What is sandbagging?

The practice of sandbagging—whereby a purchaser discovers a breach of a representation or warranty on part of the seller during negotiations but nonetheless closes the deal only to then seek indemnification for the breach—continues to plague practitioners in Canadian private M&A.

In what is frequently one of the most contentious issues in these deals, both buyers and sellers aim to safeguard their interests by shifting risk to the opposing party via pro- or anti-sandbagging clauses. Buyers will aim to insert “No Waiver” clauses which provide that knowledge of any breach does not strip the buyer of the ability to seek restitution post-closing, the idea being that this incentivizes full disclosure and helps reduce the risk of a last-minute surprise derailing the transaction. Sellers will naturally seek to include provisions that disentitle a buyer from being able to advance such a claim for restitution, and argue that this helps minimize the risk of costly and unnecessary litigation after the transaction is completed.

Sandbagging provisions in Canadian M&A

In light of the risks associated with sandbagging, one would expect to see practitioners deal with the issue as a routine part of transactions. Instead, Canadian practitioners seem to prefer a ‘wait and see’ approach in which they simply hope that the problem will not materialize post-closing.

According to Practical Law Canada’s What’s Market: Legal Trends in Canadian Private M&A (subscription required) in 2017, more than 50% of transactions remained silent on the issue and did not include either pro- or anti-sandbagging provisions (the remaining transactions were split roughly equally between pro- and anti-sandbagging clauses). Although this may be surprising, it merely underscores the difficulties practitioners, and clients alike, face in this area.

Canadian courts’ views on sandbagging

This challenge is further complicated by the fact that Canadian courts have provided little guidance as to whether pro- or anti-sandbagging provisions will be enforced in the courts. Instead, the recognition in Bhasin v. Hrynew, (2014 SCC 71) of good faith as a general organizing principle in the relations between contracting parties only raises further questions as to whether these provisions will be given legal effect.

In Bhasin v. Hrynew, Justice Cromwell’s finding that “parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract” may lead one to believe that the days of sandbagging in Canada are numbered; however, this assumption would be premature. Justice Cromwell was careful to add that the content of the duty of good faith and honest performance is a highly contextual matter, and will depend on the nature of the relationship between the parties. As a result, the content of the duty of good faith and honest performance will depend on, amongst other things, the sophistication of the parties involved in a transaction. Presumably, this means that pro- or anti-sandbagging clauses will be given effect in some but not in other transactions. What remains certain is that until the courts provide further guidance, Canadian practitioners may wish to continue avoiding the issue wherever possible.

The author would like to thank Felix Moser-Boehm, Summer Student, for his assistance in preparing this legal update.

Stay informed on M&A developments and subscribe to our blog today.