allow a third party to make a final decision on post-closing adjustments. In News Marketing Canada Corp. against De LeCampthe agreement articulated an extensive process with defined terms for adjusted working capital and requirements for the calculations to be performed in accordance with GAAP.[5] Objections and disputes were to be determined by an independent auditor.[6] However, failure to strictly follow the detailed process led to the conclusion that no adjustments could be made.[7]

More generally, the party pursuing an adjustment seeks a relatively small change. In Equitable Trust Company v. Lougheed Block Inc., the Alberta Court of Appeal ruled that a requested adjustment of 1.13% of the total purchase price ($340,704 on a $30,150,000 transaction) was not allowed in the absence of clear wording allowing for such an adjustment.[8] The provision in that case simply said “subject to customary adjustments”.

Courts have been reluctant to adopt interpretations that result in a materially different negotiated contract price. In Western Financialthe Manitoba Court of Appeal assessed competing interpretations of a CPS that provided for “lump sum payments” in subsequent years.[9] The Court did not favor an interpretation that significantly increased the purchase price when the reasons for negotiating the mark-up clauses did not appear to be engaged:

It is undisputed that the purpose of the add-on calculations was to compensate plaintiffs for any increase in HED’s earnings by comparing EBITDA at the date of the add-on calculation to EBITDA at an earlier date. However, the trial judge’s construction of the 2009 SPA would require the 2006 equity to be added back into the assessment, which would result in an additional gross-up payment to plaintiffs on the first gross-up calculation date of more than 3 $.3 million whether or not EBITDA changed. It is highly unlikely that the parties structured the transaction in this way.[10]

In reaching this decision, the Court took into account the following circumstances: “the purpose and genesis [of the agreement]; the extensive negotiations that resulted in a global share purchase agreement; the sophistication of the holidays; and the involvement of professional advisers.[11] All of these factors combined to suggest that it was not mutually intended that the contract could change by such a wide margin through the mark-up provisions in these circumstances.

In the QHR decision, the sellers also argued that experienced businessmen would not agree to submit to an uncertain process based on a party’s belief that there might be adjustments upon further investigation. . It is widely recognized that “the importance of commercial security in commercial relationships and the protection of the reasonable expectations of parties to commercial contracts cannot be overstated”.[12]

The sellers also argued that it was entirely reasonable that documentation of the discovery and precise articulation of an actual fit calculation would be required. The tight deadlines agreed upon and the narrow nature of what could be adjusted did not match QHR’s assertion that a statement of a general belief that some adjustments existed by the deadline thereafter afforded them unlimited time to request Unlimited adjustments for all of Schedule C.

The trial judge agreed:

[264] The interpretation that the DSQ urges me to adopt is not commercially reasonable in this context because, in my view, it does not make good commercial sense – the benchmark for guessing the meaning of a commercial contractual instrument. It is also not consistent with the factual matrix of this contract which indicated that the parties wanted this transaction to be concluded quickly and without undue delay.

The trial judge also noted that promissory note interest rates rose quickly if payment was not made soon after closing. This was another contextual evidence of a compact adjustment process. Since no adjustment was warranted, no exceptional circumstances existed to circumvent the contractual interest rate and QHR’s counterclaim for misrepresentation 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.

Key points to remember

Post-closing price adjustment clauses should be avoided where possible. If necessary, the what, when, where and how of the adjustment process should be clearly defined. This process must then be strictly adhered to if it is to be relied upon to make adjustments.