What do golfers and sellers have in common? Both dislike
You are preparing to close an acquisition. Your due diligence
shows that one of the seller's contractual representations
about the target is untrue. If you decide to close the deal anyway,
can you sue the seller after closing if you suffer a loss?
In M&A parlance, this is known as
"sandbagging"—an issue that has now become a topic
of open debate between buyers and sellers. The law on sandbagging
is unsettled in Canada (and in other jurisdictions it will depend
on their default rule under local law).
The issue is whether the buyer must prove it relied on the
seller's inaccurate representation (or "rep") to
enter into the deal. In practice, reliance may be difficult to
establish: the buyer already knew the rep was untrue before
signing. The buyer may also argue that the rep is a negotiated
contractual term―not an inducement to enter into the
contract―and therefore proof of reliance is irrelevant.
So how should parties address sandbagging in their contract?
If a buyer is concerned that there may be an issue with the
accuracy of a seller's rep, it may consider negotiating a
pro-sandbagging clause in the purchase agreement. This clause will
generally say that the buyer retains a right to indemnification
regardless of its investigation or knowledge of any inaccuracy or
non-compliance in respect of the seller's rep prior to
Conversely, an anti-sandbagging clause shifts the risk onto the
buyer by restricting or eliminating its ability to bring a
post-closing claim where the buyer had prior knowledge of the
breach or inaccuracy. Defining the buyer's
"knowledge" in the agreement will be critical to
Either way, while a pro- or anti-sandbagging clause may help
allocate contractual risk between the parties, it will not
necessarily determine the outcome if the matter is litigated in a
Canadian court, given the lack of case law on the subject.
This is especially the case as Canadian contract law now
recognizes a general organizing principle of good faith performance
as well as a specific duty of honest performance—at the same
time, the Supreme Court of Canada has also affirmed that freedom of
contract should allow parties to contract for their own self
How can rep and warranty insurance help?
Parties are increasingly turning their minds to rep and warranty
insurance to protect against post-closing risks. However, this
insurance usually does not cover known breaches like sandbagging.
At best, the policy may be negotiated to limit the definition of
"knowledge" to allow coverage in narrow
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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