The economic downturn caused by the ongoing COVID-19 pandemic has created a number of financial difficulties for businesses across Canada. However, an Ontario court refused to allow a party to escape its obligations under a shotgun buy/sell clause despite the party’s claims that the pandemic was to blame.
What is a Shotgun Buy/Sell Clause?
Shotgun buy/sell clauses are commonly used in business contracts such as shareholder agreements and partnership agreements. When multiple parties will be working together, there is a risk of disagreement on how to proceed which can result in project/business stagnation. If two parties with equal power are unable to agree on how to proceed with a major project or decision, it can be catastrophic for the business itself. Shotgun buy/sell clauses are intended as a means to solve this problem and allow the business to move forward by having one party buy out the other.
The clauses typically operate as follows:
- One party (Party A) will trigger the clause by making an offer to buy out the other party (Party B) at a specific price.
- Upon receiving the offer, Party B can either accept the terms presented or buy out Party A at the same price. This ensures that Party A will set a price that it would be willing to accept as well.
While the process is intended to create a fair deal for both parties, the financial positions of each party may create an imbalance, since one party may have considerably more means than the other.
Development Deal Sours
The case at hand involved two companies that had entered into a limited partnership agreement to rezone a property in Toronto and redevelop it as a luxury condominium. The parties had difficulty working together, and eventually, one party (FSC) opted to invoke the buy/sell clause in the partnership agreement. FSC triggered the clause by proposing a purchase of the other entity (ADI) for a set price. Two weeks later, ADI agreed to purchase FSC’s interest for $12,733,289, with the deal set to close three months later on April 8, 2020.
A few weeks ahead of the scheduled closing, ADI informed FSC it would not be closing as planned, due to the ‘unforeseeable delay’ caused by the COVID-19 pandemic. In response, FSC brought an application seeking the remedy of specific performance, which would require ADI to go through with the agreed-upon purchase under the buy/sell clause.
Court Rejects Claim of Frustration
ADI claimed it had not breached the buy/sell clause, as the contract to purchase FSC’s interest in the project had been frustrated due to the unforeseen problems created by the pandemic. ADI claimed that the market had taken a significant downturn and as a result, ADI was unable to secure the financing necessary to complete the purchase. However, the court rejected this claim.
The court found that while the pandemic was unprecedented, sharp economic declines are common. There are myriad issues that could affect the price of real property, and it is not unrealistic to expect extreme fluctuations in property values over even relatively short periods of time. Although in this case the uncertainty was largely tied to the pandemic, the cause could have been any number of reasons, which is a risk a developer takes when undertaking such projects.
Secondly, the court found that ADI had been lax in its pursuit of funding. The company had approached only a handful of lenders and had requested much more capital than what was required to complete the purchase from FSC. The court found that ADI could have opted to allow FSC to purchase ADI’s interest, and instead chose to buy out FSC. As a result, the court held ADI to its obligations and ordered specific performance of the contract.
Businesses should exercise due caution when presented with a buy/sell option and undertake due diligence to secure funding prior to agreeing to buy out a former parter’s share of a contract. As demonstrated by the case above, courts are unsympathetic to a business that fails to do so, even in the face of an extraordinary circumstance such as COVID-19.
Our business and commercial real estate lawyers can advise on how best to protect your business and mitigate risk in the challenging financial landscape created by the pandemic. Contact GLG LLP in downtown Toronto for efficient and skilled advice on the management of your business. Call the firm at 416-272-7557 or contact them online to schedule a confidential consultation.