Rare Earn-out Decision Provides Guidance for M&A Transactions

Earn-out provisions in Canada have become increasingly popular in private M&A transactions, appearing in 28% of deals in 2023.^[1] They are especially useful to bridge a valuation gap between the seller and buyer or to incentivize the seller to continue with the business post-closing. In an earlier article, we provided practical takeaways for negotiating and drafting earn-out provisions. This article reviews recent guidance from the Ontario Superior Court on accelerated earn-out provisions.

The Dispute

In Project Freeway Inc v. ABC Technologies Inc.,^[2] the seller (the "Seller") sold all its shares in certain companies (the "Target Companies") to a buyer (the "Buyer") for USD$165M pursuant to a share purchase agreement (the “SPA”).^[3] The SPA included an earn-out provision requiring the Buyer to pay over USD$26M to the Seller if the Target Companies achieved specific financial milestones over a two-year period.^[4] Notably, the SPA also included the following accelerated earn-out provision, requiring the Buyer to pay the USD$26M if the Buyer sold or transferred a “material portion” of the Target Companies without the Seller’s approval:^[5]

If, prior to the earlier of (i) the end of the applicable Earn-Out Period, and (ii) the payment of the aggregate Earn-Out Amount, any of the following shall occur without the prior written consent of the Vendor, the entire Earn-Out Payment for the remaining partial and full Earn-Out Periods shall immediately become due and payable to the Vendor: The Purchaser (A) merges, consolidates, sells or otherwise combines any Target Company with, to and/or into any Person other than an Affiliate of the Purchaser; or (B) directly or indirectly, sells, transfers or licenses a material portion of the assets of the Business of the Target Companies in one or a series of transactions to any Person other than an Affiliate of the Purchaser. For greater certainty, the Parties agree that the foregoing clause shall not limit the Purchaser’s right to complete mergers, amalgamations or other internal reorganizations with or among the WM Group and Affiliates of the Purchaser, and shall specifically exclude a change of control of the Purchaser Guarantor; [Emphasis added.]

After closing, the Buyer completed two transactions without the Seller’s approval:^[6]

• The Sale Leaseback (the “SLB”) Transactions: The Buyer sold lands of the Target Companies to arm’s length entities that leased back those lands to the Buyer.
• The Factoring Arrangements: The Buyer sold essentially all of the Target Companies’ customer accounts.

The Seller argued that the accelerated earn-out provision was triggered.^[7] The Buyer disagreed the transactions were material enough to trigger that provision. The Buyer argued that materiality, consistent with a non-binding Letter of Intent (the “LOI”) that pre-dated the SPA, had to be assessed in the context of the earn-out provision – i.e., did it impact the calculation of the contribution margin and earn-out, and the Buyer’s ability to pay the earn-out?^[8]

The Decision

The Court agreed with the Buyer: the accelerated earn-out provision was not triggered by the impugned transactions. The Court’s decision was based on four key factors.

First, the Court determined that the purpose of the provision was to capture business decisions that impaired the contribution margin or earn-out provisions.^[9] Here, there was no material impairment on the contribution margin targets from the impugned transactions.^[10]

Second, the Court concluded that two other provisions in the SPA permitted the Buyer to enter into transactions in the ordinary course without adversely affecting the contribution margin or the earn-out provisions.^[11]

• The SPA permitted the Buyer to undertake mergers, internal reorganizations, or the closing and consolidation of facilities without requiring the Seller's consent. The Court determined that it would be “commercially absurd” for the Buyer to engage in these activities but be restricted from participating in ordinary course financing transactions.
• The SPA explicitly specified that the earn-out did not prevent the Buyer from merging any of the target’s facilities with any of the Buyer’s facilities, provided that proper adjustments were made to track product lines for the calculation of the earn-out.

Third, the Court relied on the LOI as indicative of the parties’ mutual intention to have the acceleration provision triggered only when a transaction impaired the Seller’s earn-out.^[12]

Lastly, the Court also relied on the Seller’s post-closing conduct. The Seller was aware of the impugned transactions before they were completed and did not object, thereby confirming that the parties only intended to capture transactions that negatively affected contribution margin targets.^[13]

Takeaways

1. Context is just as important as words: Earn-outs are heavily negotiated and therefore quite bespoke. While subjective intentions cannot trump wording in an agreement, expect a court to determine the purpose of the provision based on the surrounding circumstances.
2. Negotiations might inform interpretation: Although a court will not override the words in the agreement, it could rely on communications between parties, negotiations prior to entering into an SPA, and pre-existing knowledge of parties prior to entering an SPA to aid in the interpretive exercise. 
   1. To avoid this, parties should ensure their agreement have a robust “entire agreement” provision and expressly exclude prior drafts and non-binding offers.
3. Commercial realities matter: Courts will not favour an interpretation that leads to a commercially absurd outcome. The Court will be motivated to search for an interpretation that balances a buyer’s operational freedom with a seller’s right to earn out payments not being undermined by a buyer’s self-interested decisions. In the context of an accelerated earn-out provision, a Court will want to avoid permitting a “windfall” that could never have been intended by the parties. To the extent possible, parties should include several scenarios in the agreement of how the earn out mechanism will work based on different foreseeable scenarios with sample calculations being appended to the definitive agreement.
4. Specific drafting can minimize risk of litigation: Disputes are less likely to arise when terms are highly specific. For instance, if the parties intended in this case, the following language would have triggered the accelerated earn-out provision if the impugned transactions prejudiced the earn-out:
   1. If, prior to the earlier of (i) the end of the applicable Earn-Out Period, and (ii) the payment of the aggregate Earn-Out Amount, any of the following shall occur without the prior written consent of the Vendor, the entire Earn-Out Payment for the remaining partial and full Earn-Out Periods shall immediately become due and payable to the Vendor:
      1. The Purchaser (A) merges, consolidates, sells or otherwise combines any Target Company with, to and/or into any Person other than an Affiliate of the Purchaser; or (B) directly or indirectly, sells, transfers or licenses a material portion of the assets of the Business of the Target Companies in one or a series of transactions to any Person other than an Affiliate of the Purchaser [to the extent such sale could reasonably be expected to adversely affect the earn-out.] For greater certainty, the Parties agree that the foregoing clause shall not limit the Purchaser’s right to complete mergers, amalgamations or other internal reorganizations with or among the WM Group and Affiliates of the Purchaser, [as well as ordinary course transactions such as any sale, leaseback and financing transactions] and shall specifically exclude a change of control of the Purchaser Guarantor; [Emphasis Added.]
5. Post-Closing Conduct is Important: Sellers should promptly raise issues they have with respect to the calculation or determination of an earnout to avoid the appearance of acquiescence to a buyer’s conduct that could impact the payment of an earnout. 

^[1] “What’s Market: Earn Outs”, Practical Law, Thomson Reuters (Nov. 14, 2024).

^[2] Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048.

^[3] Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 at para 13.

^[4] Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 at para 13.

^[5] Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 at para 14.

^[6] Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 at para 15.

^[7] Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 at para 39.

^[8] Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 at para 46.

^[9] Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 at para 56.

^[10] Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 at para 56.

^[11] Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 at para 54.

^[12] Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 at para 51.

^[13] Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 at para 55.