Don't Test Your Faith: Drafting Earn-Outs

You are in negotiations to buy a business with little operating history. The seller is convinced the business has significant growth potential, so you agree to include an earn-out to bridge the valuation gap. As future owner, you want to run the business as you see fit. You know that how you conduct the business will affect its performance and ability to achieve earn-out targets. But as long as you don't agree to include any performance standards in the earn-out provisions, you should be able to operate the business without any restrictions, right?

In Canada, the answer is not straightforward. While it has long been a feature of Québec law, until recently, common law provinces did not recognize a duty of good faith in the performance of contracts. However, the Canadian approach is starting to align with the United States–where courts recognize an implied covenant of good faith and fair dealing. Buyers should proceed with caution in order to minimize the risk of a