Caveat Venditor: Navigating Sandbagging Provisions in M&A Agreements

03 Jan Caveat Venditor: Navigating Sandbagging Provisions in M&A Agreements

Sandbagging provisions in purchase and sale agreements are critical components that allow a purchaser to pursue indemnification claims against a vendor for breaches of representations, warranties, or covenants, even if these breaches were known before closing the transaction. This could expose a vendor to potentially significant liability and damages caused by such breaches.

Consider a scenario where a vendor represents in a share purchase agreement that there are no undisclosed pending claims against the company the vendor is selling. During the due diligence process, the purchaser discovers an undisclosed claim from a supplier, seemingly unbeknownst to the vendor. Post-closing of the transaction, the supplier’s successful claim leads to damages against the company. Here, the purchaser could invoke the sandbagging provision in the share purchase agreement to seek indemnification from the vendor for breach of the representation under the agreement.

Such provisions therefore place vendors at risk of significant consequences. Many agreements remain silent on sandbagging, generally enabling the purchaser to claim indemnity even with prior knowledge of the breach.

Contrasting Traditional Representations and Warranties with Sandbagging

Traditionally, a purchaser’s claim against a vendor is contingent on the purchaser’s reliance on material facts in the vendor’s representations and warranties. In sandbagging scenarios, the purchaser, aware of the vendor’s breach, does not rely on these representations and warranties but can still claim for breach of the representations or warranties.

Anti-Sandbagging Measures

Vendors can mitigate sandbagging risks by incorporating anti-sandbagging provisions in the definitive agreement. These provisions disclaim vendor liability for known breaches before the closing of the transaction, underlining that the purchaser, given complete disclosure and due diligence opportunity, should not claim compensation for any known breaches.

Determining the Permissibility of Sandbagging

The allowance for sandbagging hinges on the definitive agreement’s provisions. Agreements typically either state the purchaser’s sandbagging rights, include an anti-sandbagging clause, or omit such provisions. In cases of non-consensus between the parties, agreements might exclude these provisions, a common practice in M&A transactions. However, the uncertainty this creates can be more detrimental than if the parties had agreed on specific terms and included them in the agreement.

In the absence of explicit sandbagging clauses, Canadian courts usually apply Caveat Emptor (“Buyer Beware”), implying no sandbagging. However, courts may recognize implicit sandbagging or anti-sandbagging clauses based on the context and facts, with several instances in Ontario where courts have upheld sandbagging.

Seeking Expert Legal Guidance on Sandbagging

Navigating sandbagging in M&A transactions is complex. Purchasers often favor pro-sandbagging clauses, while vendors benefit from anti-sandbagging clauses. Fully understanding one’s contractual rights and obligations and how such provisions could be relied on post-closing is essential for both vendors and purchasers.

The team at R&D LLP is equipped to assist with negotiating and preparing well-drafted definitive agreements that include sandbagging or anti-sandbagging provisions. We are here to help you understand the risks associated with buying or selling a business and help negotiate the most beneficial arrangement for you. Please reach out to discuss how we can be of further assistance.