Debt-like items that were also excluded from working capital

The situation

A buyer purchased the assets of a multi-location Ontario fitness studio chain for an enterprise value of $6,500,000, negotiated on a cash-free, debt-free basis with a working-capital true-up layered on top. Two separate lawyers, working on two separate parts of the agreement at two different points in the negotiation, each drafted one of the two definitions that would ultimately determine the price: the Working Capital definition, and the Indebtedness (or “Debt-Like Items”) definition.

The problem

The Working Capital definition listed specific current-asset and current-liability line items, and expressly excluded three categories that are ordinary and recurring in a membership fitness business: deferred membership revenue, accrued vacation pay, and member “hold” deposits — credits owed to members who had paused their memberships. The theory, as the seller's advisor later explained it, was that these items would simply sit outside the working-capital calculation altogether: neutral, not counted, no price effect either way.

The Indebtedness definition, drafted separately, took a broader approach: a non-exhaustive list ending in a sweeping catch-all covering “any other obligation of the Company in the nature of indebtedness, including deferred revenue, accrued but unpaid employee entitlements, and customer deposits or prepayments.” Nobody checked the two definitions against each other before signing. At closing, the buyer's accountants deducted all three items — $340,000 of deferred membership revenue, $86,000 of accrued vacation pay, and $124,000 of member deposits, a combined $550,000 — dollar for dollar from enterprise value, as debt-like items under the Indebtedness catch-all. The seller's pricing model had assumed “excluded from working capital” meant these items would never touch the price at all. It had never budgeted for them landing, in full, on the debt side of the ledger instead.

The numbers

The $550,000 deduction came straight off the $6,500,000 headline enterprise value. The historical twelve-month average of the same three items, which is roughly what a working-capital treatment would have measured against, was $505,000 — meaning that if these items had simply been folded into the working-capital calculation instead of the debt bucket, only the $45,000 deviation from that historical norm would have moved the price at all. Treated instead as debt-like items, the seller absorbed the full $550,000 balance.

The rule that decided it

No statute governs any of this. “Indebtedness” in a purchase agreement is a defined term with no meaning outside the four corners of the document that defines it — its scope is exactly, and only, what the parties wrote. Ontario courts do apply a real interpretive canon against this kind of overlap: a contract is construed as a whole, in a manner that gives meaning to all of its terms, and courts lean against a reading that would let one party recover, or be charged, twice for the same loss under two different provisions of the same agreement. That canon is an aid to resolving genuine ambiguity, not a licence to override clear language — it has nothing to work with where the parties' own words are not actually ambiguous. Treadstone Law's own explainer of purchase price adjustment mechanics names the two mechanisms as distinct for exactly this reason: “In many deals, the price is negotiated on a … basis, meaning the seller's cash is excluded from the sale and outstanding debt is deducted from the price at closing — a related but distinct mechanic from the working capital adjustment.” Two distinct mechanisms, operating on the same balance sheet, each capable of reaching the same liability unless one of them expressly carves it back out.

Here, the Indebtedness definition named deferred revenue, accrued employee entitlements and customer deposits expressly, by name, in its own catch-all language. The Working Capital definition's exclusion of the same items was silent as to why — it simply left them off its own list. Silence in one definition does not create an implied carve-out from an express inclusion in the other, and there is no genuine ambiguity for the anti-overlap canon to resolve: if the parties had meant the exclusion from Working Capital to also mean exclusion from Indebtedness, the Indebtedness definition needed to say so, and it did not.

The outcome

The dispute went to the purchase agreement's own independent-accountant referral mechanism before the closing statement became final. The accountant confirmed that, as written, the Indebtedness definition's express, named inclusion of deferred revenue, accrued entitlements and customer deposits controlled, and that nothing in the Working Capital definition's silent exclusion of the same items displaced it. The $550,000 deduction stood in full.

What it would have cost otherwise

Catching the overlap before signing would have cost one round of cross-checking: reading the Working Capital exclusions against the Indebtedness inclusions, line by line, and either narrowing the Indebtedness catch-all to exclude ordinary-course operating liabilities like these, or building the historical $505,000 baseline into the working-capital peg so any double effect was priced into the headline number from the outset. Either fix would have limited the seller's real exposure to something close to the $45,000 deviation from historical norms, rather than the full $550,000 balance — a difference of roughly half a million dollars sitting on one paragraph's cross-reference.

The tell

The tell was that the two definitions were drafted by different hands and never reconciled: nobody asked whether anything excluded from Working Capital also appeared, by name or by catch-all, inside Indebtedness. Wherever the answer to that question is yes, the item is being priced twice.

Takeaways

• • “Cash-free, debt-free” and working capital are two separate price-adjustment mechanisms operating on the same balance sheet — every current liability needs to land in exactly one of the two, never both.
• • A broad, sweeping Indebtedness catch-all will sweep up ordinary operating liabilities like deferred revenue and accrued vacation unless expressly carved back out.
• • An item's silent exclusion from one definition does not imply its exclusion from a separately drafted definition that names it expressly — the express inclusion controls.
• • Reconcile the Working Capital exclusions against the Indebtedness inclusions line by line before signing; the two are usually drafted separately and rarely cross-checked against each other.
• • A seller's internal pricing model is not a contract term. An assumption about what “excluded from working capital” means has to be tested against the actual Indebtedness definition, not assumed.

Sources

• • No statute governs the scope of a contractually defined term like “Indebtedness” or “Debt-Like Items” in a purchase agreement — its meaning is entirely a function of the parties' own drafting, and there is no general legal doctrine against a liability being captured by two separately drafted definitions if the words support it.
• • Treadstone Law — purchase price adjustment clauses in an Ontario business sale — identifies debt-and-cash-free adjustments as a mechanic distinct from the working capital adjustment, which is the overlap this file turns on. It does not address the double-count risk when the two definitions are not reconciled; that is addressed here.