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Bhatnagar v. Cresco Labs Inc. (2022)
Key Lessons / Points
- In a legal proceeding the burden of proof, the obligation to provide sufficient justification for a position, is the responsibility of the parties involved, not of the judge.
- In this case, neither party provided any reason as to whether the SR&ED tax credits acknowledged to be payable to the Appellant under the SPA as the working capital adjustment should or should not be adjusted.
- The Judge ordered the original working capital adjustment to be paid as there was to evidence to suggest it should not be.
Fiscal Years in Question
Court Heard In
Superior Court of Justice (Ontario)
March 1, 2022
Length of Process
2022 ONSC 1745
Amount Under Dispute
Decision The acknowledged amount of $142,775.50 should thus be paid by the purchaser to the vendors.
The Appellant, Gopal Bhatnagar, Ashutosh JHA, and Boris Giller, sold their shares in a vape company, 180 Smoke, to CannaRoyalty Corp. d/b/a Origin House, the Purchaser, in February of 2019 under a share purchase agreement (SPA). In April of 2019 the outstanding shares of Origin House were subsequently acquired by the Respondent, Cresco Labs Inc., a large cannabis operator in the United States. The issues raised in this case required the court to determine the Appellants entitlement to certain revenue & license milestone payments, and to determine whether the Purchaser breached its obligations under the SPA. These issue are not related to Scientific Research and Experimental Development (SR&ED), however, this case also involved another dispute unrelated to the Revenue and License Milestone Payments that is SR&ED-related.
After the SPA was finalized, 180 Smoke retained consultants to assist in completing their SR&ED claim for their 2017 and 2018 fiscal years. A total of $21,565.62 was incurred in consulting fees. The issue in this case is whether or not the consultant’s fees should be deducted from the SR&ED credits that 180 Smoke received in 2020. Under the SPA in Section 2.8 these amounts are acknowledged to be payable to the Appellant as working capital. The Respondent disagreed and sought to deduct the consulting fees from the ITCs that it was obligated to pay to the Appellants.
 Section 2.8 of the SPA provided for a working capital adjustment, based on a preliminary net working capital statement to be prepared by the purchaser and subject to a process of objections and eventual submission to an accountant for determination. The parties agree that the SR&ED tax credits for 2017 and 2018 would come within this adjustment provision.
The total SR&ED credits, which were received by 180 Smoke in 2020, amounted to $188,000.49 ($90,437 for F2017 and $97,557 for F2018). In the SPA the parties agree to an initial reduction from the total credits received to account for half of the 2017 credit that had been recorded as a receivable by 180 Smoke prior to closing. This brought the total down to $142,775.50.
The Respondent acknowledged that the Appellants were owed payments for SR&ED credits but sought to deduct the consulting fees, totalling $21,565.62, from the ITCs that it was obligated to pay. This would bring the total amount owing down to $121,215.88.
Key Excerpts The applicants (“vendors”) seek damages representing amounts that they claim are still owed to them under a share purchase agreement dated February 19, 2019 (the “SPA”), by which they sold their interests in a vape products company, 2360149 Ontario Inc. d/b/a 180 Smoke (“180 Smoke”), to CannaRoyalty Corp. d/b/a Origin House (“Origin House” or “purchaser”), a publicly traded company operating in the cannabis sector in the United States.  The outstanding shares of Origin House were subsequently acquired by the respondent Cresco Labs Inc. (“Cresco”), a large cannabis operator in the United States, pursuant to an arrangement agreement dated April 1, 2019 (the “Arrangement Agreement”). This arrangement transaction (the “Arrangement Transaction”) closed on January 8, 2020. As the successor company, it is not disputed that any amounts found owing to the applicants are payable by Cresco who has stepped into the shoes of the “purchaser” under the SPA.  There is a further dispute, unrelated to the Revenue and License Milestone Payments, about whether consultant’s fees should be deducted from certain tax credits (the “SR&ED credits”) that 180 Smoke received in 2020 and that are acknowledged to be payable to the vendors under the SPA as working capital, purchase price, adjustment.  The respondent had made a counter-application for monies alleged to be owing to it for certain other consultants’ fees, totalling $71,619.62, but advised at the hearing of this application that the counter-application claims were being withdrawn.
Findings of Fact
a. On September 27, 2018, 180 Smoke and Origin House entered into a binding term sheet (“Term Sheet”), the terms of which were announced in a press release of the same date, by which 100% of 180 Smoke and its affiliates would be acquired by Origin House, for total consideration of $25 million, as well as an additional $15 million upon the completion of certain post-closing milestones including a revenue target. This Term Sheet specified that there would be Revenue Milestone Payments to be capped at $12.5 million and the possibility of a further License Milestone Payment of $2.5 million if a Standard Processing License for cannabis products was obtained within a specified period.
e. The SPA was executed on February 19, 2019 and the acquisition closed on February 20, 2019.
mm. After the closing of the SPA, 180 Smoke retained consultants who assisted in the eventual recovery from the Canada Revenue Agency of SR&ED tax credits in 2020, for fiscal years 2017 and 2018. 180 Smoke incurred consulting fees of $21,565.62 in its efforts to obtain these tax credit reimbursements.
nn. The respondent seeks to deduct those consulting fees from the tax credits that it remits to the vendors. The respondent acknowledges that the applicants are owed payments for SR&ED credits in the net amount of CAD $121,215.88.
A Further Focus on Key Contractual Provisions
D. The Working Capital Adjustment for SR&ED Tax Credits Section 2.8 of the SPA provides for a working capital adjustment, based on a preliminary net working capital statement to be prepared by the purchaser and subject to a process of objections and eventual submission to an accountant for determination. The parties agree that the SR&ED tax credits for 2017 and 2018 come within this adjustment provision.  The issue associated with this contractual provision is whether the working capital adjustment is to be paid net of consultant’s fees incurred by 180 Smoke to apply for these tax credits.
The Issues to be Decided
 The respondent acknowledges that the applicants are owed payments for SR&ED tax credits that were received after closing by 180 Smoke. These fall under the working capital adjustment to be made under s. 2.08 of the SPA. This adjustment is based on a final net working capital calculation.  These credits, that were not received by 180 Smoke until 2020, totalled CAD $188,000.49 ($90,437 for 2017 and $97,557 for 2018). The parties agree to an initial reduction from the total credits received to account for half of the 2017 credit that had been recorded as a receivable by 180 Smoke prior to closing, so that brings the total down to $142,775.50. The parties also agree that subject to the deduction for consultancy fees that the purchaser wishes to make in the amount of $21,565.62, these SR&ED credits are payable by the purchaser to the vendors as a purchase price adjustment.  According to the purchaser, a consultant was retained in 2020 to assist in the process of applying for these credits and dealing with the Canada Revenue Agency. The consultant was paid $21,565.62 by 180 Smoke. These facts are not disputed. The parties disagree about whether or not this consultancy fee should be deducted from the amount of the adjusted SR&ED credits in the amount of $142,775.50. Neither has provided any guidance on the basis on which they should, or should not, be deducted for purposes of calculating this aspect of the purchase price adjustment under s. 2.08.  While there is some basic logic to the idea that an expense incurred to obtain the tax credit, even if in a different tax year, should be netted against the credit to the extent it forms part of a final net working capital calculation, no assistance has been provided to the court in this case about why or how that calculation could or should be done, whether from an accounting or other perspective. In the absence of any guidance as to how or why the consultancy fees should be deducted in the final accounting to determine the working capital adjustment to the purchase price under s. 2.08 of the SPA, the purchaser has not met its onus to establish that anything further should be deducted from the acknowledged amount of the post-closing SR&ED tax credits received in the amount of $142,775.50.  The acknowledged amount of $142,775.50 should thus be paid by the purchaser to the vendors.
d. Are the vendors entitled to be paid the SR&ED tax credits for 2017 and 2018 received in 2020 (net of acknowledged amounts accounted before the closing of the SPA), or are the amounts owing subject to deduction for the consultant’s fees?
Link to Full Ruling
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