Anonymised, illustrative composite. The share purchase agreement priced the deal on a cash-free, debt-free basis as of a locked-box date three months before closing. Seven days before closing, the outgoing sole director moved $340,000 out of the company.
At a glance
A small-cap fund agreed to buy 100% of the shares of an Ontario specialty-distribution business for an $8.4 million enterprise value, structured on the conventional cash-free, debt-free basis: the price assumed the seller would deliver the company with no interest-bearing debt and with whatever cash was sitting in it as of a fixed locked-box effective date — March 31, three months ahead of the planned June 30 closing.
Between the locked-box date and closing, the seller was permitted to run the business normally, but the share purchase agreement carried a standard no-leakage covenant: no dividends, no above-market management fees, no intercompany loan repayments or asset transfers to the seller or its affiliates outside a short, named list of “permitted leakage” items agreed at signing. Anything else that moved value out of the company between the locked-box date and closing was the seller’s to repay, dollar for dollar, on top of the purchase price.
Seven days before closing, with the seller still the company’s sole director, the corporation paid $340,000 to him personally, booked as a “management fee.” No comparable payment had been made in any of the preceding eleven months of the locked-box period, and the amount had not been budgeted, disclosed, or discussed with the buyer. It was not on the list of permitted leakage.
The buyer’s counsel caught it three days before closing, during the bring-down bank confirmation — a fresh statement pulled within 48 hours of the scheduled closing date, specifically because the deal team had asked for one rather than relying on the diligence-stage statements from six weeks earlier. Under CBCA s.122(1), a director must “act honestly and in good faith with a view to the best interests of the corporation” and exercise the care a reasonably prudent person would in comparable circumstances — a duty owed to the corporation, not to an incoming buyer, but relevant here because the same person authorising the payment was the person who would personally receive it, with no other director in the room to check it.
The arithmetic is deliberately simple, because a leakage claim is supposed to be: the deal was priced assuming the company would arrive at closing with whatever cash it held on March 31, adjusted only for normal trading. $340,000 left the company on June 23 that was never on the agreed permitted-leakage list. The purchase agreement had put $500,000 — roughly 6% of enterprise value — into a 12-month escrow account precisely to cover exactly this kind of dispute, separate from the general indemnity basket and cap that governed ordinary warranty claims.
A no-leakage covenant is a contractual promise, not a statute, and it is deliberately drafted to be easier to enforce than a warranty claim: the buyer does not have to prove loss, materiality, or breach of a specific representation. It has to show the payment happened, that it falls outside the permitted list, and that it happened after the locked-box date. Bank records settled all three within a day. In this file, the parties had drafted the no-leakage covenant to be recoverable directly from the escrow, outside the general basket and cap that applied to warranty claims — a drafting choice specific to this agreement, not a rule of law, but the reason the claim moved as fast as it did.
Without the covenant and the escrow, the buyer’s only route would have been a post-closing claim for breach of the purchase agreement’s general representations — a slower, costlier path, and a materially weaker one: by the time a claim like that is litigated, the $340,000 has already been spent by someone who no longer has any relationship with the company, and collecting a judgment against an individual is a different exercise from deducting a defined amount from money still held in trust. The escrow mechanism did not just make the recovery faster. It made the recovery real.
The tell was not in the financial statements — a locked-box structure is priced off historical numbers precisely because nothing in the interim period has been audited yet. The tell was procedural: requiring a bank statement confirmation dated within 48 hours of closing, rather than relying on the diligence-stage statements pulled weeks earlier. A locked-box deal has a gap by design — the period between the pricing date and the closing date — and that gap is exactly where a seller with sole signing authority has both the opportunity and, until the company changes hands, the legal power to move money.
The buyer submitted its leakage claim against the escrow within the notice period the agreement allowed, itemising the $340,000 payment against the permitted-leakage schedule. The seller did not dispute the facts — there was no argument to make against a dated bank record and an agreed list that did not include this payment. The escrow agent released $340,000 to the buyer and the remaining $160,000 to the seller once the escrow period closed with no other claims outstanding.
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