Alexis Klimaszewski
In the area of mergers and acquisitions (“M&A”), a buyer “sandbags” a seller when, knowing the seller has breached—intentionally or unintentionally—a representation or warranty prior to closing, the buyer nonetheless closes the sale and subsequently brings a post-closing indemnification claim. Parties to a merger or acquisition can negotiate a pro- or anti-sandbagging provision; however, the recent trend has been rising instances of silence in M&A agreements. Given the modern majority default rule, the result is that most buyers in the United States hold a sandbagging right; however, default rules are ambiguous, uncertain, and inconsistent across jurisdictions. While sandbagging at first glance appears unfair to the seller, the situation is far more nuanced, and there is potential for perverse disclosure incentives for both buyer and seller. The recent trend towards silence reflects not an acquiescence by sellers to the default rule of the governing jurisdiction, as scholars have previously suggested, but rather prohibitively high transaction costs and valuation issues faced by both parties that make negotiating over sandbagging language in the M&A agreement inherently inefficient. This Note suggests that a modified version of a pro-sandbagging default rule that focuses on knowledge of breach obtained post-signing but pre-closing, limits “knowledge” to actual knowledge obtained by senior executives and members of the due diligence team, and places a shifting burden of proof on both parties, efficiently incentivizes the buyer and seller to collaboratively disclose, handle pre-closing knowledge of breach with special indemnities and reductions in purchase price, and avoid litigation. Such a rule also effectuates the “fairest” outcome from a public policy perspective, by allowing a successful sandbagging defense only when “sandbagging” has occurred in a knowing, premeditated manner. Ultimately, the default sandbagging rule of each jurisdiction will depend upon its public policy, and this Note provides negotiating strategies for both buyer and seller when forced into an adverse sandbagging position.