Signed, Sealed and Delivered

What is a Contract?
A legal contract is an agreement between two parties that involves an exchange of rights and obligations enforceable in court[1]. The law recognizes the autonomy of individuals to create a sort of private law between themselves to regulate their own conduct in the free market. Originally, this meant upholding “freedom of contract” and the intent of the parties, regardless of imbalances in bargaining powers or external notions of fairness. The powers that be quickly realized that humans are not quite robots, and as such, this strict interpretive approach did not endure. In modern times, contracts are interpreted using several doctrines and depending on the facts of a particular case, different weights will be given to a particular doctrine. It can sometimes be a challenge to predict the outcome of this more holistic approach to interpretation, which is why “legalese” is often employed in the drafting of contracts. These are not mere magic incantations, but instead an attempt by competent solicitors to establish greater certainty in the agreement while also respecting the limitations imposed by law and public policy.
 
Elements of a Contract
In a nutshell, a contract roughly consists of five core elements: Offer, Acceptance, Consideration, Legality, and Capacity. An offer is one person’s communication to another of a willingness to enter into a legally binding agreement under specific terms[2]. Acceptance is a final, unqualified expression of assent to terms of an offer[3]. Consideration refers to the fact that promises under contract need to be “bought” or “bargained for” by an act or promise of the other party[4], ensuring an exchange of value. Alternatively, a contract signed under seal may not require consideration[5]. Legality means that a contract made for an illegal purpose or otherwise forbidden by statute will be void even if it conforms to the other elements[6]. Finally, capacity refers to the legal and mental ability to execute a contract, such as not being a minor[7].
 
Some Key Doctrines

Reasonable Person: A time tested tool for “objective” interpretation. The standard of a reasonable person is often used in different areas of law to analyse a dispute through some level of objectivity. A reasonable person is a mythical creature of the law who is not too prudent but also not reckless, is more careful than most people (and hence more careful than the average person), and consciously makes decisions accounting for the consequences of their actions[8]. It is used to determine the objective intent of contracting parties and other objective factors in a dispute.
 
Privity: The general rule from English common law is that a person who is not a party to a contract cannot have obligations or liabilities imposed on them. This part is rather uncontroversial. However, the general rule also provides that a person who is not a party to a contract cannot acquire enforceable rights under said contract. In an employment context, this second part has led to some harsh consequences, and as a result, an exception was made allowing employees to benefit from an immunity or limitation of liability granted to an employer if certain conditions are satisfied[9].
 
Honest Performance: All contracts have an implied duty of honest performance. This means that parties should not act in bad faith when performing under the contract. It does not necessarily mean acting in good faith. Respect for freedom of contract and the pursuit of economic self-interest must be weighed against the merits of judicial intervention. It is not the role of the judge to scrutinize the motives of contracting parties and enforce ad-hoc morality. Therefore, honest performance must be anchored to something objective for the court to assess[10]. This doctrine is especially relevant in employee termination, and insurance contracts.
 
Short Application[11]
Take Ursula’s contract with Ariel in the Disney rendition of The Little Mermaid. As you can imagine, there are several issues with its enforceability, but only a few need to be highlighted to make the invalid in its entirety.
 
Capacity: Ariel was a minor at the time, meaning that terms are unlikely to be enforced on her
Legality: One cannot make a contract that could lead to eternal servitude of an individual
Honest Performance: Clear attempts to undermine the performance of a counterparty to achieve a certain result under the contract would fall foul of the duty of honest performance
 
Conclusion: This contract is not enforceable in Canada. The fact that it was enforceable in Atlantica raises serious doubts about Sebastian’s confident remark that life is indeed “better down where it’s wetter… under the sea”. Don’t be like Ursula, draft proper contracts for your business venture.

Author: João Victor Lima is member of the BLG Venture Clinic and is a second-year law student at the Faculty of Law, University of Calgary.

________________
[1] CED (online), Contracts I.1, Contracts | I — Basis of Contract | 1 — Contract Defined, §1
[2] Strench v. Strench (2002), 2002 CarswellBC 695 (B.C.S.C.)
[3] CED (online), Contracts II.3, Contracts | II — Formation of Contract | 3 — Acceptance, §50
[4] CED (online), Contracts III.1, Contracts | III — Consideration for Contract | 1 — General, §102
[5] CED (online), Contracts III.1, Contracts | III — Consideration for Contract | 1 — General, §103
[6] CED (online), Contracts VIII.1, Contracts | VIII — Substantive Illegality in Contract Law | 1 — Illegality, §434
[7] CED (online), Contracts IV.2.(a).(iii), Contracts | IV — Parties to a Contract | 2 — Capacity to Contract | (a) — Natural Persons | (iii) — Infants (Minors) — Provinces Other than British Columbia
[8] Vaughan v Menlove (1837) 132 ER 490 (CP)
[9] London Drugs Ltd v Kuehne & Nagel International Ltd [1992] 3 SCR 299
[10] Bhasin v Hrynew 2014 SCC 71
[11] Clements, R., & Musker, J. (Directors). (1989). The Little mermaid [Motion picture]. United States: Buena Vista Pictures Distribution, Inc.

Standard Boilerplate Provisions
Boilerplate provisions are clauses that are included in most commercial agreements. They include governing law, severability and how time-sensitive the agreement may be. Boilerplate provisions are viewed as ancillary elements of a contract and are often the least controversial and negotiated. While parties rarely give these provisions a second look, they are fundamental in interpreting the agreement, as well as the rights and obligations of each party.[1]
 
The following post aims to shed light on five common boilerplate clauses and the importance of tailoring each provision to the needs of the parties or agreement. [2]
 

1. Jurisdiction

A jurisdiction provision will determine whether there is an exclusive or non-exclusive jurisdiction where the courts will decide disputes arising under the contract. The parties attorn to a specific jurisdiction when using an exclusive jurisdiction clause. Canadian courts are known to uphold exclusive jurisdiction provisions, “unless the party challenging the clause shows ‘strong cause’ why the clause should not be enforced…”[3] A non-exclusive jurisdiction clause will include a preferred jurisdiction but does allow parties to bring an action in another jurisdiction should the circumstances deem it appropriate.
 
Choosing a jurisdiction will depend on the parties to the agreement. It is often dictated by the location of the head office or where the business operates. A governing law provision is an inadequate substitute for a jurisdiction clause and won’t dictate where disputes may be heard.[4] The specific language of the clause can have a great impact on its interpretation. In Naccarato v Brio Beverages Inc., the court found that the word “submit” does not constitute mandatory language but was considered permissive.[5] If parties negate including a jurisdiction clause, the courts may infer the appropriate jurisdiction so long as it has a real and substantial connection to the parties or agreement.[6]
 
Specifying an exclusive jurisdiction that meets the needs of the parties is important as it can avoid unexpected legal costs in another province or country.
 
2.Entire Agreement
The entire agreement clause aims to limit the obligations of each party to only what is included in the written agreement. This means that any discussions throughout negotiations or representations made prior to signing the agreement are excluded.
 
The entire agreement provision codifies “the parole evidence rule, which provides that a contract may not be contradicted by evidence of oral and written statements made by the parties before the signing of the contract.”[7] The provision is not meant to apply proactively, only retroactively, allowing the parties to amend the agreement as needed. If a proactive application is desired, the specific wording must provide for it.[8]
 
The entire agreement provision has the power to limit the obligations of the parties to what is written and included in the agreement.[9]
 
3.Notices
A notice provision is not intended to be negotiated or favour one side or the other. It will provide the outline of how the parties must communicate throughout the term of the contract. A party can provide notice for a variety of reasons, for example: renewals, assignments, amendments, or termination. The goal is to minimize the potential for disputes to ensure each party is aware of changes in the obligations of the parties.
 
The notice clause should clarify in what manner notice should be communicated (ie. fax, e-mail, mail… etc.), who should receive the notice, where it should be sent, accepted methods of delivery and when notice is deemed received and effective.[10]
 
There are two different types of notice provisions, mandatory and permissive notice provisions. Mandatory notice provisions outline the type or types of delivery the parties must comply with. Whereas permissive notice provisions allow for delivery in ways not explicitly named in the clause. If a provision is found to be permissive, courts will take a practical approach in finding whether notice is valid, and whether the method of delivery chosen provided unfair advantages to the sender.[11]
 
It is important to tailor the notice provision to the parties and the agreement to ensure ease of delivery and acceptance.
 
4.Assignment
The assignment clause will stipulate whether or not a party to the contract can transfer the rights and obligations under the contract to another party. A common provision might look like:
 
“This agreement shall not be assigned by either party without the consent of the other party.”
 
Such a provision raises a number of concerns. Namely, it doesn’t purport to identify whether the obligations, rights or both are assigned under the agreement. Further, the clause fails to specify what standard the non-assigning party must use to approve the assignment.[12]
 
Canadian courts have addressed these concerns and found that typically, unless explicitly stated, benefits under the agreement can be assigned but the obligations must receive consent from the non-assigning party.[13] 
 
The standard by which the non-assigning party must be held is the reasonability standard. The non-assigning party may only refuse the assignment of both the benefits and obligations if it would be reasonable to do so.[14] What is reasonable will depend on the specific factual circumstances, and the parties to the agreement and the potential assignee.
 
It is important to be explicit when drafting contractual provisions. The wording of the provisions should be carefully chosen and reflect the intentions of the parties.
 
5.Force Majeure
A force majeure clause aims to protect the parties to an agreement if some unforeseeable event outside the parties control prevents them from fulfilling their obligations. The clause excuses the parties from their respective obligations without causing a breach. Generally, a force majeure clause will “acts of God, war, riots, natural or other disasters.”[15] The circumstances of force majeure fall outside what is considered normal business risk.
 
Typically, the provisions will be considered narrowly with consideration to the wording of the provision. The party seeking to evoke the provisions must prove the force majeure event.[16]
 
If a contract includes a force majeure clause, the party seeking protection must take steps to prevent the event from happening, which can vary depending on the circumstances. The party is also required to attempt to avoid the event and mitigate the potential impact. It is common for a party to provide notice to the other party to an agreement to its inability to fulfill its obligations.
 
If the contract fails to provide for force majeure, the common law provides some protection under the Doctrine of Frustration. Frustration in contract law occurs when a situation arises rendering it impossible to complete the obligations under the contract. The frustrating event must not have been foreseeable at the time the contract was entered into, nor the fault of either party.[17]
 
Conclusion
Boilerplate provisions can have powerful influence over the interpretation and application of the agreement. It is important to tailor the provisions to consider the parties interests and needs and to ensure the ability to fulfill its obligations as outlined in the contract.

    _________________________
[1] Boilerplate Clauses, Practical Law Standard Clauses, (2016), online : Thomson Reuters <https://blog.richmond.edu/lawe759/files/2016/08/Boilerplate-Clauses.doc.pdf>.
[2] Ibid.
[3] Mary Paterson, Simon Hodgett & Seth Whitmore, How to draft exclusive vs. non-exclusive jurisdiction clauses, (May, 2019) online: Osler <https://www.osler.com/en/resources/regulations/2019/how-to-draft-exclusive-vs-non-exclusive-jurisdiction-clauses>.
[4] Christmas v Fort McKay First Nation, 2014 ONSC 373.
[5] Naccarato v. Brio Beverages Inc., [1998] AJ No 47 (QB).
[6] Club Resorts Ltd. v. Van Breda, 2012 SCC 17.
[7] Soboczynski v. Beauchamp, 2015 ONCA 282 at para 46.
[8] Shelanu Inc. vs. Print Three Franchising Corp. (2003) , 64 O.R. (3d) 533 (C.A.) at paras 51 and 52.
[9] Supra note 7.                                                                                                                        
[10] J Gerard Legagneur, Why your contract’s “notices” provision is vitally important, online: < https://www.nolo.com/legal-encyclopedia/why-your-contract-s-notices-provision-is-vitally-important.html>
[11] Ross v T Eaton Co., (1992) 96 DLR (4th) 631 (Ont CA).
[12] TL Stark, Negotiating and Drafting Contract Boilerplate, (New York: AML Publishing, 2003) at page 37.
[13] Rodaro v Royal Bank, (2002), 59 OR (3d) 74 CA.
[14] McCallum, Hill & Co. v Imperial Bank, (1914), 7 Sask LR 33 (SC).
[15] Peter Wiazowski & Trevor Zeyl, Contract performance in a coronavirus world: Force majeure clauses and the doctrine of frustration, (March 2020), online: Norton Rose Fulbright LLP < https://www.nortonrosefulbright.com/en-ca/knowledge/publications/844d7cf4/contract-performance-in-a-coronavirus-world-force-majeure-clauses-and-the-doctrine-of-frustration>.
[16] Ibid.
[17] ES Block, K Brabander, M Lam, MS Bridges & K Smyth, The impact of Covid-19 on contractual obligations: force majeure and frustration, (March 2020), online: McCarthy’s LLP < https://www.mccarthy.ca/en/insights/articles/impact-covid-19-contractual-obligations-force-majeure-and-frustration>.

What are Anti-dilution Provisions?
For early-stage companies, convertible instruments offer several advantages over conventional debt or common equity.[1] However, because start-up companies change their capital structure so often, investors with convertible instruments are particularly vulnerable to changes in the value of their investment.

Anti-dilution provisions are a commonly required protection for investors in early-stage companies. The purpose of anti-dilution provisions is to ensure that a convertible instrument retains its economic value to an investor in the event the company changes its capital structure.

If the company splits its shares, for example, an investor holding a convertible preferred share should be able to convert his shares and receive the same proportion of the company as he would have before the split happened. That is an example of a corporate structural anti-dilution provision, the other type of provision is the price-protection anti-dilution provision.[2]

Corporate structural anti-dilution provisions
Corporate structural anti-dilution provisions ensure that the investor receives the same number of common shares at the same conversion price as he would have if a change to the corporation had not occurred. Common triggers include dividends, division or consolidation of common shares, amalgamation, arrangements, reorganization or recapitalization.[3]

Price protection anti-dilution provisions
Price protection anti-dilution provisions are designed to adjust the conversion price of the investor’s instrument to align with any new issuances of the companies securities. Generally speaking, these are triggered only when new securities are issued at a price below the investor’s conversion price (“down-round financing”). [4] Common triggers include the issuance of common shares, issuance of options and other convertible securities, or changes in terms of options and other convertible securities. [5]

Adjustments to the conversion price are usually calculated in one of three ways:

1. Broad-based: Weighted-average-price of all outstanding securities including shares issuable on conversion or redemption,
2. Narrow-based: Weighted-average-price of outstanding securities excluding certain conversion or redemption rights, or
3. Full Ratchet: The lowest price offered in the down-round financing.

​Generally, a full-ratchet method offers the strongest protection to the investor allowing him to receive the lowest conversion price available and a proportionately higher number of shares. To see how that works consider the example below.
​
A company has 50,000 common shares outstanding, and an additional 10,000 common shares issuable on conversion of preferred equity. An early investor has a right to convert his preferred shares into 5,000 common shares at a conversion price of $1.25 per common share. The company subsequently issues 50,000 common shares in a private placement at a price of $1.10 per common share. The investor's preferred shares contain anti-dilution provisions that are triggered by the issuance of new common shares.




​

​As the above table indicates, the impact of the price-protection mechanism matters a lot. Agreeing to anti-dilution provisions without considering the overall dilutive effect of such provisions could have serious consequences for holders of common shares (including managers or key employees).
​
Investors with bargaining power over a company will be able to extract stronger anti-dilution protections. Given the sizeable effect these provisions have on the company’s ability to attract future investors and potential dilution to common shareholders without these protections, companies should seek to limit or scale back the strength of anti-dilution provisions.

How can a company limit the severity of anti-dilution provisions?
Companies should be aware of the consequences of overly-strong anti-dilution protection given to early investors. When negotiating convertible instruments there are several ways a company can limit the severity of anti-dilution provisions.

1. Use a broad-based weighted average formula if possible.
2. Include specific exceptions for shares issued to employees or consultants, and shares issuable on other instruments.[6]
3. Include a threshold number of shares or dollar value before anti-dilution rights are triggered.[7]
4. Avoid including a catch-all provision for certain events not specifically provided for.[8]
5. Require the investor to exercise its pre-emptive rights and participate pro rata in any new financing round or else permanently lose the benefit of its anti-dilution protection (“pay-to-play provision”).[9]

     __________________________
[1] Bryce C. Tingle, Start-up and Growth Companies in Canada: A Guide to Legal and Business Practices, 3rd ed (Canada: LexisNexis Canada Inc, 2018) at p 85 [Tingle].
[2] Thomson Reuters: Practical Law Canada Corporate & Securities, Preferred Share Provisions: Conversion Privileges and Anti-Dilution Protection, s 3.6 “Adjustment to Conversion Price and Number of Conversion Shares” (Retrieved on October 7, 2020) [Thomson Reuters].
[3] Thomson Reuters, notes to ss 3.6(e) and (f).
[4] An investor might demand adjustment to their conversion price even if the price of new securities is higher than their conversion price, but lower than fair market value. Companies should do what they can to negotiate out of this trigger as it limits flexibility in future financing rounds (see Thomson Reuters, notes to s 3.6(a)).
[5] Thomson Reuters, notes to s 3.6(a) and (d).
[6] Tingle at p 359.
[7] Tingle at p 359; see also Thomson Reuters, notes to s 3.6.
[8] Thomson Reuters, notes to s 3.6(g).
[9] Thomson Reuters, notes to s 3.6.