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Sandbagging, where a buyer seeks indemnification for breaches of representations or warranties despite knowing of the breach before closing, remains a complex and often contentious topic in M&A transactions in Canada. While some US states, like Delaware and New York, have developed a pro-sandbagging stance, Canadian law is evolving, exposing significant uncertainty for deal teams navigating cross-border transactions. This insight explores the legal landscape, practical implications and drafting strategies for counsel involved in Canadian M&A deals, including those with US counterparties.
US law: Jurisdictional certainty and predictability
In the US, the approach to sandbagging varies by jurisdiction, though several key states offer a degree of predictability for deal terms.
Delaware courts have consistently enforced sandbagging provisions. They hold that a buyer's knowledge of a breach does not preclude indemnification unless the contract expressly states otherwise. In the recent 2025 ruling of the Delaware Court of Chancery in In re Dura Medic Holdings, Inc., the court confirmed that where a contract is silent on sandbagging, representations and warranties of the seller are unaffected by the buyer's knowledge of any inaccuracies.
New York follows a similar pro-sandbagging approach, though with some nuance. A buyer's knowledge obtained directly from the seller may prevent recovery, but independent knowledge typically does not. Additionally, New York requires some evidence that the buyer intended to rely on the representation or warranty at issue.
Texas, influenced by Delaware and New York, generally upholds sandbagging claims. This is unless the contract expressly prohibits them or there is evidence of active dishonesty or bad faith of the buyer.
California, however, takes a different approach, where a buyer must demonstrate actual reliance on the specific representation or warranty to succeed in a sandbagging claim. If the agreement is silent on sandbagging, California courts will not permit sandbagging unless the buyer can show that they relied on the representation or warranty in question.
Overall, US law provides deal teams with predictability within the applicable governing law of the transaction. Parties are advised to learn about regional variations, then negotiate explicit pro- or anti-sandbagging clauses. Courts in the US are generally likely to respect clear contractual language reflecting party intentions.
Canadian law: Unsettled waters
The legal status of sandbagging claims in Canada remains unsettled, with conflicting decisions and no direct guidance from the Supreme Court of Canada. While some lower court decisions have permitted sandbagging claims, others have denied them. This is especially true where the buyer's reliance on a misrepresentation is deemed unreasonable due to having prior knowledge that such representation was false.
The Supreme Court of Canada's decisions in Bhasin v. Hrynew and C.M. Callow Inc. have introduced a duty of good faith and honest performance in contracts. This has added further uncertainty to the sandbagging debate. In the context of sandbagging clauses in M&A agreements, the duty of honest performance means that a party cannot actively deceive or mislead the other about the existence of a breach of a representation or warranty. For example, a buyer who knows of a breach cannot conceal that knowledge in a way that would amount to dishonesty in the performance of the contract. This duty is distinct from a general duty to disclose and does not require parties to act in each other's best interests, but it does set a baseline standard of honesty in contractual dealings.
This evolving legal landscape means that contractual silence on sandbagging in Canadian deals can lead to unpredictable outcomes, with courts reduced to scrutinizing the parties' conduct and intentions.
In Ontario and Alberta, there is some case law that if an agreement is silent on sandbagging, a purchaser's prior knowledge of a misrepresentation will likely prevent recovery. This stands in contrast to Delaware, where silence generally favors the buyer.
While no explicit framework for assessing sandbagging claims exists in Canada, the Supreme Court cases and the lower court cases across Canada can be interpreted to suggest that the courts will likely consider the following factors in a sandbagging claim:
- Does the agreement contain explicit pro-sandbagging or anti-sandbagging provisions? Canadian courts generally respect the intentions of contracting parties.
- What is the nature of the buyer's conduct and knowledge? If a buyer actively lies or engages in misleading conduct regarding their knowledge of a breach, this would likely constitute a breach of the duty of honest performance. Dishonesty can include half-truths, omissions and even silence, depending on the circumstances.
- What is the context of the transaction and the sophistication of the parties? In sophisticated M&A transactions, some case law suggests that only affirmative lies or active misleading should constitute dishonesty, allowing sandbagging unless there is evidence of active deception.
- Is there reasonable reliance? A court might consider whether the buyer could reasonably rely on a representation if they knew it was false before closing.
Cross-border implications: Advice for deal teams
For cross-border transactions, these differences can create friction and confusion. To mitigate risk:
- Expressly address sandbagging: Clearly state in the agreement whether sandbagging is permitted or prohibited.
- Define "knowledge" carefully: Specify whose knowledge counts (e.g., actual, constructive, imputed) and how it is acquired.
- Consider good faith obligations: In Canada, be mindful of the duty of honest performance and draft sandbagging clauses to withstand potential challenges.
Conclusion
Sandbagging remains a complex and evolving issue in Canadian M&A law, especially in cross-border deals. Deal teams and counsel should prioritize clear drafting and understand the divergent approaches in Canada and the US. By proactively addressing sandbagging in acquisition agreements, parties can avoid uncertainty and ensure their intentions are respected.
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