Purchase Price Adjustment Clauses: Why Parties Should Be Wary When Using Them

• Published date: 25 November 2022
• Subject Matter: Corporate/Commercial Law, Litigation, Mediation & Arbitration, M&A/Private Equity, Corporate and Company Law, Trials & Appeals & Compensation
• Law Firm: Crawley MacKewn Brush LLP
• Author: M&A Risk Advisor, Matthew Scott and Rowan LaCasse

A purchase price adjustment clause is a clause sometimes used by parties to purchase agreements to help allocate risk in the event that the value of underlying assets and liabilities change between the signing of the agreement and the transaction closing. These price adjustments occur post-closing when closing date numbers are finally determined. Common post-closing adjustments are based upon changes in working capital, net worth or net asset value of the target company.

While carefully considered and negotiated price adjustment clauses can effectively mitigate risk to ensure that parties to an M&A transaction receive fair market value at the time of closing, disagreements over such clauses are common. Parties should be wary when using such clauses.

Draft With Care to Avoid Ambiguity

Parties should approach the drafting of price adjustment clauses with great care. Price adjustment clauses are subject to general principles of contractual interpretation. Ambiguous price adjustment clauses can result in entire purchase agreements being void. Also, parties cannot always rely on strict interpretations of such clauses where to do so would not be in keeping with both parties' intentions at the time of signing. Namely, it may not be enough to read the words of the contract literally where such an interpretation does not fit with the context in which the agreement was signed.¹

Avoid The Appearance of Bad Faith

Parties should also be cognizant of when and how they invoke price adjustment clauses, in order to avoid the appearance of acting in bad faith. In a decision recently upheld by the BC Court of Appeal, Khela v. Clarke, a price adjustment clause in a purchase and sale agreement for land was unenforceable.² The clause was not only ambiguous, but the party seeking to rely on the clause tried to enforce it within two days of the closing date. The party seeking to rely on the clause argued that it received information from a lender nine days before closing that triggered the price adjustment clause. The judge determined that the party seeking to rely on the clause was well-versed in real estate matters and used this knowledge to take advantage of the other party. The judge held that the nature and timing of the "bad news" appeared orchestrated and fit with a long-term bad faith plan. Because the price adjustment clause was a vital term to the agreement...