The Lawsuit the Seller Forgot to Mention in Peterborough

The situation

Jae-won had spent fifteen years managing commercial construction projects around Peterborough, and he had a clear idea of the kind of business he wanted to own: a mechanical contracting company with steady institutional clients, a trained crew, and equipment already paid for. His partner Yanni worked as a software developer and had been quietly building savings toward exactly this kind of move. Together they had enough set aside, plus a line on acquisition financing, to make a serious offer on a company valued at roughly $3.4 million.

The business they found checked every box. It had operated in the region for over two decades, held long-standing service contracts with several institutional buildings, and the owner, Thalia, was ready to retire and sell. Jae-won and Yanni signed a letter of intent, agreed on a purchase price of about $3.4 million, and brought the deal to Treadstone Law once the agreement of purchase and sale for the shares was drafted and due diligence was set to begin.

Due diligence on a business purchase is the period, usually several weeks, where the buyer's lawyer and accountant verify that the company is what the seller says it is: reviewing financial statements, contracts, employee records, tax filings, and any legal proceedings involving the company. For a deal of this size, skipping or rushing it is one of the most common ways buyers end up owning liabilities they never agreed to take on.

What due diligence found

As part of the standard search process, our team ran litigation searches against the corporation itself, not just against Thalia personally. These searches check court records for active or recent claims involving the company. The search returned a statement of claim filed against the business roughly eight months earlier by a former commercial client, alleging deficient mechanical work on a multi-unit building and seeking damages of approximately $310,000.

Thalia had not disclosed the lawsuit anywhere in the transaction documents. When our team raised it, her explanation was that the claim had been filed by a former client the business had already stopped serving, that her insurer's lawyer was handling it, and that she considered it a nuisance claim unlikely to succeed. That may have been an honest assessment of the litigation's merits, but it did not change the fact that the corporation Jae-won and Yanni were about to buy had an unresolved, undisclosed lawsuit attached to it — one that would transfer with the shares unless the deal was restructured to deal with it.

This is the core risk of buying a company by purchasing its shares rather than just its assets: the buyer takes over the corporation as a whole, including its liabilities, known and unknown, unless the purchase agreement specifically carves them out. A share purchase agreement typically includes representations and warranties — statements by the seller, such as "there is no litigation pending or threatened against the company" — that are supposed to catch exactly this kind of issue before closing. Here, the representation as originally drafted would have been false the day it was signed.

The practical exposure was real but bounded. The claim sought about $310,000, the business carried liability insurance that would likely respond to at least part of it, and the litigation was still in an early stage with no finding of liability. But an early-stage claim can still take a year or more to resolve, cost real money in defence even if it is ultimately unsuccessful, and — because insurance coverage for a construction deficiency claim is never guaranteed until it is confirmed in writing — there was a chance the buyers could end up funding both the defence and any eventual settlement out of the business's own cash flow.

What we did

1. Confirmed the scope of the claim in writing. Rather than relying on Thalia's characterization of the lawsuit, our team requested the full pleadings, the correspondence with her insurer, and written confirmation from the insurer of whether coverage for the claim had been accepted, denied, or was still under review. The insurer's position turned out to be that coverage was accepted subject to a standard deductible, which materially changed the real financial exposure.
2. Advised Jae-won and Yanni on their options. They could walk away under the due diligence condition still open in the agreement, renegotiate the price to reflect the risk, or ask for the transaction to be restructured so the litigation stayed with Thalia rather than the company. Walking away meant losing a business that otherwise suited them well; restructuring as an asset purchase so late in the process would have meant re-papering the entire deal and likely losing the timeline they needed.
3. Negotiated a holdback and indemnity instead. We proposed that a portion of the purchase price — roughly $150,000, reflecting the insurance deductible plus a buffer for defence costs not covered by insurance — be held back in escrow with a neutral third party rather than paid to Thalia at closing. The holdback would be released to her once the lawsuit resolved, minus whatever the company actually paid out because of it, up to the amount held back.
4. Added a specific indemnity for the undisclosed claim. Beyond the general representations in the agreement, we added a clause making Thalia personally responsible, without any cap or time limit tied to the general survival period for other warranties, for any loss the company suffered from this particular lawsuit above what the holdback covered. This meant the risk of the claim running longer or costing more than anticipated did not fall entirely on the buyers.
5. Revised the closing representations. The purchase agreement's representation about pending litigation was rewritten to specifically disclose the claim by name, rather than leaving a blanket "no litigation" statement that Thalia could later argue she had technically corrected through side correspondence. A clearly disclosed and specifically addressed risk is far stronger for a buyer than an ambiguous general clause.

The outcome

The negotiation took about three weeks longer than the original closing timeline, which strained both sides — Thalia had her own plans tied to the sale proceeds, and Jae-won and Yanni were paying to keep their financing commitment open past its original expiry. Neither side got exactly what they wanted going in. Thalia had to accept a real reduction in the cash available to her at closing and an open-ended personal indemnity she had not budgeted for. Jae-won and Yanni had to accept that they were still buying a company with an active lawsuit attached to it, rather than walking away entirely, and they took on the ongoing work of monitoring the litigation until it resolved.

About fourteen months after closing, the lawsuit settled for roughly $140,000, most of which the insurer covered after the deductible. The holdback amount covered the deductible and the modest defence costs the insurer's coverage did not reach, and the remaining balance in escrow, a little over $60,000, was released back to Thalia as agreed. No further amount was owed under the personal indemnity.

The deal closed, the business has operated successfully under Jae-won and Yanni's ownership since, and the litigation risk that could have derailed the purchase or left the buyers exposed to an unknown cost ended up resolved on terms both sides had agreed to in advance, rather than fought over after the fact.

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