Academic journal article Journal of Corporation Law

Knowledge Is Not Necessarily Power: Sandbagging in New York M&A Transactions

Academic journal article Journal of Corporation Law

Knowledge Is Not Necessarily Power: Sandbagging in New York M&A Transactions

Article excerpt

I. INTRODUCTION II. BACKGROUND    A. Sandbagging Explained    B. The Foundation of the Current Rule    C. The CBS Rule Gets Clarified    D. Putting It All Together: New York Sandbagging Law Today III. ANALYSIS    A. The Arguments for Incorporating a Sandbagging Provision    B. The Arguments for Incorporating an Anti-Sandbagging Provision    C. When the Acquisition Agreement is Silent on Sandbagging or    Anti-Sandbagging IV. RECOMMENDATION    A. Recommendation for a Buyer    B. Recommendation for a Seller    C. Recommendation for New York Courts When the Acquisition    Agreement is Silent on Sandbagging or Anti-Sandbagging        1. When Someone in the Buyer's Due Diligence Team Receives       Actual Knowledge But Does Not Pass it Along       2. When Someone in the Buyer's Due Diligence Team Receives        (Potentially) Constructive Knowledge But Does Not Realize the       Misrepresentation and Thus Does Not Pass it Along V. CONCLUSION 

I. INTRODUCTION

Sandbagging is a practice in the mergers and acquisitions (M&A) (1) context that involves "one party to an acquisition agreement (most often a buyer) seeking post-closing indemnification for breaches of representations and warranties, which breaches that party was aware of prior to signing the acquisition agreement or, in some cases, closing the transaction." (2) Buyers and sellers of businesses should be aware of this practice as it has implications for both of them. For buyers, it is a potential avenue for indemnification, and for sellers, it means a potential lawsuit. (3) Parties can directly approach this issue by incorporating sandbagging or anti-sandbagging provisions into the acquisition agreement. (4)

However, if either party does not do so and the acquisition agreement is silent on sandbagging, the state law governing the acquisition agreement will determine the appropriate outcome. (5) The focus of this Note, the State of New York, has ambiguous sandbagging case law that has made it difficult to predict what the appropriate outcome would be for buyers and sellers of businesses. (6) Despite that ambiguity, this Note argues that the New York approach is preferable to other approaches--such as those seen in California and Delaware--because it is the most equitable to all parties.

This Note will proceed as follows. Part II will begin with a background on sandbagging that includes a detailed discussion of what sandbagging is, sandbagging trends in the M&A community, and how various courts, with an emphasis on New York courts, approach sandbagging when an acquisition agreement is silent on the matter. Part III will give arguments on the reasons for incorporating a sandbagging or anti-sandbagging provision and it will discuss the various ambiguities under New York sandbagging law. Part IV will include sandbagging related recommendations for buyers and sellers in a transaction. It will also give recommendations for how New York courts, when the acquisition agreement is silent on sandbagging, can solve some of the current ambiguities that have arisen due to the relevant case law. Finally, the Note will conclude with Part V, which will give a brief summary of this Note.

II. BACKGROUND

This Part will first begin with a more detailed discussion of what sandbagging is--including examples of sandbagging provisions and anti-sandbagging provisions. This Part will then provide a brief discussion of sandbagging trends within the M&A community. It will then discuss how various jurisdictions approach sandbagging when the acquisition agreement is silent on the matter, with an emphasis on New York state law.

A. Sandbagging Explained

Sandbagging is a practice in the M&A context that involves "one party to an acquisition agreement (most often a buyer) seeking post-closing indemnification for breaches of representations and warranties, which breaches that party was aware of prior to signing the acquisition agreement or, in some cases, closing the transaction. …

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