Sandbagging in Canadian Law and Practice

Abstract

In the language of mergers and acquisitions, "sandbagging" refers to situations in which a buyer brings an indemnification claim for a breach of the seller's representations and warranties that the buyer was aware of prior to closing. In contractual negotiations, sellers often argue that sandbagging allows unscrupulous buyers to reduce the agreed-upon purchase price by abusing the indemnification mechanism. For their part, buyers argue that sandbagging can protect their legitimate contractual interests, particularly in cases where a seller seeks to dispute a valid indemnification claim. This tension between buyers and sellers is heightened by the fact that the legal status of sandbagging in Canada is unclear. Although transactional lawyers generally believe that courts will enforce clear "pro" or "anti" sandbagging provisions—i.e., contractual provisions that expressly permit or forbid sandbagging—whether courts will permit sandbagging in the face of contractual silence is uncertain.

In light of this uncertainty, this article argues that courts should adopt a clear "pro-sandbagging" default rule in cases where the acquisition agreement is silent. Although sandbagging is controversial, this article argues that there are important practical and economic reasons to allow buyers to bring indemnification claims for contractual breaches of which they allegedly had knowledge. My central argument is that a pro-sandbagging default rule is economically efficient in that it (1) facilitates the informational purpose of contractual representations and warranties and (2) reduces ex post litigation costs. By interpreting the terms of M&A agreements strictly—thereby allowing sandbagging—courts can increase legal certainty while facilitating the production of valuable information, ultimately benefiting both buyers and sellers.

Keywords: mergers and acquisition, corporate law, contract law

JEL Classification: K12