Last week we provided an overview of sandbagging in M&A transactions and outlined how buyers can mitigate their risk when an anti-sandbagging clause is included in the purchase and sale agreement. In a majority of deals, however, buyers and sellers exclude a sandbagging clause altogether, likely because they are not able to find a mutually agreeable middle ground. This week we will discuss the implications of remaining silent.

Judicial consideration of sandbagging

Unlike express sandbagging provisions, which courts in both Canada and the United States will generally enforce, there is no clear answer in Canadian case law if sandbagging is, or is not, permitted when it is not directly addressed in the agreement. The US does not provide much additional guidance, as the case law in each state varies. For example, New York takes a general anti-sandbagging position, while Delaware takes a general pro-sandbagging position. In further comparison, UK courts have historically taken an anti-sandbagging approach.

Presumption in favour of pro-sandbagging?

Case law in Canada is varied. The 2001 case Eagle Resources Ltd. v. MacDonald, 2001 ABCA 264, for example, decided in favour of the buyer and allowed a presumption of pro-sandbagging on the basis that a buyer should not be barred from enforcing a contract even if the buyer had reasons to be sceptical about the seller’s ability to perform as warranted (at para 17).

Eagle Resources was briefly referenced in the 2002 case Transamerica Life Canada v. ING Canada Inc., 2002 CanLII 22800 (ON SC), in which the motions judge struck the defendant’s pleadings, which argued a duty of good faith should prevent the plaintiff from sandbagging. In its decision, the court stated that the “enforcement of a warranty does not depend on the purchaser’s belief as to the truthfulness of the warranted facts” (at para 16). The motions judge concluded there was no overarching implied duty of good faith that would prevent a buyer from seeking indemnification for a breach of a representation that it knew about prior to closing a deal.

On appeal (Transamerica Life Canada Inc. v. ING Canada Inc. [2003] 68 OR (3d) 457), however, the pleadings struck by the motions judge were reinstated on the basis that there was a lack of jurisprudence in Canada with respect to the duty of good faith in performing contracts. As a result, the Court of Appeal held that this was an issue that had to be determined at trial, not in a pleadings motion. Unfortunately, we do not receive a conclusion for these cases as the final outcome of the Transamerica Life lawsuit is not reported, and consequently the intersection of sandbagging and the obligation of good faith between these parties was not established.

Presumption in favour of anti-sandbagging?

The recent Supreme Court of Canada case of Bhasin v. Hrynew 2014 SCC 71 may offer more clarity. This case confirmed there is in fact a duty to act in good faith and perform contractual obligations honestly. In the Court’s decision, Cromwell J. stated “parties must not knowingly mislead each other about matters directly linked to the performance of the contract” (at para 73).

Conclusion

In situations where the parties are not able to agree on a sandbagging provision, silence on the subject may be the only way to finalize the agreement. However, this leaves the parties at the mercy of the governing law, which may be difficult to discern, or worse, unfavourable to the circumstance, and largely out of the parties’ control. As a result, if at all possible, it is better to clarify the parties’ expectations in the agreement with respect to sandbagging where there is an opportunity to control the terms. This is especially true for buyers, as it appears that the duty to act in good faith as set out in Bhasin v. Hrynew could be used to argue that the parties to an M&A transaction have an implied anti-sandbagging obligation.

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