In complex M&A transactions, there could be a significant delay between the initial valuation of a target company and the closing of the deal. As we explained in our previous article, “Net working capital adjustments: what’s the deal?”, parties can protect themselves against fluctuations in value during this period by negotiating purchase price adjustments (PPAs). According to the American Bar Association’s 2016 Canadian Private Target Mergers & Acquisitions Deal Points Study, the most common PPA is the working capital adjustment (which was included in 83% of recent Canadian M&A deals with a PPA).

Mechanics of working capital adjustments

Typically, working capital adjustments provide for an adjustment to the purchase price based on the level of working capital at closing. For purposes of negotiating the purchase price, the parties assume that the target company’s working capital at closing would be at a certain level or range at closing (target amount). At closing, if working capital falls below the target amount, the purchase price is reduced to reflect the fact that the purchaser may need to inject additional cash into the business. Conversely, if working capital at closing is greater than the target amount, the purchase price is increased to ensure that the purchaser does not receive a windfall.

While the working capital adjustment may be conceptually straightforward, it is important not to lose sight of the details. For example, when should the adjustment take place? A closing balance sheet needs to be prepared to form the basis of the adjustment, but it generally cannot be finalized immediately on the date of closing. Therefore, parties typically agree to make the adjustment post-closing once the closing balance sheet is finalized (usually 30-90 days after closing). This can be done in either a single adjustment, or a two-part adjustment where an initial adjustment is made based on estimated information at closing and a final “true-up” when the finalized information becomes available.

De Santis and Iacobucci v Doublesee Enterprises Inc.

Failure to account for such timing considerations could lead to uncertainty and disputes, as demonstrated by the recent Ontario Superior Court decision in De Santis and Iacobucci v Doublesee Enterprises Inc., 2018 ONSC 400 (De Santis).

In De Santis, parties entered into a Share Purchase Agreement (SPA) for the sale of Mavis Auto Collision and Auto Glass Ltd. (TargetCo) at a total price of $465,000. The SPA contained a unique type of working capital adjustment which provided that, on closing, TargetCo must not have negative working capital, otherwise there would be a corresponding reduction in the purchase price dollar-for-dollar. In other words, the target amount of working capital was effectively zero. As it would make no commercial sense for the vendors to leave additional funds in TargetCo in excess of this target amount, the SPA allowed TargetCo to declare and make a “special dividend” of any excess prior to closing.

On the day prior to closing, the vendors’ accountant required additional time to calculate the amount of excess working capital in TargetCo. The vendor therefore prepared, signed, and delivered a draft resolution for a special dividend to the purchaser’s lawyers, which showed a dividend payable on the day prior to closing but the amount of the dividend was blank. The purchaser’s lawyers did not object or take issue with this approach. Several months later, the vendors’ accountant finally calculated the excess working capital in TargetCo, which was $68,263. However, when the vendors requested that the special dividend resolution be signed and paid out, the purchasers refused on the basis that the special dividend must be declared and paid prior to closing. The vendors brought an action to, among other things, recover the amount of the special dividend or alternatively rectify the SPA to deal with the special dividend payment.

The Court dismissed a motion for summary judgment by the defendant purchasers, as these issues require a trial for a fair and just determination. Despite the vendors’ non-compliance with the SPA, the Court found that the purchasers’ failure to object to the vendors’ approach could establish that the parties agreed to the payment of the special dividend after closing. In any event, the purchasers are estopped from denying entitlement to the special dividend or rectification.


Aside from the obvious lesson that a prudent party intending to rely on a contractual term should clearly object to any instance of noncompliance, De Santis demonstrates the importance of addressing timing considerations when drafting a working capital adjustment. Simply put, the working capital adjustment in De Santis was neither practical nor realistic. If the vendors in De Santis were to strictly comply with the requirement to dividend out excess working capital prior to closing, they would have had to finalize the balance sheet weeks or months in advance or otherwise rely on an estimate. Such information could be outdated and inaccurate upon closing, thereby defeating the purpose of the working capital adjustment.

In addition to timing, drafters of working capital adjustments should also keep in mind other key considerations as outlined in our previous article. For example, should an adjustment arise from any deviation from a working capital “peg”, or only deviations outside of an acceptable band of working capital? Which party’s responsibility is it to prepare the closing balance sheet? What standard of accounting applies to the balance sheet? Should a portion of the purchase price be held back by the purchaser or placed into escrow pending the adjustment? As adjustments to purchase price directly impact the core of the deal, addressing such considerations in advance is critical to the transaction.

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