The Ontario Superior Court of Justice (Commercial List) recently confirmed the binding nature of bought deal engagement letters when it awarded a judgment of $16,042,669 plus interest and costs in favour of Stetson Oil & Gas Ltd. (TSXV: SSN) (“Stetson“), a junior oil and gas exploration company, and against Thomas Weisel Partners Canada Inc. (now Stifel Nicolaus Canada Inc.) (“Weisel”), an investment bank and a securities dealer, for Weisel’s failure to close a bought deal private placement pursuant to an engagement letter with Stetson.

The failed transaction and events leading to the litigation

On July 13, 2008, Stetson entered into a bought deal engagement letter with Weisel under which Weisel agreed to purchase for resale 45,454,600 Stetson subscription receipts at a price of 55 cents per subscription receipt for aggregate gross proceeds of approximately $25,000,030. The letter required Weisel to close on July 31, 2008 by providing Stetson with the agreed amount, and it contemplated that the parties would negotiate and execute a definitive underwriting agreement (the “Underwriting Agreement”).

Weisel failed to close by July 31, 2008, and Stetson obtained interim loans pending an alternative (best efforts) financing with Canaccord Capital Corporation (as it was then known). In the Canaccord Capital financing, Stetson received net proceeds of $11,215,928.92 for the issuance of 60,000,000 Stetson units (each consisting of a share and a warrant) at 20 cents per unit. Additionally, Stetson agreed to issue approximately 85 million preferred shares to existing Stetson shareholders who would be entitled to “the proceeds of any final judgment or settlement monies paid to and received by the Corporation in connection with its claim against Thomas Weisel…”

Stetson later claimed damages for breach of contract against Weisel, and asked Weisel to pay the difference between the proceeds Stetson should have received under the engagement letter and the proceeds raised in the Canaccord financing, plus interim financing costs.

The decision

The Ontario Superior Court of Justice (Commercial List) found that Weisel had breached the engagement letter and it awarded Stetson the damages it sought against Weisel plus interests and costs. Weisel has indicated that it will appeal the decision.

In finding for Stetson, the court found that:

1. The engagement letter was a binding agreement despite indicating that its definitive terms would be governed by the forthcoming Underwriting Agreement, because:
   1. the engagement letter explicitly stated that upon execution by the parties it would become a binding agreement;
   2. no provision in the engagement letter made the negotiation and execution of the Underwriting Agreement a condition to the engagement letter being binding;
   3. the inclusion of an arbitration clause and an indemnity clause in the engagement letter made the engagement letter akin to a binding agreement; and
   4. Weisel’s conduct during the transaction, such as reconfirming the engagement letter and referring to its obligations under the engagement letter as a liability in internal e-mails, indicated that Weisel treated the letter as a binding obligation.
2. Weisel cannot avail itself of termination provisions that the engagement letter stated would be included in the forthcoming Underwriting Agreement, such as standard “disaster-out” and “material adverse change-out” clauses, because:
   1. there was no Underwriting Agreement containing such clauses that Weisel could rely on;
   2. Weisel made no attempt to negotiate such an agreement; and
   3. Weisel’s reliance on these clauses was first raised during litigation.

Lessons for underwriters

Going forward, underwriters should consider:

1. Carefully drafting engagement letters.
   • The non-binding nature of an engagement letter should be made explicit in the letter.
   • Arbitration and indemnity clauses included in an engagement letter should be drafted such that they are in line with the underlying nature of the engagement letter as being binding or non-binding.
   • Termination clauses should be included in the engagement letter and not merely referred to in a document to be created in the future.
2. Conducting themselves in a manner consistent with the nature of the engagement letter as a binding or non-binding agreement. Underwriters should note that conduct such as reconfirming an engagement letter and internal e-mails that treat a non-binding engagement letter as a binding agreement could become the basis for a court finding that the engagement letter is a binding agreement.
3. Communicating their reliance on and the reasons for availing themselves of termination provisions included in an engagement letter.

If you have questions about how this decision may affect you, contact any member of Clark Wilson LLP’s Corporate Finance & Securities Group.