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The concept of Sandbagging means a situation where a party has a strength or an advantage or is in a powerful position, which is concealed in order to take advantage of the other party later on. The concept of sandbagging in M&A transactions is not new. It can become a matter of debate between buyer and seller about honesty, integrity, and good faith. Let’s discuss more on Sandbagging in M&A Transactions.
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Merger and Acquisitions transactions involve the combination of two or more organizations into one. Merger means combining two or more entities into one single entity, whereas acquisition is a process where the company acquires another with a view to increase its resources and technical know-how. In merger, the parties to the transaction would include two or more entities, whereas in acquisition, the parties are the buyer, seller, and the target.
In the context of Sandbagging in M&A Transactions, it means when a buyer learns that the seller has breached the term of agreement before closing but doesn’t raise the issue until after closing when it asks for indemnification from the seller.
The agreement in a private Merger and Acquisition transaction includes a variety of representations, warranties, etc. It is made by the seller to the buyer in regard to the asset being bought and sold. Sandbagging happens when the buyer comes to know that one or more of the representations is inaccurate but doesn’t communicate to the seller and completes the transaction despite knowing that it’s inaccurate and then seeks indemnification from the seller.
In a private Merger and Acquisition Transaction, includes one of the general approaches to sandbagging. It includes pro sandbagging provisions stating that sandbagging is allowable or includes anti sandbagging provisions stating that sandbagging is not allowed or the agreement can remain silent on this issue.
As per their respective interests, buyers usually prefer pro sandbagging provisions, whereas sellers usually prefer anti sandbagging provisions.
Buyers seeking the inclusion of pro sandbagging provisions make a number of arguments:
Likewise, sellers seeking the inclusion of anti sandbagging provisions also make a number of arguments:
The merits of the above arguments can differ as per the dynamics of the deal and the circumstances of both parties.
In case of anti sandbagging provisions, the standard of knowledge of the buyer is the key. The standard could be actual knowledge or constructive knowledge. Actual knowledge means where the buyer knew about the breach, and constructive knowledge means where the buyer should have known about the breach.
When the buyer agrees with the inclusion of anti sandbagging provisions in the agreement, the buyer can reduce the risk by narrowing the scope of knowledge to its actual knowledge, thereby still seeking indemnification in situations where it has constructive knowledge of the breach.
If the agreement is silent on the issue, the legality of sandbagging[1] shall be determined by the law in the jurisdiction that governs the purchase agreement. To that end, parties are required to look to what elements are needed to establish a breach of contract in the jurisdiction that they have chosen to govern disputes under the agreement.
The key factor could be how the jurisdiction treats prior knowledge of a breach and whether reliance is required for a contract breach.
Balancing the interests of buyer as well as the seller in a sandbagging provision is not easy. Having said that, when an anti sandbagging clause is included in a purchase and sale agreement, the buyer can somewhat level the playing field by qualifying its knowledge of the seller’s breach to actual knowledge. When it comes to sandbagging in M&A, the decision to include a pro sandbagging clause or anti sandbagging clause could be an essential part of the negotiation.
Read our article:Merger and Acquisition Process in India
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