Key Legal Risks to Consider in M&A Transactions

Buying, selling, or merging a business is a transaction that goes beyond agreeing on a price. The structure of the deal, the documents signed, and the risks uncovered before closing may shape the value of the business long after the transaction is complete.

In M&A, problems often surface because a risk was found too late or because the agreement did not clearly say who would be responsible for it. A missing consent, an unresolved employee issue, a tax problem, weak financial records, or an unclear indemnity clause may delay closing, change the purchase price, or leave one party exposed after the deal is done.

Understanding the main risks in M&A gives buyers and sellers a stronger position before they sign. With due diligence and clear drafting, the parties can decide which risks to accept, which to reduce, and which to allocate in the agreement.

Key Takeaways

• M&A risks often arise when problems are found too late or agreements fail to clearly assign responsibility, which can delay closing, change the purchase price, or create post-closing exposure.
• Regulatory, tax, employment, environmental, privacy, and cross-border issues should be reviewed early because they can affect the deal timeline, structure, and valuation.
• The transaction structure matters: a share purchase usually transfers the company’s liabilities, while an asset purchase may offer more control but often requires more consents and separate transfers.
• Due diligence helps replace assumptions with facts by reviewing contracts, financial records, litigation, IP ownership, employee obligations, tax filings, and other key business risks.
• Clear drafting around indemnities, purchase price adjustments, earn-outs, representations, warranties, and closing conditions helps parties allocate risk before the deal is signed.

Regulatory and Compliance Risks

Regulatory issues are easy to miss at the beginning of a deal. At that stage, the parties are usually focused on price, financing, and closing.

Depending on the industry, a transaction may require approvals from the federal or provincial authorities. Competition law filings, permits, environmental obligations, privacy compliance, and foreign investment rules may all change the deal timeline.

If approvals are not obtained, the transaction may be delayed, renegotiated, or stopped. Regulators may also impose conditions that change the value or structure of the transaction.

A legal and regulatory review should look at:

• Competition law thresholds
• Sector-specific licences and permits
• Environmental compliance history
• Privacy and data protection practices
• Foreign ownership or cross-border restrictions
• Regulatory investigations or prior compliance issues

If the target company has unresolved compliance issues, a buyer may inherit them in a share purchase. This is why the regulatory review should begin before the parties are too far into negotiations.

The parties should also consider whether the transaction could be reviewed under the Competition Act. Even when a formal filing is not required, regulators may still examine transactions that could reduce competition. That review can extend the timeline and require detailed financial and business information.

Environmental matters may also change the risk profile of a deal. If the target owns or leases property, the buyer should confirm whether environmental assessments have been completed. Historic contamination may lead to cleanup orders, remediation costs, and liability that continues after closing.

Privacy compliance deserves the same attention. If the target collects customer, employee, or supplier data, it must comply with Canadian and Québec privacy laws. Weak cybersecurity practices, past data breaches, or unclear data retention practices may reduce the value of the business or create post-closing exposure.

Cross-border transactions add another layer of review. Foreign investment rules may apply if the buyer is not Canadian. Certain sectors, including telecommunications and transportation, may also have ownership restrictions or require additional approvals.

The purchase agreement should state what happens if approvals are delayed, refused, or granted with conditions. It should also set out each party’s cooperation obligations, information-sharing duties, and closing conditions tied to regulatory matters.

Regulatory compliance may change the price, delay closing, or give one party more leverage in the negotiation.

Contractual and Structural Risks

The structure of the transaction determines which liabilities transfer to the buyer, which consents are required, and what protections each party has after closing.

In a share purchase, the buyer usually acquires the company with its assets, contracts, obligations, and liabilities. Specific protections must be negotiated if the buyer does not want to assume certain risks.

In an asset purchase, the buyer may have more control over which assets and liabilities are assumed. The tradeoff is that more third-party consents and separate transfers may be required.

This choice may change the tax result, employment obligations, contract continuity, regulatory approvals, and post-closing liability.

The main contractual issues usually involve:

• Indemnification clauses
• Purchase price adjustment mechanisms
• Earn-out provisions
• Representations and warranties
• Limitation of liability clauses
• Closing conditions
• Escrow or holdback arrangements

Risk management in M&A often starts with these provisions because they determine how exposure is divided after closing. For example, an unlimited indemnity for tax liabilities can leave a seller exposed to large post-closing claims. On the buyer’s side, weak indemnity language may offer little protection if a serious issue is discovered after closing.

Indemnity clauses should address caps, survival periods, claim procedures, thresholds, exclusions, and remedies.

Purchase price adjustments are another frequent source of disputes. If working capital, debt, cash, or normalized earnings are not clearly defined, the parties may disagree after closing about the final price. The agreement should specify the accounting standards, calculation method, review process, and dispute mechanism.

Debt treatment should also be settled before signing. The agreement should state whether the business is being sold on a cash-free, debt-free basis. It should also address shareholder loans, bank debt, equipment leases, and financing arrangements.

If these mechanics are unclear, sellers may receive less than expected and buyers may assume more than intended.

Earn-outs need precise drafting. If part of the purchase price depends on future performance, the agreement should define the metric, revenue recognition rules, permitted expenses, reporting obligations, and level of control after closing. Without clear rules, earn-outs often become a source of disagreement.

Representations and warranties should reflect the actual condition of the business. Broad statements increase exposure. Vague statements create uncertainty. Accurate statements, supported by disclosure, help both parties understand the risk being allocated.

A strong contract does not remove every risk. It makes the risk visible enough to negotiate.

Due Diligence Failures

Due diligence is where assumptions are tested.

Before signing or closing, a buyer needs to understand what is being acquired, including liabilities that may not be apparent on the surface. For sellers, due diligence also matters because unresolved issues may reduce the price, delay closing, or lead to claims after closing.

In a legal due diligence M&A review, counsel will usually examine:

• Corporate records
• Financial statements
• Material contracts
• Customer and supplier agreements
• Litigation history
• Regulatory compliance
• Intellectual property
• Employment matters
• Tax filings
• Real estate and leases
• Insurance coverage
• Debt and security arrangements

M&A due diligence should also test whether the review has missed issues such as:

• Customer concentration risk
• Change-of-control clauses
• Pending or threatened litigation
• Environmental liabilities
• Incomplete tax records
• Contract transfer restrictions
• Intellectual property ownership issues

Each missed issue may affect value, timing, or liability.

For example, if one client represents 40 percent of the company’s revenue, that concentration changes the risk profile of the business. If that client’s contract also includes a termination right on change of control, the risk becomes more serious.

Due diligence does not remove uncertainty. It replaces assumptions with documents, facts, and negotiated protections.

Employment and Labour Risks

Employment issues can create serious M&A transaction risks.

In an asset transaction, employees may be terminated by the seller and rehired by the buyer, depending on how the deal is structured. This can raise questions about notice, severance, continuity of service, vacation, and benefits.

In a share transaction, employment usually continues, but the buyer may inherit existing employment liabilities, including claims or obligations that arose before closing.

The buyer should pay close attention to:

• Unpaid overtime
• Vacation accruals
• Misclassified independent contractors
• Pending labour disputes
• Non-compliant employment contracts
• Weak restrictive covenants
• Termination liabilities
• Pension or benefit plan obligations
• Workplace health and safety issues

If the buyer acquires a company with past employment violations, those issues may become post-closing claims.

Legal due diligence should include employment agreements, contractor agreements, compensation arrangements, workplace policies, termination history, benefits, and any disputes with current or former employees.

In some cases, employment exposure can be managed through specific indemnities, escrow holdbacks, purchase price adjustments, or pre-closing remediation.

Employment issues can become part of the purchase price, the transition plan, or a post-closing claim.

Intellectual Property Risks

For many businesses, intellectual property accounts for a large part of the company’s value, making intellectual property (IP) ownership a key risk in M&A. 

This is especially true for companies with software, product designs, brand assets, trade secrets, customer data, proprietary processes, or technical documentation. IP issues are often discovered late in the transaction, sometimes after the purchase price has already been negotiated.

The IP review should look for issues such as:

• Unregistered trademarks
• Unassigned contractor inventions
• Expired or poorly maintained registrations
• Inadequate confidentiality agreements
• Software licensing violations
• Unclear ownership of code, designs, or documentation
• Prior infringement claims
• Use of third-party materials without proper rights

If ownership is unclear, the buyer may not receive the assets it expected to acquire.

For example, if outside contractors built a software platform but never signed assignment agreements, the company may not fully own the code. If a brand name has been used for years but was never registered as a trademark, there may be uncertainty around exclusivity and enforcement.

An M&A risk assessment should confirm whether:

• IP is registered where registration is needed
• Employees and contractors have signed assignment agreements
• Confidential information is protected
• Licensing terms permit transfer or continued use
• No infringement claims are pending or threatened
• Digital assets, domains, software, and accounts are controlled by the company

Failure to address IP risk may reduce valuation, delay closing, or weaken the commercial purpose of the transaction.

Taxation and Financial Risks

Tax exposure is one of the M&A risks most likely to change the outcome of a transaction.

The structure of the deal affects the tax outcomes of both buyer and seller. Asset purchases and share purchases can produce very different results under Canadian tax law. The parties should understand those consequences before agreeing on price and structure.

The main tax and financial issues usually involve:

• Undisclosed tax liabilities
• Aggressive historical tax planning
• GST, QST, or sales tax non-compliance
• Payroll remittance deficiencies
• Transfer pricing exposure
• Unfiled or late tax returns
• Disputes with tax authorities
• Unrecorded debt or contingent liabilities

The review should include tax filings, correspondence with tax authorities, payroll records, sales tax records, and any prior assessments or audits.

M&A risk management often includes tax indemnities, longer survival periods for tax representations, purchase price adjustments, and, where appropriate, pre-closing tax restructuring.

Financial reporting quality also matters. If earnings are overstated, expenses are understated, liabilities are missing, or revenue recognition is inconsistent, the valuation may be unreliable.

Buyers need to test the numbers behind the price. Sellers should expect to prove them.

Tax and financial issues are not limited to accounting. They shape the price, the structure, and the legal protections required in the agreement.

Dispute and Litigation Risks

Pending or threatened litigation can affect a transaction immediately.

Even a dispute that appears minor at first may become more serious after closing. A buyer does not want to learn after the transaction that a customer claim, supplier dispute, shareholder disagreement, or regulatory investigation was more material than disclosed.

The review should cover:

• Active lawsuits
• Demand letters
• Arbitration proceedings
• Regulatory investigations
• Customer or supplier disputes
• Shareholder disputes
• Insurance claims
• Settlement agreements
• Threatened claims not yet filed in court

Legal due diligence should assess the nature of each dispute, the amount claimed, the likelihood of loss, available insurance coverage, and the possible effect on operations.

Where needed, the agreement can include specific indemnities, escrow arrangements, purchase price reductions, closing conditions, or representations tied to known disputes.

Ignoring dispute exposure is a costly mistake. Optimism does not protect a party in court. A realistic review of worst-case outcomes is often necessary before the deal is signed.

Get Legal Guidance Before Buying or Selling a Business

M&A transactions can create opportunities, but they require discipline.

Before signing a letter of intent, purchase agreement, or other binding document, buyers and sellers should understand the legal risks in M&A that may affect value, timing, liability, and post-closing obligations.

Legal risks in mergers and acquisitions do not disappear after closing. They follow the structure, documents, and decisions made before closing. This is why transaction planning depends on due diligence, clear drafting, and a deliberate allocation of liability.

At Paquette Attorneys, we help buyers and sellers understand what is being transferred, what remains exposed, and what needs to be addressed before signing.

If you are preparing to buy, sell, transfer or merge a business, contact us for legal guidance on mergers and acquisitions.