Western Larch Limited v Di Poce Management Limited: The Enforceability of Shotgun Clauses
In Western Larch Limited v Di Poce Management Limited, 2013 ONCA 722 [Western Larch], a decision released on November 29, 2013, the Ontario Court of Appeal reviewed the exercise of a shotgun buy-sell provision (a.k.a. a “shotgun clause”) in a partnership agreement. The motion judge, presiding over the Commercial List, found that the buy-sell offer made by the respondents in this case was valid and enforceable despite it not complying fully with the shotgun buy-sell provision. The enforceability of the buy-sell offer was the primary focus of this appeal.
Introduction to Shotgun Clauses
Shotgun clauses, often found in unanimous shareholder agreements, partnership agreements, and joint venture agreements, are mechanisms through which one or more of the parties to a business venture may be expelled. Following the expulsion, the business venture will continue without the expelled party/parties.
Generally, the offeror will trigger the provision by putting forth a shotgun buy-sell offer to the offeree to purchase the latter’s interest in the business venture or to sell his or her own interest to the offeree for a stated value. This leaves the offeree with a decision, which he or she must make by an agreed upon date: whether to sell the interest in the business venture or to buy the offeror’s interest in the business venture. If the offeree does not make this choice by the agreed upon date, the offeror may force the purchase on the offeree, requiring closing to take place on the terms set out in the offer.
Because this process expels a party from what is usually a viable business venture, it is “seen to be a draconian remedy… . This has led courts to require a shotgun buy-sell offer to comply ‘strictly’ with the shotgun buy-sell provision in the authorizing agreement, to be enforceable” (Western Larch, para 42).
Five partner corporations signed a partnership agreement. The business arrangement at issue in this case was created in 1997 – the Amended Restated Partnership Agreement (“PA”). There were two avenues through which a partner could be required to leave the partnership under the PA:
- By the death of a partner shareholder; or
- Through the operation of the shotgun buy-sell provision.
When one of the partner shareholders died in 2009 (Giovanni Guglietti), three of the four remaining partner shareholders wanted Mr. Guglietti’s associated partner corporation (Red Alder Limited) to continue as a partner. One of the remaining partner shareholders, Mr. MacIver from Western Larch Limited, did not want the continuation. As a result, the three partner shareholders in agreement developed a two-pronged strategy:
- Red Alder Limited would be brought back as a partner in a restructured partnership, if
- The three partner corporations in agreement (Di Poce Management, Eastern Hemlock, and Large Tooth Aspen) delivered their shotgun buy-sell offer to Western Larch.
The buy-sell offer put forth contained two options for Western Larch to consider, Alternative 1 and Alternative 2. Its terms and the valuation of the partnership in the offer were not initially attacked by Western Larch or Mr. MacIver. Indeed, Mr. MacIver and Western Larch attempted to secure financing so that they could reverse the offer; they were, however, unsuccessful in securing the required financing. The buy-sell offer provided that if Western Larch did not select between either Alternative 1 or Alternative 2, it would be deemed to have chosen Alternative 1.
The Decision of the Commercial List
Mr. MacIver and Western Larch issued a Statement of Claim attacking the validity of the buy-sell offer; they also unsuccessfully moved for an injunction to stop the respondents in this case from implementing the buy-sell offer.
Following this failed injunction, the forced acquisition of the appellants’ interest in the partnership was carried out in accordance with Alternative 1 in the buy-sell offer. In return, the appellants were paid about $33 million.
The respondents moved for summary judgment to dismiss the action stemming from the buy-sell offer (Western Larch Limited v Di Poce Management Limited, 2012 ONSC 7014). The motion judge agreed with the appellants that the law required the buy-sell offer to comply strictly with the PA. However, the motion judge did not agree with the appellants’ position that the buy-sell offer did not meet the standard of strict compliance.
The appellants’ primary complaint was that the valuation used by the offerors was not based on the fair market value of the partnership. The motion judge found that there was no requirement in the PA that the valuation in the buy-sell offer was to be at fair market value. The appellants made five other complaints; for the purpose of brevity, I will not explore these complaints in detail. However, the appellants argued that any of these deficiencies should have been sufficient to render the buy-sell agreement unenforceable.
The motion judge ultimately directed a trial on the appellants’ claims for damages for three breaches of contract arising out of the respondents’ imposition of Alternative 1 – as discussed above – on the appellants. However, he ruled that the respondents’ buy-sell offer was valid and enforceable.
Sophisticated Parties, Sophisticated Shotgun Provisions
It is important to observe the lens through which the Ontario Court of Appeal viewed this case. For example, the court observed:
The members of this partnership are sophisticated and experienced business people who operated a successful and complex business for many years under a comprehensive PA. It appears that they have been assisted throughout by legal and other advisors. The PA contemplates the event of a falling out among the partners, since it contains a shotgun buy-sell provision, which was described, by the two experienced Commercial List judges who heard the injunction motion and the summary judgment motion, as well-drafted and carefully designed.
Two design features in this shotgun buy-sell provision are notable, in my view. First, the partners could have included, but did not, a provision requiring the valuation specified in a buy-sell offer to be at the partnership’s fair market value… Second, the partners could have included a provision, but did not, prohibiting partners from combining to oust another partner (paras 44-45).
In short, the court was hesitant to rescue parties that regretted a contractual arrangement that had been prepared with the assistance of legal (and other) advisors. The court also recognized the need to determine whether the shotgun clause was sufficiently strict, “given the vagaries and complexities of commercial arrangements and commercial life, which the parties have plainly accounted for in their contractual arrangements. Strict compliance is not perfect compliance” (para 46). In “deciding whether a shotgun buy-sell offer meets the strict compliance test, the commercially reasonable expectations of the parties in the factual context must be considered” (para 65).
Alternative 1, Alternative 2
The court agreed with the motion judge’s finding that Alternative 2 was compliant with the shotgun buy-sell provision in the PA. Consequently, the inclusion of Alternative 1 – even if that offer was not contemplated by or compliant with the PA – in the buy-sell offer was not unfair, as the appellants were free to accept or reverse the compliant Alternative 2 (or accept Alternative 1, which would have effectively meant that they had agreed to amend the PA along the lines of the accepted offer).
The court found that it was not permissible for the offerors to compel the offerees to select Alternative 1, however, as Alternative 1 was not compliant with the PA (note: it was not compliant with the shotgun buy-sell provision in the PA because it did not require repayment of the partnership’s debt to Western Larch ‘in full on closing’). The respondents could only require the appellants to sell according to the provisions in the compliant Alternative 2. In short, the court will “not enforce the alternative that is not strictly compliant with a shotgun buy-sell provision. It will enforce the compliant alternative shotgun buy-sell offer” (para 65).
Despite this, the court found that the imposition of Alternative 1 on the appellants by the respondents did not render the buy-sell offer unenforceable:
The motion judge fully and carefully considered the evidentiary record, and boiled down the evidence. At the end of that exhaustive exercise the motion judge found only three damages claims that warranted a trial. I agree with the motion judge that the elements of non-compliance were, in this particular factual context, commercially insignificant, and can be fully and fairly remedied by damages (para 63).
Therefore, despite having elements of non-compliance, the court found that the buy-sell offer was sufficiently compliant with the shotgun buy-sell provision in the PA to meet the strict compliance standard referenced above: “in view of the minor deficiencies, compliance is best effected, and the breaches of the shotgun buy-sell provision are best addressed, through damages” (para 61).
Potential Impact of this Case
This decision should alert future partners to the importance of ensuring that shotgun buy-sell provisions are carefully drafted. For example, if partners want the valuation in a buy-sell offer to be based on fair market value, their agreement should expressly provide for that approach. Such a “draconian” remedy requires thoughtful consideration and significant attention to detail.