Anti-Sandbagging, explained

Limiting post-close liability: Understanding “anti-sandbagging” provisions

When negotiating a purchase agreement, a seller generally seeks to limit its potential liability as much as possible. As previously discussed, a seller can – and should – employ various legal methods to achieve this result (such other methods include a basket and cap and survival provisions). One such tool in an attorney’s toolbox is the “anti-sandbagging” provision.

In a typical purchase agreement, a buyer is tasked with doing its due diligence before closing on the purchase. In addition to conducting its own due diligence, a buyer will negotiate certain representations and warranties from the seller that the buyer can rely on in order to alleviate some of the buyer’s due diligence responsibilities. Representations and warranties often survive a closing for a set period of time, during which a buyer can seek recourse against a seller if such representations and warranties are found to be untrue (subject to a basket and cap, if applicable). However, what happens if the buyer knew the representation and warranty was untrue prior to closing, but failed to inform the seller, with the intention that it would sue the seller after the closing for damages (a/k/a the buyer would “sandbag” the seller)? This is the potential liability that an anti-sandbagging provision addresses.

Definition

An anti-sandbagging provision prohibits a buyer from seeking post-closing recourse against a seller regarding matters which the buyer knew about (or, as discussed below, should have known about) at or prior to closing. As the name suggests, it prevents a buyer from “sand-bagging” a seller after the fact.

The following is an example of a pro-seller anti-sandbagging provision (emphasis added):

“If Closing occurs, Buyer hereby expressly waives, relinquishes and releases any rights or remedies available to it at law, in equity, under this Agreement or otherwise, including any claim against Seller for damages that Buyer may incur, as the result of any of Seller’s representations and warranties being untrue, inaccurate or incorrect if Buyer is that any representations and warranties were untrue, inaccurate or incorrect at the time of Closing, and such Seller’s representations and warranties shall be deemed modified or qualified to reflect such knowledge.”

The highlighted portion demonstrates the real contentious portion of any negotiation of an “anti-sandbagging” provision. While the core component of anti-sandbagging may be intuitive (most people would inherently agree that a buyer should not be able to knowingly close on a false representation and warranty with the intent to sue), the amount of knowledge that a buyer is “deemed to know” can vary greatly from negotiation to negotiation.

Buyer Considerations

A buyer wants matters of which it has knowledge to be very limited; typically, covering only matters of which it has actual knowledge, and without an obligation to make inquiry. Furthermore, since many buyers are entities and not people, a buyer should define the specific person(s) that must have knowledge for it to be “actual knowledge,” in order to further limit its potential anti-sandbagging obligations. If, for example, a lower-level employee has knowledge of a matter, a buyer will want to exclude such employee’s knowledge unless a specific principal receives notice. Using the sample provision above, below is a pro-buyer markup of the anti-sandbagging provision (additions are in blue, deletions are in red):

“If Closing occurs, Buyer hereby expressly waives, relinquishes and releases any rights or remedies available to it at law, in equity, under this Agreement or otherwise, including any claim against Seller for damages that Buyer may incur, as the result of any of Seller’s representations and warranties being untrue, inaccurate or incorrect if Buyer has Actual Knowledge  is “deemed to know” that any representations and warranties were untrue, inaccurate or incorrect at the time of Closing, and such Seller’s representations and warranties shall be deemed modified or qualified to reflect such knowledge Actual Knowledge. For the purposes of this clause, “Actual Knowledge” shall mean the actual knowledge of [INSERT NAME OF BUYER PERSON(S)] without a duty of inquiry.”

As you can see, the anti-sandbagging provision has been limited to make clear (1) who must have knowledge, and (2) what type of knowledge (actual) it must be, in order for the anti-sandbagging provision to be applicable. However, the above markup is strongly in the buyer’s favor, as it softens the buyer’s duty to do its own due diligence, almost to the point of requiring the buyer to do no due diligence regarding any of the representations and warranties presented delivered by the seller.

Seller Considerations

The seller wants the buyer’s knowledge to be broadly defined; typically, requiring some level of inquiry on the part of the buyer. The biggest debate often comes with respect to the level of diligence a buyer must do with respect to the seller’s disclosures. As you may know, a seller delivers a lot of paper (usually on a datasite) for a buyer to review during its diligence. Leases, service contracts, property condition reports, appraisals, and other third-party matters can be hundreds of pages long. If a breach of a representation and warranty is buried on page 62 of one out of 100 leases applicable to the building, and the buyer was given such lease, should it have knowledge of such breach and be prevented from bringing a claim against seller after closing?

The answer often lies in somewhere in the middle. It’s probably unreasonable for a buyer to be required to do such an intense level of due diligence, but at the same time, a buyer should be excused from reading the lease. If, for example, the breach of a representation and warranty is on page 1 of the lease, in bright ALL CAPS RED LETTERS, instead of buried on page 62, a buyer should probably have the responsibility to discover that breach prior to Closing. Consequently, these provisions require negotiation and nuance depending on the nature of the transaction.

With that in mind, once again using our example provision from above, the following is a pro-seller anti-sandbagging provision (emphasis added):

“If Closing occurs, Buyer hereby expressly waives, relinquishes and releases any rights or remedies available to it at law, in equity, under this Agreement or otherwise, including any claim against Seller for damages that Buyer may incur, as the result of any of Seller’s representations and warranties being untrue, inaccurate or incorrect if Buyer is “deemed to know” that any representations and warranties were untrue, inaccurate or incorrect at the time of Closing, and such Seller’s representations and warranties shall be deemed modified or qualified to reflect such knowledge. Buyer shall be “deemed to know” any fact, circumstance or information (a) that any Buyer’s representative has, or would reasonably be expected to have after diligent inquiry, actual knowledge of a particular fact or circumstance or information that is inconsistent with any Seller’s representations and warranties, or (b) or is contained in this Agreement, any Closing documents executed by Seller, any document posted in the electronic data room with respect to the Property, any estoppel certificate delivered in connection with this Agreement, and any reports prepared or obtained by any Buyer’s representatives in connection with Buyer’s due diligence.”

As you can see, the buyer has an affirmative obligation of diligent inquiry and is deemed to have knowledge of a wide set of facts, including matters contained in any document posted in the electronic data room. This is a very strong position for the seller to take, and likely one that a buyer will push back on.

Other Limitations on Liability

An “anti-sandbagging” provision is just one method of limiting a party’s liability. A seller should also include a survival period and basket and cap provisions to limit its potential liability.