In a typical M&A transaction, the vendor and the purchaser are front and centre stage. The spotlight is focused on the parties to the transaction, the negotiations and “papering” the deal. However, together with their respective counsel, the vendor and purchaser must also consider the role of third-party beneficiaries.
Who is a third-party beneficiary?
To fully appreciate the importance of third-party beneficiary issues, it is necessary to understand how a third party can become a beneficiary in the first place. Many purchase and sale agreements contain representations and warranties that may be relied upon by persons who are not parties by definition, but nevertheless seek to benefit from the agreement. For instance, employees may attempt to benefit from a provision related to continued employment for the target company employees when such a provision is typically intended to benefit and be enforceable by the purchaser. On the flip side, a purchaser may want to ensure that its affiliates or related entities can benefit from certain aspects of the agreement, such as the seller’s indemnification obligations. Without carefully determining which provisions are actually intended to benefit and be enforceable by a third-party, conflict can arise, increasing exposure and risk during the M&A process or thereafter.
Implications in a Purchase Agreement
Accordingly, the purchase and sale agreement should clearly and explicitly indicate the parties’ intention to either exclude a third-party from attaining contractual benefits or create rights in favour of a third-party. If a boilerplate “no third-party beneficiary” clause is incorporated into the agreement, any parties for which a benefit may have been intended should be carved out. Depending upon the circumstances, it may also be advisable for the parties to provide context as to why a third party is to be entitled to a particular benefit. By using unequivocal and explanatory language, parties can prevent unwarranted future legal fees.
Without a clear, express and explicit provision in the agreement, the parties may end up in litigious circumstances. Under Canadian common law (with the exception of New Brunswick), the doctrine of privity of contract exists, meaning that a contract cannot confer rights or impose obligations on any person other than the parties to the contract. While one might assume that this bodes well for a vendor or purchaser seeking to exclude a third-party, this is not the case as the doctrine has been met with mixed treatment in recent years. In the leading cases of London Drugs Ltd. v. Kuehne & Nagel International Ltd. and Fraser River Pile & Dredge Ltd. v. Can-Dive Services Ltd., the Supreme Court of Canada created a principled exception for when a third party can obtain the benefit of protections under a contract, thereby permitting third-parties to use contractual provisions as a shield. Although the Supreme Court was reluctant to allow third-parties to use the contract as a sword (i.e., to enforce an affirmative benefit), the Ontario Court of Appeal has ruled otherwise, creating doubt and ambiguity. In any event, the key consideration remains whether the parties to the contract intended to extend a benefit to the third-party or preclude it from such.
As a result, it is critical to be mindful of the risks involved when a suitable mechanism is not in place to ensure that a beneficiary will either be included or excluded from having certain rights enforced, should the need arise.
The author would like to thank Joseph Palmieri, Articling Student, for his assistance in preparing this legal update.
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