Mergers and Acquisitions (M&A) generally involve integrating two or more organizations into one single entity. A merger is a corporate strategy and business transaction in which two or more companies combine to form a new company or when one company absorbs another. In a merger, the participating companies typically agree to join their resources, operations, and ownership structures to create a larger, more robust entity. An acquisition is a transaction wherein one company purchases most or all of another company’s shares to get control of that company.
In M&A transactions, buyers typically conduct due diligence before finalizing the deal to identify and assess legal risks. Due diligence is crucial as it helps buyers evaluate key factors about the targets, such as their assets, liabilities, financial status, business risks, and compliance. Based on due diligence findings, buyers factor in identified risks in the financial and contractual aspects of the deal, seeking protection through representations, warranties, and indemnities.
Sandbagging provisions are commonly used in M&A deals to safeguard the buyer’s interest. These provisions allow buyers to make indemnification claims against sellers for breaches even if the buyer was aware of the breach before closing the deal. On the contrary, sellers often seek anti-sandbagging provisions to prevent indemnification claims if the buyer knew about the violation before closing. However, buyers may still seek specific indemnities to cover pre-identified liabilities.
This provision typically states that the buyer can seek post-closing indemnification for any breaches of the seller’s representations & warranties in the transaction agreement, irrespective of whether the buyer was aware of such breaches or the falseness of specific representations or warranties before signing the agreement or completing the transaction. In other words, a “sandbagging” or “pro-sandbagging” provision ensures that the buyer’s rights against the seller are preserved, regardless of whether the buyer had prior knowledge of the facts giving rise to an indemnification claim.
Concerning any transaction involving a substantial amount of finances, the buyer had a certain valuation/expectation in mind for its target based on the seller’s statements and assurances. If these statements are untrue, buyers contend they paid more than they should have and deserve reimbursement. Buyers also make the case that pro-sandbagging clauses enhance the level of assurance for both parties. For instance, they eliminate specific obstacles to seeking compensation, such as lengthy and expensive disputes during the indemnification process related to the buyer’s knowledge before the closing.
On the other hand, sellers may request an “anti-sandbagging” provision, which is favorable to the seller and prevents the buyer from seeking indemnification for breaches of representations or warranties that the buyer was aware of before signing the agreement or closing the deal.
An “anti-sandbagging” provision prohibits the buyer from seeking post-closing indemnification for breaches of the seller’s representations or warranties that the buyer already knew about. It’s a provision that benefits the seller and is typically opposed by buyers and their legal representatives.
Anti-sandbagging clauses focus on the buyer’s knowledge instead of the seller’s misrepresentation. A more fruitful and suitable time for addressing any seller’s misrepresentation is before the closing when it can be resolved. If the buyer delays until after the closing, the indemnification process detailed in the purchase agreement to seek remedies is the only way out. This exposes the buyer to limits on liability, deductible thresholds, and time constraints for filing a claim. Furthermore, if the matter becomes disputed, it can result in a protracted legal process with an uncertain outcome.
The definition of “knowledge” becomes critical when agreements contain anti-sandbagging provisions. The scope of knowledge may include both actual and constructive knowledge, extending to employees and key personnel of the buyer. A broader definition, encompassing implied or constructive knowledge, makes it difficult for the buyer to claim ignorance of facts leading to an indemnification claim.
Dealing with the “sandbagging” issue while negotiating the letter of intent (LOI) is crucial for both buyers and sellers in M&A transactions. In cases where parties cannot agree on the sandbagging matter, the LOI or the final M&A agreement may remain silent on the issue. In such cases, the choice of governing law for the agreement becomes a significant concern, and the parties and their legal counsel should carefully consider the legal implications of remaining silent on the matter.
In summary, well-crafted sandbagging and anti-sandbagging provisions are vital for buyers and sellers, as the absence of explicit contractual terms may lead to legal interpretation. While courts worldwide have taken different approaches to these issues, there is a lack of legal precedents regarding sandbagging clauses in the Indian context.