On our fourth installment of our M&A blog series, we are discussing what is sandbagging and anti-sandbagging in the context of mergers and acquisitions.

For an overview of whether you should do an asset or stock sale, whether you should hire an M&A broker or an advisor, and the different types of caps and baskets, please refer to our previous blogs, which have been linked to this one.

So let’s talk about sandbagging. Imagine you’re selling a profitable business. You know it. The buyer knows it. It’s a great deal for both of you. However, there is one caveat: you, as a seller, are aware of a potential liability pertaining to the sale. The buyer knows it too, but still wants to move forward with the purchase. What are the parties to do? Enter sandbagging and anti-sandbagging provisions in the purchase agreement. Both terms allocate risk should there be a breach of warranty by the seller; but they have different consequences.

What is sandbagging?

Obviously, each party is going to push to include contract terms that will be most favorable to them. Typically, the buyer is going to prefer a sandbagging provision, since the same would allow him or her to bring a claim against the seller for indemnification for a known legal liability. It’s pretty much saying: “I know there may be an issue, but I don’t care. I’ll buy the business anyway and I’ll sue you later if I have to.”

What is anti-sandbagging?

By the same token, the seller will want to include an anti-sandbagging provision so that the acquisition of his or her business is a clean cut. Once the purchase is done, the seller is no longer liable for anything relating to the business. Keep in mind, though, that this provision would only work if the buyer was aware of the liability risk at the time of the sale.

Because this could easily turn into a “he said/she said” situation, it’s best to specify in the purchase agreement whether the knowledge requirement is limited to actual knowledge, or whether constructive knowledge applies as well. (Constructive knowledge means that even if the purchaser didn’t actually know about the potential warranty breach, he or she should have known about it through due diligence).

What if the purchase agreement is silent on this issue?

If the parties fail to include either a sandbagging or an anti-sandbagging provision in the purchase agreement, the Court will look at the governing law in the jurisdiction in which the contract was entered into (or in the case of contracts that have a choice of law provision, the Court will look at the governing law of the agreed upon jurisdiction).

As with everything else regarding the sale of a business, what will be in your best interest will depend on your specific set of circumstances. What may be acceptable in one merger or acquisition may prove to be fatal in the sale of a different business. The only way to make an informed decision when you’re contemplating selling or buying a business is to consult with an experienced business law attorney. Hunter Business Law can help.

This Blog was written by Hunter Business Law Founder, Attorney Sheryl Hunter. View her profile HERE.

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