Preserving (or Limiting) Contractual Claims to Address ‘Sandbagging’

July 24, 2013

Publication| Corporate Transactions

The Delaware Court of Chancery’s decision in Universal Enterprise Group, L.P. v. Duncan Petroleum Corporation, No. 4948-VCL (Del. Ch. July 1, 2013), follows recent a line of Delaware cases indicating that the Delaware courts may permit some degree of so-called “sandbagging.” The opinion also serves as a reminder that buyers and sellers should take particular care when allocating the risks in acquisition agreements.

The term “sandbagging” has been used generally in the M&A context to refer to the buyer’s assertion of post-closing claims for breach of representation and warranty despite its pre-closing knowledge that the seller’s representations or warranties were not true and correct when made. Although counterparties may contract around sandbagging by expressly preserving or limiting the buyer’s right to assert claims in cases where it knew (or was on notice) of a seller’s breach prior to closing, in the absence of a “pro-sandbagging” or “anti-sandbagging” provision, the permissibility of sandbagging is a matter of the law of the jurisdiction governing the agreement.

Certain earlier cases of the Delaware courts could be read to suggest that a buyer seeking to assert a claim for breach of representation or warranty is required to show that it had relied on the representation or warranty giving rise to its claim, including Kelly v. McKesson HBOC, No. 99C-09-265-WCC (Del. Super. Jan. 17, 2002), Bleacher v. Bristol-Myers, 163 A.2d 526 (Del. Super. 1960), and Loper v. Lingo, 97 A. 585 (Del. Super. 1916). Under that type of framework, a buyer that learned through pre-closing due diligence that certain of the seller’s representations and warranties were not true and correct but proceeded to closing in spite of that information would be largely precluded from establishing a viable claim for breach because of the difficulty of demonstrating that it had justifiably relied on a representation or warranty that it knew was not true and correct when made.

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