Overview and Key Takeaways
A tariff war between the U.S. and Canada would be highly unusual. What, then, would be an “ordinary course” reaction by a Canadian target to such unprecedented circumstances?
In our previous update, we explored the complex interaction of tariffs and “material adverse effect” (“MAE”) clauses in M&A. We now explore the equally complex interaction of tariffs and “ordinary course of business” covenants (“ordinary course covenants”) in M&A.
Our key practical takeaways include:
- Every Canadian company’s individual exposure to tariffs would be unique. How the target may wish to respond to any tariffs may be equally unique. Ordinary course covenants are well-suited for this variability by being inherently customizable. Whether buyer or seller, foresight and negotiation strategy is critical.
- Caselaw issued during the pandemic provides helpful guidance regarding how courts approach ordinary course covenants and three qualifiers commonly included in them. However, the rulings are inconsistent on certain points. The rulings also raise several potentially important drafting considerations, including as relate to tariffs.
- We expect the threatened tariffs to result in particular emphasis and negotiation around “buyer consent” qualifiers. Unlike in MAE clauses, these envision communication between the buyer and seller regarding the target’s operational decisions where the bounds of the ordinary course are tested and provide the opportunity for agreement regarding a reasonable mitigation strategy.
For more detailed discussion of ordinary course covenants and MAE clauses, see Fasken’s Private M&A in Canada: Transactions and Litigation (LexisNexis, 2024). For other Fasken M&A thought leadership, visit our Capital Markets and M&A Knowledge Centre and subscribe.
Ordinary Course Covenants in Brief
The principal purpose of an ordinary course covenant is to ensure the target’s business remains substantially the same at closing as it was at signing.[1] Stated differently, it is an undertaking by the seller(s) that the target will be run during the interim period in the same manner as the target was run before it such that the buyer will acquire the same business it agreed to purchase.
Ordinary course covenants have historically attracted less attention than MAE clauses and, until recently, were often not as heavily negotiated. The COVID-19 pandemic changed this. A key realization was that a breach of the covenant could result in a buyer termination right for events potentially far less significant than an MAE. The increased focus on the covenant quickly led to more complex and nuanced drafting.
Example Ordinary Course Covenant
Ordinary course covenants typically involve both a specific definition and a specific undertaking employing that definition. One example, taken from Fairstone (discussed below), is as follows:
Except as expressly provided in this Agreement… or with the prior written consent of Purchaser, which consent shall not be unreasonably withheld, and to the extent lawfully able to do so, the Principal Sellers shall cause the Acquired Companies to, and the Acquired Companies shall, during the Interim Period, conduct their respective Businesses (as applicable) in the Ordinary Course…
“Ordinary Course” means with respect to an action taken by a Person, that such action is consistent with the past practices of the Person and is taken in the ordinary course of the normal day-to-day operations of the Person.[2]
Ordinary course covenants are often paired with an express undertaking to “preserve” the target’s assets, goodwill and business relationships.[3] They are also typically paired with a series of (1) negative covenants listing specific actions the company is prohibited from taking during the interim period,[4] and (2) affirmative covenants listing specific actions the target is required to take during the interim period.
Key Drafting Considerations in Ordinary Course Covenants
This multi-pronged structure makes an ordinary course covenant highly customizable to the target’s particular circumstances, including for tariffs. Because a fulsome review of these possibilities is beyond the scope of this article, we instead focus on the three most common qualifiers to ordinary course covenants. These are underlined in our example above, and are:
- “consistent with past practice” qualifiers;
- “except as otherwise provided by this agreement” qualifiers; and
- “buyer consent” qualifiers.
We also consider three key rulings regarding ordinary course covenants and these qualifiers prompted by the COVID-19 pandemic and issued in 2020 and 2021,[5] being (1) in Canada, the decisions of the Ontario Superior Court of Justice (Commercial List) in Fairstone[6] and Cineplex,[7] and (2) in the U.S., the decisions of the Delaware courts in AB Stable.[8]
As we review these cases we provide related drafting takeaways. We conclude by focusing specifically on the interaction of tariffs and ordinary course covenants.
1A – “Consistent with Past Practice” Qualifiers
A “consistent with past practice” qualifier ties a target’s ordinary course to its operating history. The courts are generally aligned in confirming that “consistent” does not mean “identical” but rather “congruous, compatible and adhering to the same principles of thought and action”. The courts are less aligned regarding whether it is appropriate to consider how other companies have operated in similar circumstances.[9]
Delaware courts, including in AB Stable, instruct that by employing the phrase “consistent with past practice” the parties create “a standard that looks exclusively to how the business has operated in the past” and precludes the court from considering any other behaviour or standards. By contrast, Canadian courts have sent mixed signals on this point.
Notwithstanding that the “consistent with past practice” qualifier in Fairstone was expressly tied to the target, the court stated the ordinary course requires comparisons with “standards in the industry” as well as whether the conduct would “surprise a reasonable businessperson”. It then peppered its ordinary course analysis with comparisons of the target’s conduct during the pandemic with that of its peers. Cineplex, on the other hand, explained that its brief “consideration of peer companies” related only to that part of the target’s interim period undertakings requiring it to use “commercially reasonable efforts” to preserve its business relationships and not to the court’s ordinary course analysis.[10]
The drafting takeaway for M&A parties in Canada is to consider addressing the matter in greater detail, e.g., by additional language reinforcing that the “ordinary course” is determined solely by reference to the target’s – and not any third party’s – history or practice.
1B – Does the “Ordinary Course” Include Extraordinary Measures in Extraordinary Times?
An issue related to whether the ordinary course involves comparing a target’s actions to those of its peers is whether the ordinary course should include extraordinary measures in extraordinary times.[11]
Fairstone held that it is “part of the ordinary course of any business” to experience macroeconomic disruptions and to “take steps in response to those sorts of systemic economic changes”. This led the court to hold that the target’s reactions to the pandemic that were “prudent”, didn’t have “long-lasting effects” and didn’t “impose any obligations” on the buyer were not outside the ordinary course. Similarly, the court sought evidence the changes were pursued in “good faith” for the purpose of continuing the business “as normally as possible” in light of the pandemic, and “not changing it”. The point was not at issue in Cineplex.
By contrast, AB Stable held that the formulation “only in the ordinary course of business consistent with past practice” effectively froze the target to its past practice, even in the face of COVID-19 and even if the target’s actions were reasonable responses to the pandemic. U.S. commentators (Harvard) have argued that even a basic ordinary course covenant should not be interpreted to allow extraordinary measures in extraordinary times, including as doing so injects significant uncertainty regarding (1) when extraordinary times have been entered, and (2) how much (or how little) is expected of the target as a result.
The resulting drafting consideration for M&A parties is to weigh whether to specifically address whether and how extraordinary circumstances impact the ordinary course.
2 – “Except as Otherwise Provided by this Agreement” Qualifiers
It is apparent that the “except as otherwise provided by this agreement” qualifier often included in ordinary course covenants is intended to create exceptions to the ordinary course undertaking.[12] Less clear is which other M&A clauses can or should be caught by this reference. Candidates considered by the courts include more bespoke interim period covenants as well as a seller’s representations and warranties. Unfortunately, however, such arguments were not ultimately decided.[13]
A closely related analysis where the courts have made definitive rulings is the appropriate interaction between ordinary course covenants and MAE clauses. That said, their conclusions varied.[14]
AB Stable held that the two clauses “serve different purposes” and “guard against specific risks”. Specifically, the courts held than an “ordinary course” covenant protects against a change in how the target operates while a MAE clause protects against a significant decline in the target’s value. This did not mean that changed circumstances could not trigger both clauses. But it did mean that the “outcome of the analysis” and the “contractual results” flowing from the changed circumstances could be different such that the outcome under one clause did not “dictate the outcome” under the other clause.
By contrast, Fairstone and Cineplex deemed it appropriate to read the two clauses together given the basic principle that “contracts should be read as a whole”. Additional support for this approach was that a more general provision (i.e., the ordinary course covenant) should yield to a more specific provision (i.e., the MAE clause) and that the risk allocation set by the MAE clause should be preserved. Stated differently, as both clauses were triggered by the pandemic, and as the MAE clause expressly addressed emergencies and allocated systemic risk to the buyer, the courts held the “ordinary course” covenant should not be read in a manner that conflicts with the MAE clause.
It is arguable that different facts and drafting explain these divisions between AB Stable, on the one hand, and Fairstone and Cineplex, on the other hand, and this is the brief indication made in Cineplex. Other aspects of the decisions suggest a more principled rift between the courts, however. What is not debateable for Canadian M&A is that ordinary course covenants and MAE clauses should be considered in tandem and that, should the M&A parties desire otherwise, they can consider drafting toward that end.
3 – “Buyer Consent” Qualifiers
The third and final qualifier to an ordinary course covenant we consider is that whereby the target can deviate from the ordinary course with the buyer’s consent. In our example clause from Fairstone (see above) this was phrased as requiring “the prior written consent of Purchaser, which consent shall not be unreasonably withheld…” The qualifier was substantively identical in AB Stable.[15] In both cases the sellers admitted to never seeking buyer consent. Once again, however, the courts came to opposite conclusions.[16]
Fairstone held that even if the target had been operating outside of the ordinary course, it would have been unreasonable for the buyer to have withheld its consent. Important for the court was that the target measures at issue “were not particularly complex, were often mandated by government regulation [and] were common to those that businesses around the world had taken”. The court also highlighted that the buyer “did not introduce any evidence of what it would have done differently or what it did differently in its own business”. The sellers were therefore not in breach.
By contrast, AB Stable rejected arguments that the “reasonableness” element of the qualifier could result in any manner of deemed or constructive consent. The court held that compliance with the notice requirement was “not an empty formality” because it entitles the buyer to “engage in discussions with the seller” and if warranted “seek [additional] information about the situation under its access and information rights” under the purchase agreement. This was important as it enables the buyer to “protect its interests”, including by “propos[ing] reasonable conditions to its consent” and “anticipat[ing] and account[ing] for the implications of the non-ordinary course actions when planning for post-closing operations”. The result that the breach began and ended with the fact the seller had not consulted with the buyer regarding its pandemic response.
Given the ruling in Fairstone and the rationale of AB Stable, M&A parties in Canada can consider expressly drafting to exclude the possibility of a reference to reasonableness in a buyer consent qualifier leading to deemed or constructive consent.
Concluding Comments: What Would Be the “Ordinary Course” in an Unprecedented Tariff War?
The interaction between an ordinary course covenant and a potential tariff war between the U.S. and Canada presents a special challenge for M&A lawyers: what would be the ordinary course in unprecedented circumstances? Numerous secondary questions are also raised:
- If the target and its operating history provide little or no guidance regarding what is ordinary course amid a tariff war, is it still appropriate to tie the standard (1) to the target’s past practice, and/or (2) exclusively to the target?
- Were the M&A parties to consider wholly or partly detaching the ordinary course from the target, what other options are practically available when the circumstances are unprecedented across the economy generally?
- An alternative might be to tie the ordinary course to industry best practice going forward, but this presents its own problems, particularly regarding uncertainty. The standard may be inherently unpredictable such that the parties couldn’t be sure what was being agreed. It may also be unenforceable for ambiguity should industry reaction lack any meaningful consistency.
The reaction of dealmakers to the pandemic provides some guidance.[17] Examples include:
- defining past practice to include reasonable responses to previous extraordinary events;
- increased scrutiny of potential exemptions to negative covenants, e.g., which will and will not be subject to a “buyer’s consent, not to be unreasonably withheld” qualifier; and
- imposing time limits on the period in which the buyer must reply to the seller’s request for consent.
We expect similar scrutiny and evolution of ordinary course covenants as a result of the potential tariff war. That said, different contexts warrant different considerations. For example, during the pandemic a common negotiation point was whether, in addition to compliance with evolving legal mandates, the ordinary course required compliance with non-binding guidelines issued by industry associations. By contrast, amid a tariff war, examples of scenarios that could cause tension with the ordinary course might include:
- the target significantly ramping up raw material purchases in anticipation of tariffs;
- the target pivoting to one or more significant new customers in Asia or Europe to divert sales away from the U.S.; and/or
- the target exploring the relocation of production to avoid U.S. tariffs and/or focus on new markets in Asia or Europe.
Lastly, critical to appreciate is that compliance with, or a potential breach of, an ordinary course covenant tends to occur over a period of time as driven by the target’s operational decisions rather than being driven by a sudden (often external) development, as an MAE typically is. This is highlighted by the “buyer consent” qualifier within ordinary course covenants, a feature absent in MAE clauses. The qualifier also highlights the “back and forth” communication envisioned by the covenant and an underlying presumption that, where interim period developments test the bounds of the ordinary course, both parties should be incentivized to agree to a reasonable mitigation strategy. We would therefore expect particular emphasis and negotiation around buyer consent qualifiers in ordinary course covenants as a result of the tariff war, not unlike during the pandemic.
[1] Courts have also recognized that ordinary course covenants guard against moral hazard and the risk of the seller acting opportunistically during the interim period given that, upon closing, the consequences will generally be borne by the buyer.
[2] Fairstone Financial Holdings Inc. v. Duo Bank of Canada, 2020 ONSC 7397 (CanLII) [Fairstone] at paras. 154 and 156.
[3] See Cineplex v. Cineworld, 2021 ONSC 8016 (CanLII) [Cineplex] at para. 41: “[T]he Company shall, in good faith, use commercially reasonable efforts to maintain and preserve its and its Subsidiaries business organization, assets, properties, employees, goodwill and business relationships with customers, suppliers, partners and other Persons with which the Company or any of its Subsidiaries has material business relations.”
[4] See, for example, Cineplex at para. 43.
[5] For a detailed discussion of pre-pandemic ordinary course of business caselaw, see Fasken’s Private M&A in Canada: Transactions and Litigation (LexisNexis, 2024) at §5.02.
[6] Fairstone arose from the acquisition of a large Canadian consumer finance company. The court held the seller’s response to the pandemic did not breach its ordinary course covenant on the basis the target’s business remained “fundamentally” unchanged. All of the buyer’s arguments were rejected, including regarding the modifications made to branch operations, to loan origination, to collection processes, to expenditures and to employment arrangements. The target’s changes to its accounting methodology required the closest scrutiny as these could lead to the buyer paying a higher price under the acquisition agreement’s purchase price calculation mechanism. However, the court concluded that the accounting standards binding the target required the application of judgement and thus adaption to the novel circumstances of the pandemic; to have remained static and continue to “mechanically” apply the target’s base model would have actually been to “cease to operate in the ordinary course”.
[7] Cineplex arose from the aborted acquisition of a large Canadian cinema operator. The court held the target had complied with its ordinary course covenant for two main reasons. First, the covenant expressly required the target to conduct its business in accordance with applicable laws. Therefore, as cinemas had been ordered closed by government mandate, the target was not in default for operating with its theatres shut. Second, the “cash management tools” of “payment deferrals and spending reductions” the target implemented to “preserve its cash flow” following the mandated closure of movie theatres qualified as ordinary course. The target’s business was one inherently characterized by “fluctuating and unpredictable revenues” and such payment deferrals and spending reductions were “levers that [the target] had previously used to manage its liquidity”. Nor did the fact the target had “used these tools on a larger scale because of the mandated theatre closures” change the outcome.
[8] AB Stable VIII LLC v. MAPS Hotels & Resorts One LLC, C.A. No. 2020-0310-JTL (Del. Ch. Nov. 30, 2020), aff’d AB Stable VIII LLC v. MAPS Hotels & Resorts One LLC, 268 A.3d 198 (Del. Sup. Ct. Dec. 8, 2021) [collectively, AB Stable]. AB Stable involved the acquisition of a target that operated multiple luxury hotels. The court held the target’s departure from the “normal and customary routine of its business” as “established by past practice” was proven by “overwhelming evidence”. This included the closure of two hotels entirely and the severe limitation of operations at the remaining 13, who were placed in a state described as “closed but open” and as “quasi-catatonic”. All food and beverage service had been halted except for room service with limited menus and services times. Gyms, pools, spas and health clubs were shut down or limited. Employee headcount was “slashed” as operations pivoted quickly to “skeleton staffing”. Marketing was also minimized and all non-essential capital expenditures were restricted. Delaware’s highest court affirmed the ruling, repeatedly describing the seller’s changes to the target’s hotel operations as “drastic”.
[9] See Fasken’s Private M&A in Canada: Transactions and Litigation (LexisNexis, 2024) at §5.02[2][c].
[10] The acquisition agreement in Cineplex defined the “ordinary course” as actions “taken in the ordinary course of the normal day-to-day operations of the business of the Company… consistent with past practice.”
[11] See Fasken's Private M&A in Canada: Transactions and Litigation (LexisNexis, 2024) at §5.02[2][c][i].
[12] In our example clause from Fairstone, this qualifier is phrased “Except as expressly provided in this Agreement…” In AB Stable, the qualifier was phrased “Except as otherwise contemplated by this Agreement…”
[13] See Fasken’s Private M&A in Canada: Transactions and Litigation (LexisNexis, 2024) at §5.02[2][d].
[14] See Fasken’s Private M&A in Canada: Transactions and Litigation (LexisNexis, 2024) at §5.02[2][d][i].
[15] It read: “unless the Buyer shall otherwise provide its prior written consent (which consent shall not be unreasonably withheld, conditioned or delayed)…”
[16] See Fasken’s Private M&A in Canada: Transactions and Litigation (LexisNexis, 2024) at §5.02[2][e].
[17] See Fasken’s Private M&A in Canada: Transactions and Litigation (LexisNexis, 2024) at §5.02[3].
