One of the highlights from the American Bar Association's (ABA) 2016 Canadian Private Target M&A Deal Points Study in which our firm was a key participant (the 2016 Study), was the increased inclusion of sandbagging provisions in deals. The 2016 Study saw the inclusion of sandbagging provisions in 46% of deals (up from 29% in the ABA's 2014 Canadian Private Target M&A Deal Points Study (the 2014 Study)).
As explained in a previous post, sandbagging provisions deal with a circumstance in which a buyer asserts a post-closing indemnification claim in relation to the seller's breach of a representation or warranty of which the buyer had knowledge prior to closing. A "pro-sandbagging provision"1 permits a buyer to pursue this course of action whereas an "anti-sandbagging provision"2 restricts a buyer from pursuing this course of action. A buyer may insist on a pro-sandbagging provision in order to shift risk onto the seller, especially when it lacks confidence in the accuracy of a seller's representation or warranty. Conversely, a seller may insist on an anti-sandbagging provision in order to shift risk onto the buyer.
It is of note that the uptick in the inclusion of sandbagging provisions was largely reflected in an increase in pro-sandbagging provisions, which jumped from 15% in the 2014 Study to 31% in the 2016 Study. This increase in pro-sandbagging provisions may reflect the uncertainty in Canadian jurisprudence on the enforceability of sandbagging provisions. Unlike their American counterparts, Canadian courts have yet to directly consider the enforceability of sandbagging provisions. Adding a clearly drafted "pro-sandbagging provision" demonstrates the explicit intention of the parties to account for a situation where a buyer "sandbags" the seller. Nevertheless, until Canadian courts directly consider the issue, there is no guarantee that the addition of a sandbagging provision will be enforceable. In light of this uncertainty, in some cases, it may be prudent for a buyer to obtain representation and warranty insurance that specifically covers "known" breaches.
Footnotes
[1] An example of a "pro-sandbagging provision" is as follows: "The right to indemnification, payment, reimbursement, or other remedy based upon any such representation, warranty, covenant, or obligation will not be affected by any investigation conducted or any Knowledge acquired at any time, whether before or after the execution and delivery of this Agreement or the Closing Date, with respect to the accuracy or inaccuracy of, or compliance with, such representation, warranty, covenant, or obligation." (2016 Study, slide 68)
[2] An example of an "anti-sandbagging provision" is as follows: "No party shall be liable under this Article for any Losses resulting from or relating to any inaccuracy in or breach of any representation or warranty in this Agreement if the party seeking indemnification for such Losses had Knowledge of such Breach before Closing." (2016 Study, slide 68)
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