Sandbagging In M&A Deals: Silence May Not Be Golden

Article by Luke P. Iovine, III1

"Sandbagging" is a concept that refers to the practice of one party to an acquisition agreement (most often a buyer) seeking post-closing indemnification for breaches of representations and warranties, which breaches that party was aware of prior to signing the acquisition agreement or, in some cases, closing the transaction.2 This includes circumstances in which the seller is not aware of the breach and therefore did not properly disclose the breach or relevant exception on the disclosure schedules. Although sandbagging is not a new concept, it is an issue that continues to elicit emotional reactions and intense negotiation from both buyers and sellers. Should the buyer be permitted to close the transaction without alerting the seller to a potential breach and then seek damages post-closing for the breach? Or, as sellers argue, should the agreement effectively provide that a buyer that closes over a known breach has waived its rights to post-closing indemnification? Interestingly, more than half of acquisition agreements completed in 2010 were silent on this issue.3

Sellers view sandbagging as an issue of fundamental fairness and have a tendency to impute bad motives to buyers that insist on a provision permitting sandbagging. To sellers, sandbagging is a patently unfair and ethically questionable practice. This perspective is relevant, whether or not one believes that a buyer would actually proceed to close the transaction in the face of a known breach and assume the risk that it will be able to establish the breach and damages after the closing (and then collect those losses from the seller).

For their part, buyers tend to look at sandbagging as merely a matter of ensuring that they receive the benefit of their bargain. Buyers believe they are bargaining - and paying - for the right to rely on the representations provided by their sellers and to enforce indemnification obligations for breaches of those representations, regardless of whether someone involved in an extensive due diligence process had, or should have had, knowledge of facts or circumstances that made those representations untrue. Furthermore, buyers often argue that including a provision prohibiting sandbagging undermines the disclosure scheduling process and encourages sellers to "dump" diligence documents on the buyer at the last minute in an attempt to get the benefit of a later argument that the buyer had knowledge of matters not...