Private M & A - Sandbagging v. Benefits of the Bargain

All sandbagging contexts assume an actual breach of a representation, knowledge of the same by the buyer and closing---a busted rep. The risk to the seller is the buyer's lie in wait and sandbag by bringing the claims post-closing. Hence the seller's attempt to include an anti-sandbagging clause---it is a defense to a claim for indemnification if the buyer knew of the facts giving rise to the indemnifiable loss prior to the closing. The buyer will counter with a so-called "pro-sandbagging" or "benefit of the bargain" clause, saying that the fact that the buyer knew or should have known about a breach of a representation is irrelevant to the indemnification claim, which can be brought regardless of the buyer's knowledge.

In CBS, Inc. v. Ziff-Davis, 75 N.Y.2d 496 (N.Y. 1990) decided by the New York Court of Appeals, the court held that the proper analysis of a claim for indemnity is not whether the buyer relied on the accuracy of the facts represented to it, but whether it relied on the contractual promise to make good through an indemnity if the representation was untrue.

A number of people will tell you that under New York law silence in the agreement is pro-sandbagging. Unfortunately, it's not quite that clear. In fact, New York law recognizes an exception from the general rule that pre-closing knowledge is not a defense to a claim for indemnity, knowledge is a defense if the source of the information that tells the buyer that the representation is untrue is the seller. The source of the information may be very clear if the seller simply shows up at the closing and says, "Before you close I want to tell you about this variation from the representations," or even puts the disclosure in the closing certificate. It's not quite as clear that the seller was the source of the information if something came up during the diligence process. Any buyer who relies on the underlying law to function as a pro-sandbagging provision makes a serious mistake. That's because the first thing you're going to have to do is to litigate what the underlying law is and, in New York, for example, you're not necessarily going to like the result, since you will then need to litigate the source of the information. The relatively recent decision of the Southern District, Powers v. Stanley Black & Decker, 137 F. Supp. 3d 358 (S.D.N.Y. 2015), the court held New York law to be that information that the buyer acquired from the sellers is a defense to an indemnity claim unless there's a properly worded pro-sandbagging clause, something along the lines that the right to indemnification or other post-closing remedy based on a breach of a representation or a warranty shall not be affected by any knowledge acquired or capable of having been acquired by the buyer at any time, whether prior to or after the execution or delivery of the agreement or the closing. In that case, the court gave effect to a properly drafted pro-sandbagging clause.