Delaware Sandbagging: Are There Still Benefits to Remaining Silent?

Sunday, October 28th, 2018 at 1:13 pm by Micaela Piña

In the M&A context, after lengthy negotiations, a buyer may become aware that a certain representation or warranty is false–through its own due diligence–but decide to close the deal anyway. The buyer may then decide to sue the seller for that very same breach. This practice is known as sandbagging. In other contexts, sandbagging is defined as concealing or misrepresenting one’s true position or intent with hopes of gaining an advantage over another. When the purchase agreement is silent on the sandbagging issue, governing law determines whether sandbagging is permissible.

Sandbagging Case Law

Case law surrounding sandbagging is unsettled. A widespread belief among dealmakers is that Delaware courts are “pro-sandbagging,” meaning that if the parties are silent on the sandbagging issue, a buyer can seek indemnification for the seller’s breaches of representations or warranties–even if the buyer was aware of such a breach before closing. This reflects a contract-based approach, where a breach of contract claim requires only that the opposing party did not perform its promises under the contract and that the plaintiff suffered damages as a result. This is contrasted with a tort-based approach, which focuses on a defendant’s wrongful act that resulted in injury to the plaintiff. Consistent with the tort-based approach, some states require the buyer to prove it relied on the truth of the representation or warranty. This view reasons that if the buyer closed with full knowledge of the breach, the breach was waived. Like much of contract law, the parties are free to contract around this supposed default provision. In fact, many parties add “anti-sandbagging” provisions to their purchase agreements, which deny the buyer the benefit of any bargained-for representation or warranty if the buyer was aware that such representation or warranty was false prior to closing.

Delaware Supreme Court Decision

The Delaware Supreme Court’s recent decision in Eagle Force Holdings, LLC v. Campbell, however, has created some ambiguity regarding what silence on sandbagging means in a purchase agreement governed by Delaware law. In a footnote, the court observes that it has “not yet resolved this interesting question.” The court further observes that most states follow the New York Court of Appeals’ decision in CBS Inc. v. Ziff-Davis Publishing Co., holding that traditional reliance is not a necessary element for a breach of express warranty. The only “reliance” required is a reliance on the express warranty as part of the bargain between the parties. The court in Eagle Force Holdings, LLC refrained to further comment, as the issue was not before the court.

Moving Forward

When negotiating purchase agreements in Delaware, dealmakers should remain cautious when deciding whether to remain silent on sandbagging or to include a pro- or anti-sandbagging provision. Given the Delaware Supreme Court’s recent ambiguity, the safer bet is the latter.

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