Sandbagging Clauses in M&A Purchase Agreements

In the complex world of mergers and acquisitions, a key part of negotiations often involves what are known as pro and anti-sandbagging clauses. These are rules in a purchase agreement, that dictate the extent to which a buyer can seek compensation (indemnification) for breaches of representations and warranties that were known prior to closing the transaction. Their presence or absence shapes the post-closing dynamics between the buyer and seller, influencing strategies around risk management, due diligence, and dispute resolution. There is an intricate balance these clauses strike in purchase transactions.

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Pro-Sandbagging Clause: Buyer Protection & Ensuring Seller Accountability

Pro-sandbagging clauses are designed to protect the buyer. It is a layer of protection, serving as a safeguard against the risks associated with the seller’s disclosures, even if the buyer knew about problems before the purchase. A typical pro-sandbagging clause might read as follows:

Buyer’s right to indemnification or any other remedy available under this Agreement will not be affected by any knowledge acquired or that could have been acquired at any time concerning any fact or matter, including, without limitation, any knowledge that was acquired or that could have been acquired during due diligence or any investigation made in connection therewith.

By explicitly allowing buyers to seek indemnification for known breaches of representations and warranties, pro-sandbagging clauses underscore a transactional philosophy where the seller is held accountable for the accuracy and completeness of their disclosures, regardless of the buyer’s awareness. This protective mechanism is not just about securing a financial safety net for the buyer; it’s about reinforcing the principle that the integrity of the transaction should not be compromised by the buyer’s pre-closing knowledge. The inclusion of a pro-sandbagging clause in a purchase agreement signals a clear expectation that the seller stands behind their representations and warranties, providing the buyer with the confidence to proceed with the transaction.

Anti-Sandbagging Clauses: Promoting Due Diligence and Transparency

On the other hand, anti-sandbagging clauses focus on the buyer’s responsibilities in conducting thorough due diligence. By preventing the buyer from seeking indemnification for breaches they were aware of before closing, these clauses promote a more equitable approach to transactional risk. The reasoning behind anti-sandbagging clauses is that buyers should not be able to leverage their pre-closing knowledge to secure a post-closing advantage. Instead, these provisions encourage buyers to negotiate known issues during the pre-closing phase, fostering a transaction environment characterized by transparency and mutual adjustment. The belief is that a well-informed buyer should use their knowledge to facilitate fair negotiations rather than as a tool for post-closing indemnification claims. A typical anti-sandbagging clause might read as follows:

No party will be liable under this Agreement for any losses arising from or relating to the breach of any representation, warranty, or obligation in this Agreement if Buyer or Seller had knowledge or was capable of acquiring knowledge after conducting a reasonable investigation of such breach prior to the closing.

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Weighing the Pros and Cons of Sandbagging Clauses

The discussion on whether to include pro-sandbagging or anti-sandbagging clauses in purchase agreements highlights wider principles in contract law and negotiation tactics.

Advocates for pro-sandbagging clauses argue that they provide a necessary mechanism for protecting the buyer against the seller’s potential misrepresentations, thereby ensuring that the seller cannot simply absolve themselves of responsibility by pointing to the buyer’s due diligence. This perspective views the protection afforded by pro-sandbagging clauses as essential for maintaining the transaction’s integrity, especially in complex deals where the scope for due diligence might be inherently limited or where the transaction’s scale magnifies the potential impact of undisclosed liabilities.

However, proponents of anti-sandbagging clauses contend that these provisions foster a more diligent and proactive approach to due diligence, compelling buyers to fully investigate and negotiate any concerns prior to closing. This stance emphasizes the value of upfront negotiation and resolution of potential issues, arguing that it leads to clearer expectations and a smoother post-closing integration. The inclusion of an anti-sandbagging clause is seen as a way to balance the scales, ensuring that the buyer cannot withhold information about known breaches for strategic post-closing advantage. This view of anti-sandbagging clauses not only encourages thorough pre-closing investigations but also promotes a more honest and equitable negotiation process.

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Understand the Right Sandbagging Clause for Your Merger & Acquisition

The choice between pro and anti-sandbagging clauses in purchase transactions ultimately depends on what each party wants to achieve, their willingness to take risks, and how they view the balance of power in the negotiations. 

Each sandbagging clause brings with it a distinct set of incentives and protections, shaping how parties approach the transaction from initial due diligence through to post-closing adjustments. The inclusion of either clause is ultimately a strategic decision to be negotiated by the parties after careful consideration of their bargaining strength and understanding of long-term goals. 

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John H. Prorok
John Prorok

John Prorok possesses an invaluable understanding of privately held business owners’ needs in business planning, corporate formation, and transactions. He frequently speaks and counsels emerging and start‐up enterprises, offering insightful legal strategies toward success.