Originally published in ALM's Delaware Business Court Insider
In the M&A context, the term “sandbagging” refers to one party asserting a claim based on a representation made in connection with the transaction despite knowing or having had reason to know pre-closing that the representation was inaccurate. Jurisdictions have split among “pro-sandbagging” and “anti-sandbagging” positions. Delaware generally has been viewed as a pro-sandbagging jurisdiction, which Vice Chancellor Joseph Slights recently confirmed in Arwood v. AW Site Services, 2022 WL 705841 (Del. Ch. Mar. 9, 2022). As the Vice Chancellor wrote in Arwood, “in my view, Delaware is, or should be, a pro-sandbagging jurisdiction. The sandbagging defense is inconsistent with our profoundly contractarian predisposition. Even if Delaware were an anti-sandbagging jurisdiction, I am not satisfied that a buyer’s reckless, as opposed to knowing, state of mind would trigger the doctrine in any event.” Applied in that case, the sellers could not escape liability based on a sandbagging defense, including because they failed to prove the buyers actually knew pre-closing that a representation was false.
In In re Dura Medic Holdings Consolidated Litigation, 2025 WL 559233 (Del. Ch. Feb. 20, 2025), Vice Chancellor J. Travis Laster again confirmed Delaware’s pro-sandbagging position.
Background
This post-trial decision arose out of the sale of a privately held company in the medical equipment industry, Dura Medic, Inc., to a private equity buyer, Comvest, via a merger. Post-merger, the company performed poorly. The buyer sued the selling stockholders for indemnification in connection with alleged breaches of three representations and warranties in the merger agreement. Those representations concerned the company’s collection rates and earnings, notice of any material customers terminating or limiting their accounts and undisclosed audits.
The Court of Chancery Rejects Sellers’ Sandbagging Defense
At trial, the buyer established a breach on the second issue. The sellers failed to disclose that two significant customers had given notice of their intent to terminate or limit their relationship with the company. The buyer also established a breach on the third issue. The company received increasing regulatory scrutiny prior to closing and was subject to several audits that the sellers failed to disclosure on the relevant disclosure schedule as required by the agreement.
Relevant here, regarding one of the undisclosed audits, the sellers argued that they had in fact informed the buyers of the audit on a conference call prior to closing. According to the Vice Chancellor Laster, however, the sellers’ argument was irrelevant. In the court’s words, “for purposes of the contractual representation in the merger agreement, whether the sellers disclosed the … audit to the buyers outside the merger agreement has no bearing on the legal analysis.” The court cited pro-sandbagging authorities in Delaware, explaining that reliance is not an element of a claim for breach of representation and warranty. The Vice Chancellor also endorsed Delaware’s pro-sandbagging stance. The court explained the acceptance of sandbagging as a matter of contractual risk allocation in the transaction diligence process that imposes the risk of inaccuracies on the seller. According to the court, a pro-sandbagging position “keeps with Delaware’s contractarian regime, particularly in light of Delaware’s willingness to allow parties to restrict themselves to the representations and warranties made in a written agreement.”
The court also cited the merger agreement’s integration clause as foreclosing the sellers’ argument that the buyers’ knowledge of the audit effectively modified the agreement’s terms. Additionally, the court went on to find that the trial record did not support the sellers’ contention that they disclosed the audit or that the buyers otherwise learned of the audit pre-closing. Ultimately, the buyers were awarded as damages certain expenses they incurred in dealing with the undisclosed audits.
Key Takeaway
Several decisions from the Court of Chancery, including most recently Dura Medic, confirm Delaware’s pro-sandbagging position. However, dicta from the Delaware Supreme Court may be read to suggest otherwise. See Eagle Force Holdings v. Campbell, 187 A.3d 1209, 1236 n.185 (Del. 2018). In any event, Delaware law remains contractarian and parties therefore should consider provisions unambiguously adopting or disclaiming default sandbagging rules. Accordingly, sellers wishing to avoid sandbagging of the type asserted in Dura Medic should consider including an anti-sandbagging provision in their transaction agreement.
