Key person clause

How BC law treats it

A key person clause is a creature of contract; no BC statute defines it. It is not an employment provision about duties or severance. The clause names the key persons, defines a key person event (for example, death, disability, ceasing to be an officer, or devoting less than an agreed share of working time) and states what follows. The clause appears in several settings. In investment fund limited partnership agreements, a key person event typically suspends the general partner's ability to make new investments until investors approve a replacement. In venture financing and loan agreements, the loss of a founder may be an event of default or give investors redemption or consent rights. In acquisition agreements and earn-outs, it can affect payments or trigger a buyout. In service contracts, it can require a named professional to lead the work. Because these clauses are interpreted under ordinary contract principles, the words chosen matter. BC courts read a contract as a whole, in light of its commercial purpose and the surrounding circumstances known to the parties (Sattva Capital Corp v Creston Moly Corp, 2014 SCC 53). Vague triggers, such as a founder ceasing to be actively involved, invite disputes. Parties should define measurable triggers, notice requirements, cure or replacement periods and the exact remedy.

What it means for your business

Founders signing a term sheet or loan should read key person clauses closely, because a personal event such as an illness or a career move can trigger a default for the whole company. Investors and lenders rely on these clauses to protect a bet on particular people. Negotiating reasonable triggers, a replacement process and a cure period keeps the clause doing its job without putting the business at risk. Key person insurance can fund the consequences. Example: A BC venture fund's limited partnership agreement provides that if both named managing partners stop devoting substantially all their business time to the fund, new investments are suspended until two thirds of the limited partners approve replacements.

Risks and common mistakes

Confusing a key person clause with an employment contract term about duties or severance. Accepting vague triggers such as reduced involvement without a measurable standard. Agreeing to an immediate default with no cure period or replacement process. Failing to coordinate the clause with key person insurance and the shareholders agreement. Overlooking key person clauses buried in loan or lease documents during due diligence.