Canadian Lawyer

June 2022

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BANKING ON CORPORATE UPFRONT High-concept sandbags When parties to M&A deals press their advantage by exaggerating their weaknesses Neill May is a partner at Goodmans LLP in Toronto focusing on securities law, with an emphasis on M&A and corporate finance. The opinions expressed in his articles are those of the author alone. However, the tendency of agreements to be silent on the point begs the question of how it tends to be approached by courts. Though there have periodically been question-raising comments from Delaware courts, the Delaware Supreme Court has not definitively addressed the point. That state is generally thought to be a pro-sand- bagging jurisdiction. The recent decision of the Chancery Court in Arwood v. AW Site Services, LLC supports this view. In that case, the court rejected the sellers' argument that, given the buyer's intimate knowledge of the sellers' business and unre- stricted access to information in diligence, the buyer either knew the sellers' representations to be untrue or acted with reckless disregard for the truth. The court expressed the Delaware stance succinctly: "The sandbagging defense is inconsistent with our profoundly contracta- rian predisposition." By contrast, New York, another frequent choice for governing law, is generally considered to be an anti-sandbag- ging jurisdiction. Canadian courts have not been entirely consistent on the point. There is reference in some of the case law, perhaps predictably, to the concept of "good faith." The question in Canada is likely to be considered under the rubric of the Supreme Court of Canada's 2014 decision in Bhasin v. Hrynew, which recog- nized an organizing principle of good faith and a duty of honest performance in Canadian contract law. Though it's not clear how Canadian courts would approach the issue, the Bhasin case suggests that Canadian courts would be unlikely to take a strong and uniform pro-sandbagging approach. It is likely that the concept will endure as an issue in acquisition negotiations. I suspect this not only for the reasons noted, but because the sandbag in my gym has never lost a boxing match with me ever, demonstrating its dura- bility as well as its heartlessness, as it just stares back at me, unsympathetic. IN M&A negotiations the concept of "sand- bagging" arises so frequently that one wishes that the term had a more exotic or entertaining origin. As a general matter, "sandbagging" describes a circumstance in which a party pretends to be in a weaker position than it is in order to gain longer-term advantage (like a pool hustler). In the context of negotiation of purchase agreements, the term comes to mean a buyer closing an acquisition based on representa- tions in the agreement it knows to be false, and then suing, post-closing, for breach of those same representations. In view of the detailed diligence that buyers often perform, the issue arises frequently. I like to think that the evocative term might have arisen from the practice of people hitting others with bags ostensibly of sand but instead holding something like bricks. But my lazy research has failed to uncover anything so colourful. Parties negotiating acquisition agree- ments have three ways to address this ques- tion: pro-sandbagging language (which favours the purchaser, expressly giving it the right to sue for breaches of representa- tions it knew to be inaccurate); anti-sand- bagging language (which provides the opposite, sometimes coupled with a specific representation that the buyer is unaware of any misrepresentations, and is thus favour- able to the seller); and silence. Correspondingly, different jurisdictions have three approaches to litigation where sandbagging is an issue: some are thought to be pro-sandbagging, some anti-sandbag- ging, and in others the answer is not clear. The arguments in favour of sandbagging include the paramountcy of the contractual language: parties should be bound by their written commitments, and to find otherwise is to invite uncertainty and cost. Purchasers may also argue that sandbagging encourages care in the framing of representations and preparation of disclosure schedules, which also support clarity and certainty. Another point that will resonate with acquirors and their advisors is that diligence is often an immense task. Being pinned with knowledge of information buried somewhere in a data room that undermines the remedies for the buyer is daunting. Anti-sandbagging arguments are based on reluctance to allow buyers to game the exercise by purchasing with a known breach and thereby essentially reducing the purchase price. Surveys have consistently shown that acqui- sitions agreements in both Canada and the United States tend to opt for silence, meaning that agreements often do not include any form of express sandbagging provision. Naturally the terms of an agreement depend on the particular fact circumstances, the parties' relative bargaining strength, the scope of the diligence conducted, the relationship of the parties, and other factors. "Different jurisdictions have three approaches to litigation where sandbagging is an issue" www.canadianlawyermag.com 13

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