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Court Considers MAE Termination Right and Ordinary Course Covenant in Context of COVID-19

January 5, 2021

In its recent decision in Fairstone Financial Holdings Inc. v. Duo Bank of Canada (Fairstone), the Ontario Superior Court of Justice (Commercial List) (Court) addressed the interpretation of material adverse effect (MAE) clauses and ordinary course covenants in M&A transactions. Such provisions are of renewed interest to many prospective buyers, sellers and target companies in view of the ongoing effects of COVID-19.


Fairstone provides some important considerations for parties negotiating purchase agreements. In particular:

  • Interpretation of MAE provisions

  • Burden of proof and constituent elements of an MAE

  • Rule of contractual interpretation (i.e., contracts should be read and interpreted as a whole, with a specific determination that it would be inappropriate to allow the ordinary course covenant to override the MAE provision).


On February 18, 2020, Duo Bank of Canada (Duo) agreed to purchase all of the shares of Fairstone Financial Holdings Inc. (Fairstone) for a purchase price calculated on the basis of Fairstone’s tangible shareholders’ equity (subject to adjustment at closing) plus a premium. Closing was originally scheduled for June 1, 2020, with an outside date of August 31, 2020.
On May 27, 2020, Duo advised Fairstone that it was not obligated to close the transaction on the basis of the occurrence of a MAE and breaches by Fairstone of the “ordinary course” covenant and other specific covenants related to COVID-19. In response, Fairstone and its shareholders sued Duo for specific performance.

The Court found that Fairstone had not breached the share purchase agreement (SPA) and ordered specific performance of the transaction.


The SPA stated that Duo was permitted to terminate the agreement if an MAE in respect of Fairstone occurred between the date of signing and the date of closing. MAE was defined in the SPA as a condition that has (or would reasonably be expected to have) a material adverse effect on the business of Fairstone, taken as a whole, except to the extent that:

  1. Such material adverse effect resulted from any of a number of specified clauses, which included: (a) worldwide, national or provincial emergencies, (b) changes in the markets or industry in which Fairstone operates, and (c) the failure to meet forecasts

  2. Certain of such specified causes did not disproportionately affect Fairstone relative to others in its industries or markets.

In determining whether an MAE had occurred pursuant to the SPA, the Court examined:

  1. The burden of proof that an MAE had occurred

  2. The constituent elements of a MAE

  3. The application of the exceptions or “carve-outs” provided in the definition of the MAE

  4.  The application of the disproportionate effect provision contained in the definition of MAE

The Court found that the burden of proof to establish that an MAE occurred falls on the party making such assertion, in this case Duo. Additionally, the Court established that the appropriate burden of proof to demonstrate that a MAE “would reasonably be expected to have” occurred was on a balance of probabilities. Assuming the initial assertion that an MAE had occurred succeeds, the burden of proof then shifted to Fairstone to establish that one of the carve-outs to the definition of MAE applied. Finally, the burden of proof shifted back to Duo in its assertion, in accordance with the exceptions to certain of the carve-outs, that one or more of the carve-outs should not apply because of a disproportionate impact to Fairstone relative to others in Fairstone’s industries or markets.

Moving to the elements of an MAE, the Court noted that the definition of MAE used in the SPA was not helpful, as it referred back to itself. Instead, the Court pointed to a widely used MAE definition in American jurisprudence: “…the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner”, which contains three elements: an unknown event, a threat to overall earnings potential and durational significance.

Examining these three constituent elements, the Court found that Duo had met its burden of proof, on a balance of probabilities, to demonstrate that an MAE arose between signing and the determinative date. In considering the “unknown event” aspect of the definition, the Court found that although COVID-19 was a known event at the time the parties entered into the SPA, there was no evidence that either party appreciated the effect that COVID-19 would have on Fairstone’s business. The Court also accepted that COVID-19 posed a threat to Fairstone’s earning potential. Finally, on the question of the durational significance of the effect of COVID-19 on Fairstone’s business, the Court found that that the evidence suggesting an adverse impact to Fairstone’s business for approximately two years was durationally significant from the perspective of a reasonable purchaser in Duo’s circumstances.

The Court next considered whether any of the carve-outs to the definition applied. Perhaps most interestingly, the Court held that the lack of express reference to “pandemic” in the emergency carve-out was not determinative of the parties’ intent to exclude pandemics from the carve-out, but rather that a broad interpretation of the provision was appropriate. In making this decision, the Court found that a broadly worded carve-out was “consistent with a general principle underlying MAE clauses of allocating systemic risks to the purchaser while leaving company-specific risks with the seller”.

Ultimately, the Court concluded that Fairstone fell within the three carve-outs referred to above. The Court also rejected the argument that COVID-19 disproportionality affected Fairstone relative to others in the market or industry. Accordingly, although the constituent elements of an MAE were proven, the Court was satisfied that an MAE had not occurred on the basis of the carve-out provisions.


The SPA also contained an ordinary course covenant requiring Fairstone to operate the business, to the extent lawfully permitted, in the ordinary course between the date of the SPA and closing of the transaction, and that any actions taken outside of the ordinary course would require consent by Duo, such consent not to be unreasonably withheld. The SPA defined “ordinary course” to mean actions taken by Fairstone consistent with past practice and taken in the ordinary course of normal day-to-day operations.

Duo argued that Fairstone had breached the ordinary course covenant by taking the following measures in response to COVID-19:

  1. Changing its operations from a branch-based system to an online system

  2. Changing its collection practices by implementing a national deferment program

  3. Reducing employee headcount and providing daily pay premiums to certain employees

  4. Decreasing expenditures

  5. Revising accounting practices by changing the way in which it calculated loan-loss reserves in the second quarter of 2020.

The Court considered interpretations of the “ordinary course” expression in various contexts and determined that despite the actions taken in response to COVID-19, Fairstone did not operate its business outside of the ordinary course. While the Court did not set out a universal rule for determining ordinary course conduct, it did provide guiding principles and a list of factors to consider when determining whether an action was taken in the ordinary course.

The Court accepted that there are systemic economic changes that will affect a business in the ordinary course and that prudent steps taken by a business in response to such changes that do not have a long-lasting effect or impose obligations on a purchaser can be actions taken in the ordinary course. The Court found that Fairstone’s actions did not fundamentally change the nature of the acquired business, impose long-term obligations or dispose of assets or portions of the business.

Additionally, Fairstone’s conduct was consistent with that of other businesses in the same industry and the Court found that the changes Fairstone made were to keep its business operating as normally as possible in light of COVID-19.

The Court also rejected Duo’s position that the ordinary course covenant required Fairstone’s conduct to be “consistent with the past practices” of Fairstone and “taken in the ordinary course of normal day-to-day operations” prior to signing of the SPA. In rejecting Duo’s position, the Court held that the practical effect of this interpretation would mean that Fairstone could not have operated its business in the ordinary course during the pandemic as anything it did in response to COVID-19 would be operating outside of the ordinary course. In addition, this interpretation would override the emergencies exclusion in the MAE covenant and to do so would not read the contract, but instead as a series of unrelated, standalone provisions.

On whether Fairstone’s conduct was “consistent with past practices”, the Court indicated that “consistent” does not mean “identical” and found that Fairstone’s conduct was consistent with steps that it had taken during past economic contractions and that the operational changes were consistent with past practices “in that they allowed Fairstone to continue its normal day-to-day business operations of lending to consumers, managing the consumer loan portfolio and collecting on its consumer loan portfolio”.

The Court added that even if Fairstone’s actions were outside of the ordinary course, it would have been unreasonable for Duo to withhold its consent to such actions had it been asked.

This determination can be contrasted to the decision in AB Stable VIII LLC v. Maps Hotels and Resorts One LLC (AB Stable), in which the Delaware Court of Chancery found that the target company’s response to COVID-19 was so extensive that its business was not conducted in the ordinary course and consistent with past practice such that the buyer was relieved from its obligation to complete the transaction. The Delaware court also rejected the argument that the target company’s responses to COVID-19 were reasonable or similar to that of other businesses. Although the facts in AB Stable differed from those in Fairstone, the Delaware court applied a plain reading of the purchase agreement and noted further that the MAE provision in the purchase agreement was to be read separately from the ordinary course covenant, in contrast to the court in Fairstone.


Fairstone provides guidance on the interpretation of MAE provisions and ordinary course covenants in Canadian M&A transactions and when it may be possible for a purchaser to terminate a transaction as a result of unforeseen events such as COVID-19. While the particular facts and circumstances of Fairstone contributed to the Court’s analysis and findings, it is a message for M&A participants to consider MAE clauses and ordinary course covenants carefully in the context of each transaction.

For further information, please reach out to a member of our Mergers & Acquisitions or Litigation & Dispute Resolution groups or your usual Blakes contact.