Several months ago we asked whether a COVID-19-related impact on a business might constitute a “Material Adverse Change” (referred to as a “MAC,” or a material adverse effect, “MAE”) under merger agreements, and we noted the near complete absence of case law on the issue in Canada (see: “COVID-19 and Material Adverse Change Provisions in M&A Agreements”). Fortunately, we now have some Canadian case law to provide guidance. A recent decision of the Ontario Superior Court of Justice relating to the impact of COVID-19 suggests that MAC/MAE clauses will be interpreted narrowly in Canada, which follows the trend in the case law from Delaware courts.

The Decision: Fairstone Financial Holdings Inc. v Duo Bank of Canada

In February 2020, Duo Bank of Canada (Duo) announced that it would acquire consumer finance company Fairstone Financial Holdings Inc. (Fairstone) by way of a share purchase agreement (SPA). The transaction was expected to be completed on June 1, 2020. In the intervening time, the COVID-19 pandemic hit North America and Fairstone’s business was significantly affected. In May 2020, year-over-year new loan origination had decreased by 56%, and it was clear that Fairstone would have to reduce lending and tighten lending requirements, thus reducing its earnings potential.

In late May, Duo informed Fairstone that it did not intend to complete the transaction on the basis that, among other things, there had been a material adverse effect on Fairstone’s business and various steps Fairstone took to manage its business through  the pandemic violated its covenant to operate its business in the ordinary course.  Duo was careful, however, not to terminate the SPA.  As the court noted, Duo was the successful and aggressive bidder in an auction and it knew that if it terminated the SPA, Fairstone would not be able to sell the business for the same price that Duo had offered.  If Duo turned out to be wrong about its right to terminate, it would be responsible for damages potentially in the hundreds of millions of dollars.

In response to Duo’s notice, Fairstone sought to compel Duo to complete the transaction by way of a court application for specific performance.  Fairstone sought damages for breach of the SPA as an alternative to specific performance, although Duo made clear that it would prefer to complete the transaction rather than pay damages.

Was there an MAE?

In its decision, the court acknowledged that “at first blush,” it appeared that an MAE had occurred as a result of COVID-19. However, the MAE clause in the SPA contained a number of carveouts which excluded material effects caused by (i) worldwide, national, provincial or local conditions or circumstances, including emergencies; (ii) changes to the markets or industry in which Fairstone operates; and (iii) the failure of Fairstone to meet any financial projections.  The first two carveouts included the further requirement that only an MAE caused by emergencies or market changes which had a “materially disproportionate adverse impact” on Fairstone would relieve Duo of its obligation to complete the transaction.  The court concluded that COVID-19 fell into the definition of the first carveout, and also that the changes to Fairstone’s business were changes to the entire market and industry in which Fairstone operates and Fairstone had not been disproportionately affected.

There are several important takeaways from the court’s analysis of the parties’ arguments regarding an MAE:

  1. Burden of Proof: The party alleging the MAE (in this case, Duo) bears the burden of proving it. However, the court also found that the burden shifted back to Fairstone to establish that one of the carveouts to the definition of MAE is present.
  2. Standard of Proof: The court considered whether the parties’ use of the phrase “has (or would reasonably be expected to have)…a material adverse effect on the business” in the SPA signalled an intention that something lower than the civil burden of proof (i.e. a balance of probabilities) was required to establish an MAE. After surveying the case law on the interpretation of similar language in both Canada and the United States, the court confirmed that the ordinary civil burden of proof applied, such that Duo needed to demonstrate on a balance of probabilities that the conditions of the COVID-19 pandemic would reasonably be expected to have a material adverse effect on Fairstone’s business.
  3. The Role of Expert Evidence: The determination of whether there had been a disproportionate effect on Fairstone turned on expert evidence.  Fairstone’s experts addressed directly the issue by comparing Fairstone to its direct competitor and others in the industry across a broad range of qualitative and quantitative factors, including net income, expenses, impairment charges, operational expenses and history of managing problems. The court preferred this evidence to that of Duo’s expert, who compared Fairstone’s results against results derived from analysts’ projections for public companies for a similar period.
  4. Definition of MAE: The court adopted the widely used definition of MAE from Delaware case law: “…the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner.”

Had Fairstone Conducted its Business in the Ordinary Course?

As mentioned above, Duo also alleged that Fairstone, in responding to the pandemic, had breached its covenant to conduct its business in the ordinary course.  The term “ordinary course” was defined in the SPA as “consistent with past practices”.  In effect, Duo argued that nothing done by Fairstone in response to the pandemic could be ordinary course because the pandemic is an extraordinary event.  In rejecting Duo’s position, the court noted that such a conclusion would make the pandemic a reason for not closing the transaction even though emergencies in the nature of the pandemic were excluded from the definition of MAE.  The court found that in reading the SPA as a whole and not as a series of unrelated, standalone provisions, precedence ought to be given to the specific emergency exclusion in the MAE clause over the more general ordinary course provision.

The court noted that the “fundamental purpose” of the ordinary course covenant is “to protect the purchaser against company specific risks and the moral hazard of management acting in a self-interested, opportunistic manner detrimental to the purchaser’s interests.  Without purporting to set out a universal rule, the court set out a number of principles to assist in the consideration of what actions can be said to be taken in the “ordinary course”:

  1. As a general rule, the purchaser of a business accepts systemic economic risks associated with the ownership of a business, including the risk of economic contractions and the detrimental effect they have on a business.
  2. It is part of the ordinary course of any business to encounter local or national recessions and to take steps in response to those sorts of systemic economic changes. Whether these steps are taken in the ordinary course will involve a comparison of (a) what the business has done in similar economic circumstances to what it is doing now, or (b) what the business is doing now to what other businesses are doing.
  3. If a business takes prudent steps in response to an economic contraction, that have no long-lasting effects and do not impose any obligations on the purchaser, it should not be seen to be operating outside of the ordinary course.

Recent Delaware Decision

The Fairstone decision aligns with the American approach to determining when a MAC/MAE has occurred. As noted above, the Ontario court adopted the definition of MAE used in Delaware case law.

It is also noteworthy that in a decision released just two days before Fairstone, the Delaware Court of Chancery reached a similar conclusion on the issue of whether COVID-19 constituted an MAE. The Delaware court found that the consequences of the COVID-19 pandemic fell within an exception to the MAE clause for effects resulting from “natural disasters and calamities.”

However, the Delaware court found a breach of the ordinary course covenant.  Significantly, the court found that the actions of the seller “departed radically from the normal and routine operation of the [business] and were wholly inconsistent with past practice.”  This result was driven by very different facts than were present in the Fairstone decision, but it is noteworthy that the Delaware court declined to consider the MAE clause in its interpretation of the ordinary course covenant.  As discussed above, the Ontario court adopted an approach that considered the SPA as a whole and not as a series of unrelated, standalone provisions.


The Fairstone decision provides valuable guidance as to how Canadian courts will interpret MAE carveouts and ordinary course covenants, which makes it a must-read for participants in Canadian M&A.