This article is split into three parts and focuses on the mechanics and benefits of RWI in the franchise system M&A context. The first part presents a brief overview of the benefits and utility of RWI in general. The second part discusses the mechanics of a typical RWI policy. The third and final part sets out why franchise systems are an attractive investment, and discusses how RWI can facilitate more efficient and stress-free transactions.

What Is Representations and Warranties Insurance and Why It’s Beneficial?

In short, RWI shifts the risk of purchasing a business from the buyer to a third party insurer in exchange for a price, also known as an insurance premium.

In purchasing a business, the purchaser and seller each make certain representations and warranties (together, “Rep” or “Reps”) under the transaction agreement to induce the other party to enter into the transaction. Reps are set out in the purchase agreement and cover a wide range of concerns relating to the transaction, spanning matters like the financial valuation of the target entity, environmental concerns, tax liability, employment matters, material contracts, and beyond. To determine which party bears liability in the event of a breach or misrepresentation of a Rep, purchase agreements often contain at least one, or a combination, of the following risk allocation mechanisms:

• Purchase price holdbacks or escrow amounts, payable upon the fulfillment of certain conditions set out in the purchase agreement;
• Indemnification provisions, whereby the indemnifying party agrees to pay the damages or liabilities suffered by the party to the agreement who relied on a misrepresentation or breach of a Rep; and
• RWI, which is a policy that a party to the agreement (most often the purchaser) takes out from an insurance provider to cover claims of misrepresentation or breach of Reps made in the course of a transaction.

To buyers and sellers, RWI presents numerous benefits with respect to risk allocation.[1] From a buyer’s perspective where there is indemnity coverage in the purchase agreement, RWI mitigates the risk of the indemnifier failing or delaying to pay out claims after a breach or misrepresentation is proven. It also allows the purchaser to reduce the indemnification obligation of the seller in exchange for favourable terms in the purchase agreement such as broader limitation of liability clauses or longer Rep coverage terms. By reducing or eliminating the seller’s indemnification obligations, the purchaser minimizes the risk of becoming involved in costly and adversarial indemnification claims, while preserving a source of recovery through RWI.[2]

From a seller’s perspective, RWI reduces indemnification obligations and the potential liability under such a provision. It also minimizes the holdback or escrow amounts in the transaction, allowing the seller to receive more of the purchase price sooner. RWI further affords the seller a cleaner exit by minimizing post-closing obligations and reducing the risk of future indemnification claims.[3]

How Does RWI Work in a Franchise Acquisition?

Although common perceptions are that RWI is reserved for large market transactions (starting at valuations around $25 million or more[4]), that is not always the case. Middle to small market transactions, still benefit from the use of RWI.[5]

RWI policies typically have a duration of three to six years depending on the type and nature of the Rep in question (compared to twelve to eighteen months under a customary seller’s indemnity).[6] For instance, Reps more fundamental to the purchaser entering into the transaction, such as the financial valuation of the target entity, will often have a longer coverage term than general or less fundamental Reps. The coverage often offered for RWI is for ten percent of the purchase price,[7] but depending on the circumstances, up to one-hundred percent coverage can be obtained.[8]

Coverage exclusions from RWI policies range from the general to the deal specific. A general coverage exclusion may be where the buyer has actual knowledge of a breach of a Rep.[9] Insurers may also add exclusions if they are uncomfortable with the level of disclosure or the quality of diligence around a suspected area of risk.[10] Deal specific coverage exclusions are uniquely drafted for the particular transaction, and include issues discovered in the due diligence process of a deal.[11]

Franchise-Specific Considerations for RWI and Due Diligence

As benefits of franchise systems abound, so do the risks. In addition to RWI, having experienced counsel in franchise law is critical to understanding – and avoiding – the risks. Below are examples of Reps to look out for and consider while forming the RWI policy and due diligence process.

• Franchise Agreements in Good Standing. Purchasers should diligently examine the franchise agreements for each target franchise location (including any area development/master franchise agreements) and assess the terms for any inconsistent or troublesome provisions, as well as ensuring that such agreements have been fully executed and are in good standing. Notable terms in franchise agreements include franchise fees, royalty payments, termination obligations, non-competition clauses, and the exclusive territory given to the franchisee (if any). In addition to the franchise agreements, other material contracts common to franchise grants which should also be reviewed include general security agreements, personal guarantees, and leases. While proper diligence will help mitigate these risks for a purchaser, RWI provides additional certainty for the purchaser and seller alike.
• Franchise Disclosure Legislation Compliance. The mechanics, process, and timing of each franchise grant should also be reviewed to uncover any outstanding liabilities under Canada’s provincial franchise acts, including live rescission claims. Franchise legislation provides an extraordinary remedy for franchisees in the event they have not received adequate disclosure. A franchisee can rescind their franchise agreement, leave the franchise system, and be fully reimbursed for all investments made into such franchise, if a franchise disclosure document is not provided to the franchisee in the acceptable form and timeframe prescribed by applicable legislation. Potential purchasers of franchise systems should closely review the franchise disclosure documents of any franchise grant made within the last two years.

Franchises are regulated on a provincial basis in Canada. Currently, there are seven provinces which have legislated franchise law regimes: Ontario, Manitoba, Alberta, British Columbia, New Brunswick, Prince Edward Island, and Saskatchewan. The acceptability of the franchise agreement and ancillary documents (like the general security agreement, and guarantee) should be reviewed in each jurisdiction for potential liabilities.

• Unit Economics: Assessing the unit economics across the franchise system is critical. After parsing out the obligations of each franchisee under each respective franchise agreement, the flow of funds for the royalty streams, franchise fee, working capital needs, should be reviewed to see whether the financial mechanics of the franchise system work on a consistent and regular basis. It should be ensured that the Reps provided to the purchaser by the seller accurately reflect the on-the-ground performance of its units, barring which RWI may provide both parties with additional certainty in the event of an error or misrepresentation.

Though the benefits of purchasing a franchise system are substantial, so too are the risks if such a transaction is not carefully planned and executed. While expensive, the presence of RWI in a purchase transaction can soften the costs and discomfort caused by incorrect or inaccurate Reps made in a purchase of a franchise system. Where economically viable, RWI should be strongly considered by both the purchaser and seller of a franchise system as part of a transaction.

If you are considering the acquisition or sale of a franchise system in Canada, our team can advise on transaction structure, franchise-specific due diligence, purchase agreement risk allocation and the role RWI may play in the transaction.

About the authors

Jason Brisebois is a corporate and commercial lawyer whose practice focuses on mergers and acquisitions and franchise law. He advises franchisors, investors and privately held businesses on the acquisition and sale of franchise systems and other corporate transactions. Qualified to practise in Ontario and New York State, Jason has been recognized by the Canadian Legal LEXPERT Directory, Lexology Index: Canada and Best Lawyers in Canada, and received the 2024 Lexology Client Choice Award for Franchising in Canada.

Sam Fata is a corporate and commercial lawyer whose practice includes mergers and acquisitions, corporate finance and securities law. He advises businesses on acquisitions, dispositions and other corporate and commercial transactions across a range of industries.

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A “time is of the essence” (TOE) clause is a common contractual provision used in a wide range of commercial agreements. At its core, a TOE clause indicates that compliance with specified timelines is a material term of an agreement and that failure to meet those timelines, however minor or inconsequential, can constitute a breach entitling the non-breaching party to terminate the contract. In transactions with clearly defined deadlines (such as a fixed closing date), a TOE clause demonstrates that performance within a stipulated timeframe is an essential term of the agreement.

Notwithstanding their widespread use, TOE clauses have frequently been the subject of commercial disputes, highlighting the persistent challenges associated with their interpretation and application. Most recently, the Supreme Court of Canada (SCC) granted leave to appeal the decision of the Court of Appeal of Newfoundland and Labrador in Nova Fish Farms Inc. v Cold Ocean Salmon Inc., highlighting the continued significance of TOE clauses in Canadian contract law.

The Dispute: Nova Fish Farms Inc. v Cold Ocean Salmon Inc.

In this dispute, Cold Ocean Salmon Inc. (the Seller) agreed to sell several trout farms to Nova Fish Farms Inc. (the Buyer) under an agreement of purchase and sale signed in February 2020 (the Agreement). The trout farms were on property leased from the provincial government and were licensed and regulated by both federal and provincial governments. As a result, the sale of the trout farms was conditional on government approval. The Agreement required each party to take the necessary steps to obtain government approval “as promptly as practicable” and that the parties use “commercially reasonable efforts” to obtain approval before closing. The Agreement contained a TOE clause.

Due to the COVID-19 pandemic, neither of the parties took any meaningful steps to obtain the necessary government approvals over the next 16 months. In June 2021, the Buyer submitted transfer applications to the government and received approval in October 2021. The Buyer then notified the Seller of the government approval and that the Buyer wished to proceed with closing. The Seller ultimately informed the Buyer that it did not intend to close, which led to the Buyer suing for specific performance.

The Lower Court’s Decision

The trial judge found that the Buyer had breached the Agreement by failing to take the necessary steps to obtain government approval “as promptly as practicable”. Although there were no set timelines in the Agreement to obtain the government approvals, the trial judge held that the 16-month period was not in the contemplation of the parties and that the TOE clause entitled the Seller to terminate the Agreement.

The Court of Appeal’s Decision

The Court of Appeal disagreed with the trial judge, holding that the TOE clause did not extend to obligations governed by indefinite time provisions (i.e., “as promptly as practicable”). Rather, the Court of Appeal observed that the cases cited by the parties where TOE clauses were enforced “involved precisely stipulated time limits”, such as a fixed or outside closing date.

The Court of Appeal placed particular emphasis on the need for certainty in commercial agreements. It explained that contracting parties utilize TOE clauses to provide clear consequences of a breach relating to timelines, most notably, that a failure to meet such timelines entitles the non-breaching party to terminate the contract. Extending a TOE clause to obligations without defined timelines, the Court of Appeal cautioned, would undermine this objective by introducing ambiguity as to both compliance and the point at which termination rights arise.

Key Takeaways for Drafting and Strategy

The Nova Fish Farms Inc. v Cold Ocean Salmon Inc. case underscores the nuanced application of TOE clauses in Canadian commercial contracts. While TOE clauses are designed to ensure timely performance of contractual obligations, their enforceability may be tied to the presence of clearly defined deadlines. Subject to further guidance from the SCC, the Court of Appeal’s decision suggests that where contractual obligations are expressed in indefinite terms, such as “as promptly as practicable,” a TOE clause may not automatically grant a party the right to terminate.

This case serves as a cautionary reminder to contracting parties of the importance of establishing clear and precise deadlines within their agreements, particularly where the timing of performance is intended to be of fundamental importance. Parties should also carefully assess whether the inclusion of a TOE clause is appropriate in the circumstances. Such clauses should not be adopted as a matter of course, and instead should be evaluated and tailored on a case-by-case basis to ensure alignment with the parties’ intentions.

For businesses navigating complex commercial agreements, the use and interpretation of “time is of the essence” clauses can have significant legal and financial consequences. Sotos LLP has extensive experience advising clients on contract drafting, risk management, and high-stakes commercial disputes. If you have questions about how these developments may impact your agreements or require strategic guidance, our team would be pleased to assist.

About the Author
Sam Fata is an associate in the corporate and commercial group at Sotos LLP. His practice focuses on corporate finance, mergers and acquisitions, securities, and commercial law. He advises clients across a wide range of industries, including technology, manufacturing, mining, agribusiness, entertainment, artificial intelligence, and consumer goods. Sam takes a client-focused approach, working closely with businesses to understand their objectives and deliver practical, tailored legal solutions. He can be reached at 416.530.0447 or sfata@sotos.ca.

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