The weapon of choice for the nineteenth-century mugger was a sock filled with sand. Easy to make, easy to conceal, easy to discard without a trace and very effective at incapacitating the intended victim. Sandbagging (i.e., beating a victim with an innocent-looking sock converted by the sand filling into a truncheon) was apparently considered a particularly heinous crime involving deception, as well as physical assault. Today, of course, “sandbagging” is a term that is used not only to refer to the cheating golfer, who inflates his or her handicap to gain strokes in a match, but also to the buyer, who asserts post-closing indemnification claims against a seller based upon contractual representations and warranties, when the buyer allegedly acquired pre-closing knowledge suggesting that those contractual representations and warranties were inaccurate. But despite the derivation of the term, is a so-called “sandbagging buyer” really the equivalent of a nineteenth-century mugger or a cheating golfer? Indeed, is the term “sandbagging” even appropriate when a buyer simply insists on the benefit of its contractual bargain and resists the imposition of tort concepts into the enforcement of that bargain? And are so-called “pro-sandbagging” states really more appropriately called “contractarian” or “benefit of the bargain” states? And isn’t the reliability of a “contractarian” or “benefit of the bargain” approach to the enforcement of acquisition agreements what both sides of an M&A deal actually want?
Two recent Delaware Court of Chancery decisions have renewed interest in the question of where Delaware stands on the so-called “sandbagging buyer” question. Is Delaware, as most M&A deal professionals believed prior to the infamous Eagle Force footnote, a “pro-sandbagging” or “benefit of the bargain state,” or is it instead a state that views claims for breaches of contractual representations and warranties as the equivalent of tort claims premised upon those contractual representations and warranties, where concepts like “justifiable reliance” are requirements for enforcement?
Despite Delaware’s reputation as a particularly strong contractarian state, the Delaware Supreme Court observed in a footnote to a 2018 case, Eagle Force Hldgs., LLC v. Campbell, 187 A.2d 1209 n. 185 (Del. 2018), that the question of whether a buyer could sue upon a contractual representation and warranty made by the seller when the buyer had acquired knowledge that such contractual representation and warranty was false, either before signing or between signing and before closing, had never actually been definitively addressed in Delaware. Accordingly, while acknowledging that the majority view “holds that traditional reliance is not required to recover for breach of an express warranty,” the court simply noted that Delaware “had not yet resolved this interesting question.”
Prior to that footnote, conventional wisdom had been that it was unnecessary for buyers in Delaware-law governed acquisition agreements to specifically address any potential sandbagging claim because silence was the equivalent of a pro-sandbagging clause. But after this footnote, there was a significant stir in the transactional bar suggesting that doubt had now been cast upon the reliability of Delaware’s traditional contractarian, and therefore pro-sandbagging/benefit of the bargain, approach to the enforcement of contractual indemnification claims (as opposed to tort-based fraud claims) premised upon inaccurate contractual representations and warranties. Some deal lawyers believed firmly that Delaware-law governed acquisition agreements must now all include an express “pro-sandbagging” clause to obtain the unfettered benefit of the buyer’s bargained-for indemnification regime, while others had faith that Delaware’s reliable contractarian approach would prevail whenever the issue was joined notwithstanding the fact that the Delaware Supreme Court had not yet spoken definitively upon the issue.
While the Delaware Supreme Court has still not addressed this issue definitively, two recent Delaware Court of Chancery cases addressing sandbagging have both come out strongly on the side of contractarianism (and therefore on the pro-sandbagging/benefit of the bargain side). In the first of these two decisions, Level 4 Yoga, LLC v. CorePower Yoga LLC, 2022 WL 601862, at *13 (Del. Ch. March 1, 2022), Vice Chancellor Slights, while acknowledging that Eagle Force had noted that the issue of sandbagging had not been officially resolved in Delaware, nonetheless stated definitively that “because the APA does not contain an anti-sandbagging provision, nothing expressly prevented CorePower from closing on a tranche of studios and then seeking indemnification for a known breach.” Moreover, in a footnote referencing the Eagle Force uncertainty, Vice Chancellor Slights favorably cited a pre-2018 transcript ruling by Vice Chancellor Laster that had observed that “Delaware is what is affectionately known as a ‘sandbagging’ state.”
In the second decision, Arwood v. AW Site Services, LLC, 2022 WL 705841 (Del. Ch. March 9, 2022), Vice Chancellor Slights again weighed-in on the sandbagging issue in Delaware. This time, the Vice Chancellor stated explicitly that:
Delaware is, or should be, a pro-sandbagging jurisdiction. The sandbagging defense is inconsistent with our profoundly contractarian predisposition.
Elaborating on Delaware’s contractarian approach, Vice Chancellor Slights noted that:
When parties choose not to (or fail to) allocate the risk of sandbagging in their contract, the buyer may rest on its reasonable belief that it has acquired as part of the transaction the seller’s implicit promise to be truthful in its representations. “This view of ‘reliance’—i.e., as requiring no more than reliance on the express warranty as being a part of the bargain between the parties—reflects the prevailing perception of an action for breach of express warranty as one that is no longer grounded in tort, but essentially in contract.” Viewed through the lens of contract, not tort, the question is simple: was the warranty in question breached? If it was, then the buyer may recover—regardless of whether she relied on the warranty or believed it to be true when made. “Stated otherwise, the fact that the buyer has questioned the seller’s ability to perform as promised should not relieve the seller of his obligations under the express warranties when he thereafter undertakes to render the promised performance.” Reliance, whether justified or unjustified, is not a prima facie element of breach of contract.
As applied here, Arwood and the Selling Entities made certain representations and warranties in the APA. AWS accepted those promises when it signed the contract. Whether AWS was oblivious to their falsity pre-closing, or fully cognizant, does not matter. It was entitled to believe that it was “purchasing [the Selling Entities’] promise” that the representations and warranties were true, and it may recover damages if that promise was breached.
It is important to note that, in contrast to the buyer’s contract-based claim, the buyer’s justifiable reliance was implicated in the separate tort-based fraud claim brought by the buyer against the seller. There the court found that there was no justifiable reliance in this case:
With this symmetry in mind, [the buyer] has failed to prove justifiable reliance because [the buyer] w[as], at the very least, reckless in any reliance they might claim upon [the seller’s] misleading omissions. This is not a case where a buyer simply failed to discover the hidden skeleton in the closet during due diligence. Rather, [the buyer] passed warning sign after warning sign as the information [the buyer] now points to as the source of the fraud stared them in the face. The preponderance of the evidence reveals they either saw the evidence of improper billing, improper lien practices and damaged vendor relationships and chose to ignore it, or they somehow missed what [the seller] placed right before their eyes. Either way, any reliance they might now claim cannot be deemed justified.
To Vice Chancellor Slights, silence in a Delaware-law governed acquisition agreement is the equivalent of a pro-sandbagging provision and a seller who wishes to avoid application of that rule respecting contract-based claims needs to specifically bargain for an anti-sandbagging clause. A contact-based claim premised upon an express representation and warranty (unlike a tort-based fraud claim) does not require “justifiable reliance.” The contractual obligation to indemnify, like any other contract-based claim, is simply based upon the fact that a breach of a contractual warranty occurred, without any externally imposed pre-conditions.
And despite some discomfort with the idea of a sandbagging buyer, it is largely a myth that buyers deceptively concoct strategies, like the nineteenth-century mugger, to “lay in wait on the other side of closing with a breach claim he knew before closing he would bring against the seller.” Buyers hate sandbagging claims in much the same way as sellers hate extra-contractual fraud claims—they are easy to allege, difficult to disprove and susceptible to the erroneous conclusions of judges and juries. In other words, defeating sandbagging claims by sellers against buyers is as much about avoiding the need to defend one’s self against allegations based on who knew what when as it is a deliberate effort to actually engage in sandbagging as a strategy. And as was noted in a 2007 article, which was appropriately titled Debunking the Myth of the Sandbagging Buyer: When Sellers Ask Buyers to Agree to Anti-Sandbagging Clauses, Who Is Sandbagging Whom?, there are a number of reasons (which would not “involve morally questionable behavior”) why a buyer may close over potentially inaccurate warranties notwithstanding it having allegedly acquired some knowledge suggesting those warranties were inaccurate at signing or closing.
It is important to note that in deals where there is no post-closing indemnity and recourse is limited to representation and warranty insurance, there is typically a built-in anti-sandbagging exclusion. Buyer’s simply cannot, as a matter of contract with the insurer, make a claim against the insurer if they knew that a particular warranty was inaccurate when made. But to the extent old-fashioned indemnification by the seller is part of your deal, the debate about sandbagging may well continue. And, despite the uncertainty created by the infamous Eagle Force footnote, the recent indications from the Delaware Court of Chancery still point to silence as being golden for the buyer (and requiring the seller to bargain for an anti-sandbagging clause should the seller wish to condition the enforcement of its contractual warranties on the buyer’s lack of any prior knowledge of their purported inaccuracy). Hopefully, the Delaware Supreme Court will have occasion to confirm this in the future consistent with Delaware’s reliable contractarianism.
- See generally, Glenn D. West & Kim M. Shah, Debunking the Myth of the Sandbagging Buyer: When Sellers Ask Buyers to Agree to Anti-Sandbagging Clauses, Who is Sandbagging Whom?, The M&A Lawyer, Vol. 11, No.1 (Jan., 2007), available here.↵
- See Eagle Force Holdings LLC v. Campbell, 187 A.3d 1209, 1236 n. 185 (Del. 2018).↵
- See Glenn West, A Delaware Supreme Court Footnote Reignites Concerns about the Reliability of Contractual Representations & Warranties–Are Deal Lawyers Really Going to Start Debating Sandbagging Again? Weil Insights, Weil’s Global Private Equity Watch, October 1, 2018, available here.↵
- Arwood v. AW Site Services, LLC, 2022 WL 705841, at *3 (Del. Ch. March 9, 2022).↵
- Id. at *31 (citations omitted). Vice Chancellor Slights also noted, however, that even if Delaware were not a pro-sandbagging/benefit of the bargain state, a sandbagging claim still would have been unavailing in this case because the buyer had not been shown to have actually known about the falsity of the contractual warranties pre-signing, but instead had simply fallen into the category of buyers who chose to ignore red flags that should have alerted them to its falsity. Recklessness or indifference to facts in front of the buyer that should have called into question the reliability of the contractual warranty, without evidence of actual knowledge of its falsity, is simply not enough to implicate sandbagging as a defense to a contract-based claim, even if the sandbagging defense applies in Delaware.↵
- Id. at *25. There is an interesting question as to whether justifiable reliance remains an element of a fraud claim based upon contractual representations and warranties, as opposed to extra-contractual representations or omissions. In Arwood, the buyer had not pursued a claim of fraud based upon contractual representations and warranties, only a claim of fraud based upon extra-contractual fraud and omissions. In a footnote, Vice Chancellor Slights suggested that proof of justifiable reliance may be unnecessary where the written acquisition agreement specifically provided that the buyer was relying upon the express contractual warranties. But in so suggesting, Vice Chancellor Slights then cited to two Delaware Court of Chancery decisions that appeared to reach contrary positions on this issue. He did not go on to add his position because “[t]hat issue has not been joined in the briefs, … so I do not address it here.” Id. at *23 n. 236.↵
- In an interesting twist to this case, the Arwood opinion was amended on March 24, 2022. The purpose of the amendment was to note that despite the March 9th opinion having assumed that the APA was silent on the issue of sandbagging, the APA in fact contained a form of a pro-sandbagging clause. But neither party had referred to this clause in their briefing. Notwithstanding the fact that there was apparently a pro-sandbagging clause, Vice Chancellor Slights reaffirmed that it didn’t matter under Delaware common law because silence was the equivalent of a pro-sandbagging clause and, in the absence of an anti-sandbagging clause, Delaware does not or should not recognize sandbagging as a defense.↵
- See id. at *30.↵
- West & Shah, supra note 1, at 3.↵