When negotiating a corporate merger or acquisition, both buyers and sellers would benefit from agreeing to and contractually specifying their position about sandbagging, which is when a buyer knows that a seller’s representation or warranty is false or inaccurate but goes ahead and signs the agreement in order to later pursue a claim against the seller. In this article, we will discuss on how sandbagging provisions (or the silence on such) is regulated in Colombia, Mexico, Chile, Brazil and Peru, as well as case law, if any.
One of the main issues to be hammered out when negotiating a merger or acquisition is, undoubtedly, what claims a buyer can make to the seller in connection with the business or company acquired and the legal and contractual rules governing such claims. As we know, whether or not the seller can be found liable depends to a large extent on what the buyer knew about the target before signing and whether or not it accepted the consequences of such contingencies.
This is where sandbagging clauses come in play. In order to understand the concept, it is helpful to recall the origin of this term. In golf, a “sandbagger” is a person who pretends to be a worse player than he really is in order to take advantage of his or her rival. By lying about his abilities, a sandbagger gains additional handicap strokes and increases his chances of winning.
In asset and share purchases, sandbagging typically refers to a situation in which the buyer is aware (either through its due diligence or its prior knowledge) that a representation or warranty is false or inaccurate but nevertheless proceeds to sign the agreement or close the deal, and later sues the seller over the breach.
A pro-sandbagging clause, then, establishes that the buyer’s right to indemnification is not limited by the knowledge that it may or may not have had or that it could have obtained through a legal due diligence, while an anti-sandbagging clause prohibits the buyer from seeking post-closing recourse for any breach it already knew about.
It is increasingly common to see M&A negotiations in which sellers want to include an an anti-sandbagging clause by which buyers may not sue them for any inaccuracies in their representations and warranties if the buyer was aware (or could be aware based on the information disclosed) of such falsehood or inaccuracy. Naturally, some buyers will strongly resist against such clauses, since they play a significant role in the allocation of risks.
What happens if the two parties cannot agree on what constitutes prior knowledge by the buyer about the existence of contingencies? Could the buyer be prevented from suing if it had prior knowledge of a given fact, based, for example, on the obligation to negotiate and conclude contracts in good faith? The answer to these questions could depend on how the buyer gained the knowledge (if the seller disclosed the breach to the buyer or if the buyer learned it from a third party or through its own due diligence) and, naturally, on the law applicable in the jurisdiction in which the deal is carried out. In that regard, it is interesting to briefly analyze the possible weight of pro-sandbagging and anti-sandbagging clauses in some of the chief jurisdictions in Latin America, namely Colombia, Mexico, Chile, Brazil and Peru.
In order to avoid subsequent disputes, sellers and buyers should come to an agreement about sandbagging, given that, as we have indicated, the judge or arbitrator will take into consideration the parties’ shared intention when interpreting contract clauses.
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