Anonymised, illustrative composite. A clause deemed the full earn-out earned the moment the buyer breached its operating covenant. The buyer called the deemed payment an unenforceable penalty rather than a genuine pre-estimate of the seller's loss.
At a glance
A buyer purchased all of the shares of an Ontario B2B software company for $3,000,000 upfront, plus up to a further $2,000,000 over twenty-four months tied to revenue retention. To protect the seller against the risk every earn-out seller faces — a buyer that controls the business and can suppress the metric — the agreement included an operating covenant requiring the buyer to run the business as a going concern and not divert its customers to a competing product line it already owned. A deemed-achievement clause backed the covenant: on breach, the full remaining earn-out would be “deemed fully earned and immediately payable in full, without regard to actual performance.”
Nine months into the twenty-four-month earn-out period, the buyer — which had separately acquired a competing SaaS platform — merged the acquired company's customer base into it and redirected all sales effort away from the acquired product. It was a clear breach. Rather than try to prove what revenue retention would have been absent the breach — the exact speculative exercise the deeming clause existed to avoid — the seller invoked it and demanded the full remaining $2,000,000 immediately.
The buyer's defence was that the clause was an unenforceable penalty: it paid the full $2,000,000 regardless of the true scale of harm, and the buyer's own estimate of the revenue actually diverted over the unexpired fifteen months put provable damages closer to $750,000 — a sum roughly 2.7 times its own estimate of the loss it caused.
The earn-out maximum was $2,000,000, of which the deemed-achievement clause claimed the entire remaining balance at month nine. The buyer's own internal estimate of the actual revenue diverted over the remaining fifteen months of the earn-out period was roughly $750,000 — a gap of roughly $1,250,000, or the deemed sum running at close to 2.7 times the buyer's own estimate of the harm it caused.
Ontario has a statute squarely on this ground, filed under civil procedure rather than contract law. The Courts of Justice Act gives a court an express power, headed “Relief against penalties”: “A court may grant relief against penalties and forfeitures, on such terms as to compensation or otherwise as are considered just.” Unlike the common law's all-or-nothing penalty doctrine — a true penalty is simply unenforceable, leaving the claimant to prove actual damages — s.98 lets a court grant partial relief, on whatever terms it considers just, without first deciding the clause is a penalty at all.
The Court of Appeal for Ontario has explained how the two frameworks relate. In Redstone Enterprises Ltd. v. Simple Technology Inc., 2017 ONCA 282, the court applied s.98 to a forfeited deposit and, citing its earlier decision in Peachtree II Associates-Dallas L.P. v. 857486 Ontario Ltd. (which “involved stipulated penalty clauses, not deposits”), held that “courts should, whenever possible, favour analysis on the basis of equitable principles and unconscionability over the strict common law rule pertaining to penalty clauses.” The test asks first “that the proposed forfeited sum is out of proportion to the damages suffered by the claimant,” and second “that it would be unconscionable for the vendor/claimant to retain” the full amount — unconscionability turning on “inequality of bargaining power, a substantially unfair bargain, the relative sophistication of the parties, the existence of bona fide negotiations, the nature of the relationship between the parties, the gravity of the breach, and the conduct of the parties.”
Applied here, the first branch is easy: $2,000,000 against a $750,000 estimate of actual harm is a real disproportion. The second branch could genuinely go either way — both sides were sophisticated parties who negotiated the clause to avoid an impossible damages proof, a legitimate purpose, while the deliberate breach cuts toward the seller. The common-law doctrine in H.F. Clarke Limited v. Thermidaire Corp. Ltd., [1976] 1 S.C.R. 319 (cited by name only; not reachable to quote), asks a closely related question and points to the same unresolved territory — which is why this dispute settled rather than went to judgment.
Neither side wanted to litigate a question s.98 leaves genuinely open — the seller risked a court granting partial relief toward the $750,000 the buyer could prove, and the buyer risked a court finding no unconscionability and enforcing the full $2,000,000, the way the Court of Appeal enforced the full deposit in Redstone once it found the disproportion insufficient. The parties settled at $1,300,000, roughly splitting the deemed sum and the buyer's estimate.
Had the deeming clause instead tied the accelerated sum to an objective, already-accrued figure — the earn-out actually earned on a trailing basis to the date of breach, rather than the full remaining maximum — the disproportion branch of the s.98 test would have had little to work with, and the seller's claim would likely have avoided a discounted settlement altogether.
The tell was that the deemed sum was pegged to the full remaining maximum, with no reference to how much of the period had elapsed or how the business had performed — exactly the gap s.98's disproportion test is built to catch.
This file runs on Ontario's s.98 and the common-law penalty doctrine; Quebec has neither. The Civil Code of Québec defines the mechanism directly: “A penal clause is one by which the parties assess the damages in advance, stipulating that the debtor will suffer a penalty if he fails to perform his obligation.” (art. 1622). Article 1623 answers Thermidaire's question differently: “A creditor who avails himself of a penal clause is entitled to the amount of the stipulated penalty without having to prove the injury he has suffered.” The Code gives a court only a narrower, adjustable remedy: “the amount of the stipulated penalty may be reduced if the creditor has benefited from partial performance of the obligation or if the clause is abusive.” A Quebec court would not ask whether $2,000,000 is a valid pre-estimate of loss at all — the seller is presumptively entitled to it without proving the $750,000 of actual harm — and the only live question is whether the gap between the two, or the partial performance already delivered, makes the clause abusive enough to be reduced by the court. Same clause, same numbers, a different starting presumption and a different remedy entirely.
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