Conditions Precedent (Closing Conditions)

In a share or asset purchase, conditions precedent are what must be true, or must happen, before a party is obliged to close. They matter only when signing and closing are separated, in which case the share purchase agreement or asset purchase agreement lists the conditions, usually grouped into those for the buyer's benefit, those for the seller's benefit and those for both. A letter of intent previews them, and our free LOI and term sheet builder helps you list them early.

A condition is different from a covenant. A covenant is a promise, and failing to perform it is a breach. A condition is an event on which the obligation to close depends; if it does not happen, the protected party can walk away, but no one is in breach unless someone promised to bring it about. Many conditions are paired with covenants for that reason: the buyer promises to apply for financing promptly, and the seller promises to request the landlord's consent.

Where the agreement is silent, a court may imply such a covenant. In Dynamic Transport Ltd. v. O.K. Detailing Ltd., [1978] 2 S.C.R. 1072, the Supreme Court of Canada implied an obligation on a vendor to apply for the subdivision approval the sale required and to use its best efforts to obtain it.

Whether a party can waive a condition and insist on closing is often disputed. The leading case is Turney v. Zhilka, [1959] S.C.R. 578, an Ontario appeal. A purchaser agreed to buy land provided it could be annexed to the Village of Streetsville and a plan of subdivision approved by the village council. When that did not happen, the purchaser tried to waive the condition as being for his sole benefit and sued for specific performance. The Supreme Court of Canada held that he could not. Justice Judson called the condition a true condition precedent, "an external condition upon which the existence of the obligation depends": its fulfilment depended entirely on the will of a third party, neither side had promised it would occur, and until it occurred there was no right to performance on either side.

A majority of the Court declined to revisit that rule in Barnett v. Harrison, [1976] 2 S.C.R. 531, reasoning among other things that a purchaser free to rely on or waive conditions at will would hold an option to buy it never paid for, and that certainty favoured a rule applied since 1959. In Dynamic Transport, the Court restated it as a rule that a true condition precedent cannot be waived by either party without express reservation of a power of waiver.

The lesson: draft waiver rights expressly. Each condition should state:

1. which party it benefits;
2. that it may be waived, in whole or in part, by that party by written notice;
3. the date by which it must be satisfied or waived; and
4. what happens if it is neither, typically termination and return of the deposit.

Private-company deals usually combine several:

• Financing. The buyer's obligation depends on obtaining acquisition financing on stated or satisfactory terms by a set date, paired with a covenant to apply promptly and in good faith.
• Due diligence. Small deals often sign a conditional agreement instead of finishing diligence first. Even a sole-discretion condition must be exercised honestly and in good faith; see the duty of good faith in contracts and our guide to the due diligence period.
• Third-party consents. The landlord's consent to a lease assignment or change of control, consents from key customers or suppliers under a change of control clause, and a franchisor's approval for a franchised business.
• Regulatory approvals. Transfers of licences and permits and, where a deal meets the relevant thresholds, clearance or approval under the Competition Act or the Investment Canada Act.
• Shareholder approval. Under subsection 184(3) of Ontario's Business Corporations Act, a corporation selling all or substantially all of its property other than in the ordinary course of business needs shareholder approval by special resolution, so asset deals of that size make the vote a condition.
• Bring-down and deliveries. The other side's representations remain accurate, its covenants are performed, no material adverse change has occurred and the closing documents are delivered.

The agreement should also set an outside date, after which either party may terminate if the deal has not closed.

Representations and warranties speak as of signing. The bring-down condition requires them to be true again on the closing date, so the buyer is not forced to close on a business that changed in between. The standard is negotiated. Fundamental representations, such as title to the shares and the capitalization, are usually brought down in all respects. The rest are brought down in all material respects or, in the most seller-friendly version, only to the extent that the inaccuracies would not amount to a material adverse effect.

The condition is satisfied by a bring-down certificate: an officer's or seller's certificate delivered at closing confirming that the representations and warranties remain true to the required standard and that the pre-closing covenants have been performed. It is usually drafted as a representation in its own right, so an inaccurate certificate also supports an indemnity claim after closing. Where the agreement lets the seller update its disclosure schedules before closing, buyers should check whether an update cuts off their right to terminate or claim.

A material adverse change (MAC) or material adverse effect (MAE) condition lets a buyer refuse to close if something seriously harmful happens to the target between signing and closing. It is usually built from a broad definition followed by carve-outs for general economic conditions, industry-wide changes, changes in law, emergencies and the target's failure to meet projections. Some carve-outs fall away where the event affects the target disproportionately compared with others in its industry.

The leading Ontario decision is Fairstone Financial Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397. Duo Bank of Canada signed a share purchase agreement on February 18, 2020 to buy Fairstone, a consumer lender, and on May 27, 2020 told Fairstone it would not close, relying on the COVID-19 pandemic as a material adverse effect and alleging that Fairstone's response breached its covenant to operate in the ordinary course. Justice Koehnen of the Superior Court's Commercial List found that Duo had proved a material adverse effect under a widely used three-part test: an unknown event that substantially threatens the target's overall earnings potential in a durationally significant way. He held, however, that it fell within the carve-outs for emergencies, changes in markets and industries, and failure to meet projections, which allocated systemic risks to the buyer and company-specific risks to the seller. Duo had not proven a disproportionate effect, Fairstone's pandemic measures were within the ordinary course, and the court ordered Duo to complete the purchase.

The lesson for owner-operated deals: a general MAC condition is hard to rely on, so a buyer worried about a specific risk, such as losing a major customer, should make it a separate condition with an objective test.

Grace Liu's corporation owns a commercial printing business in Vaughan. Tomasz Nowak's new company signs an asset purchase agreement to buy it for $2.3 million, with closing 60 days later. The conditions are:

1. bank financing of $1.4 million within 30 days, for the buyer's benefit and waivable by it in writing;
2. the landlord's consent to the lease assignment, for both parties' benefit;
3. no customer representing more than 10% of annual revenue having given notice of termination, for the buyer's benefit; and
4. the usual bring-down of representations and covenants.

The bank's commitment arrives on day 26, and Tomasz's company gives written notice that the financing condition is satisfied. The landlord's consent takes longer, so the parties sign an amendment extending the closing date by 15 days. Ten days before the new date, a customer that accounts for 18% of revenue gives notice that it will move its printing in-house.

A general MAC argument would face the demanding test applied in Fairstone, but the customer condition is objective and has plainly failed. Rather than terminate, Tomasz uses it to renegotiate: the price drops by $250,000, an earn-out of up to $200,000 is added for revenue retained over the next year, and Grace's corporation delivers a bring-down certificate with an updated customer schedule. The deal closes on the extended date.