R&W and sandbagging in M&A

Mount St Quentin - Arthur Streeton

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In M&A, private equity, and venture capital the use of representations and warranties (R&W) is complemented by sandbagging clauses. These types of clauses can be classified in various ways but basically include anti-sandbagging clauses and pro-sandbagging clauses, depending on whether their content affects the R&W in a way that benefits one party or the other.

About the use of R&W the following post of the blog can be read: “Types of representations and warranties”.

If R&W are made directly and without conditions or limitations, the seller (or the company/shareholders receiving the investment) is liable to the purchaser or investor for their veracity. If the representations made by the seller are not correct, the purchaser can claim for non-compliance with the relevant representation.

Along with the provision of R&W, qualifications or limitations to such R&W can be included as sandbagging clauses.

Among these qualifications or limitations, the first option is to add an anti-sandbagging clause. The anti-sandbagging clause consists of an additional mention of the seller about its R&W, stating that he it not liable for the R&Ws if the purchaser had knowledge of the incorrectness of certain representation and, even knowing this, had entered into the contract with such representation. In practice, this anti-sandbagging clause applies in a similar way to not providing such representation by the seller. The purpose of the anti-sandbagging clause is to avoid those claims from the purchaser that can be considered contrary to contractual good faith. Despite the use of anti-sandbagging is for the convenience of the seller, the difficulty to apply this rule, its introduction can lead to a chain of demands that need to be considered and analyzed.

Due to both the existence of the rule of contractual good faith and the existence of the anti-sandbagging clause, the purchaser often requests specific indemnities. Specific indemnities are explicit mentions of issues on which the seller is liable in any case, regardless of the R&W. These specific indemnities allow the purchaser to claim damages in respect of the matters referred to as such, regardless of the purchaser's knowledge.

As a result of the seller's anti-sandbagging statements, many purchasers opt, in addition to using specific indemnities, to add an anti-anti-sandbagging or pro-sandbagging clause. These are clauses in which the purchaser includes that its knowledge of potential damages will not limit the scope of the R&W in any way.

This chain of demands from both sides of the negotiations provokes a complex situation, often difficult to draft. This final draft often ends up with the coexistence of R&W, specific indemnities, anti-sandbagging mentions, pro-sandbagging mentions and, finally, the regulation of the concept of purchaser's knowledge.

The purchaser's knowledge concept regulates what is considered knowledge. In this regard, it can be regulated that such knowledge needs to be easily deducible from the due diligence and/or limited to the knowledge of certain persons.

Furthermore, the use of anti-sandbagging statements can be limited to direct claims of the purchaser. Therefore, third-party claims are not affected by the anti-sandbagging statements.

In short, lack of trust by the parties makes the relatively simple regime of R&W plus specific indemnities, to be complemented by a complex system of anti-sandbagging statements, pro-sandbagging statements, and the regulation of the purchaser’s knowledge.