India: Sandbagging And Anti-Sandbagging Provisions: A Mixed Bag

Introduction to Concepts of Sandbagging and Anti-Sandbagging

Typically, in M&A transactions, buyers undertake due diligence on targets prior to consummation of the transaction, to identify and assess key legal risks involved in the transaction. Due diligence is fundamental to M&A transactions as it enables buyers to ascertain and evaluate critical factors pertaining to targets, inter alia their assets, liabilities, financial position, business risks, and compliance levels. Basis findings of such due diligence, buyers, on the financial front, appropriately factor the identified risks while calculating the purchase consideration and, on the contractual front, require the seller to provide specific representations and warranties, backed by appropriate indemnities, to seek protection in case of a breach.

Sandbagging provisions, also called pro-sandbagging provisions, are widely used and negotiated in M&A transactions to cover scenarios where a buyer proceeds with a transaction despite knowing of the falsity of certain representations or warranties made by the seller, before consummating the transaction. These provisions enable buyers to raise indemnification claims against sellers for breaches despite knowledge of the same.

While inclusion of sandbagging provisions is insisted by buyers, sellers often insist upon the inclusion of anti-sandbagging provisions. Anti-sandbagging provisions prevent buyers from making indemnification claims where the buyer had knowledge of a breach of representations or warranties made by the seller before consummating the transaction. Nevertheless, claims arising out of critical pre-identified liabilities are often sought to be covered by buyers by way of specific indemnities.

The scope of "knowledge" becomes fundamental where agreements contain anti-sandbagging provisions. Relevant considerations include whether "knowledge" would be construed to mean actual as well as constructive knowledge, whether such knowledge extends to employees/ key personnel of the buyer etc. A broader definition that includes implied or constructive knowledge impedes the buyer from pleading ignorance to prior knowledge of facts giving rise to an indemnification claim.

Jurisprudence

In GWL Properties v. James Mackintosh & Company Private Limited¹, an arbitral award favouring the buyer was challenged. The seller contended that since the buyer had conducted due diligence on the seller, it could not claim suppression of documents or material facts. The Bombay High Court upheld the arbitral award, and held that, since the share purchase agreement contained sandbagging provisions, the buyer's reliance upon representations and warranties would not be affected by the due diligence conducted prior to the transaction.

Where the agreement does not explicitly contain sandbagging or anti-sandbagging provisions, the matter becomes subject to interpretation by courts.

Across jurisdictions, judicial interpretations differ, as seen in the US Court of Appeal's stance in Frank A. Galli v. James T. Metz and Delaware Chancery Court's decision in Arwood v. AW Site Services, LLC, reflecting both pro and anti-sandbagging perspectives. The US Court of Appeal for the Second Circuit in Frank A. Galli v. James T. Metz², leaning towards an anti-sandbagging approach, held that, where buyers had full knowledge and acceptance of the facts leading to a breach of warranties, unless such right was expressly preserved by the buyer in the warranties, the right to make a claim against such breach would be deemed to have been waived. In Arwood v. AW Site Services, LLC, the Delaware Chancery Court, referring to Delaware as a "pro-sandbagging" jurisdiction, held that buyers are entitled to relief if they have purchased "the seller's promise as to the truth". The Chancery Court also referred to the Delaware Superior Court's judgement in Interim Healthcare, Inc. v. Spherion Corp³., wherein it was held that buyers are entitled to rely upon the accuracy of representations irrespective of due diligence findings to the extent that the seller warranted such facts or circumstances to be true in the agreement.

Under Indian law, if consent of a party has been obtained by misrepresentation, the contract is voidable at the option of the party whose consent was so obtained, except in cases where the party whose consent was so obtained had the means of discovering the truth with ordinary diligence. The courts in India have held that if a person has affirmed the contract by express notice or conduct, they cannot later seek to avoid such contract. In Sudhakar Tiwari v Delhi Development Authority⁴, where the licensee had retained possession of the property in question even after becoming aware of the misrepresentation as to its utilisable area, the Delhi High Court held that he had elected to affirm the contract and thus could not be permitted to avoid it.

Application of doctrine of Caveat Emptor

The doctrine of caveat emptor, i.e., "let the buyer beware", is a globally recognised principle of contract law and is summarised by Black's Law Dictionary as "the purchaser of an article must examine, judge, and test it for himself, being bound to discover any obvious defects or imperfections, thereby shifting the burden upon the buyer". In Mr. Rajesh Gupta v. Sh. Ram Avtar⁵, the Delhi High Court observed that the principle of 'caveat emptor' does not apply where an express representation is made by the seller and is relied upon by the purchaser. While the principle of caveat emptor imposes a general responsibility on buyers to exercise prudence and care, the inclusion of express representations can alter how this principle is enforced.

Conclusion

In summary, well-drafted sandbagging or anti-sandbagging provisions become extremely important for both buyers as well as sellers since the absence of explicit contractual provisions would open doors to judicial interpretation. While courts have taken a varied approach on these issues across the globe, there is a dearth of legal precedents concerning sandbagging clauses in the Indian context.

Footnotes

1. 2012 SCC OnLine Bom 404

2. 973 F.2d 145 (2d Cir. 1992)

3. 884 A.2d 513, 548 (Del. Super. Ct. 2005)

4. 2016 SCC OnLine Del 667

5. O.M.P. Comm. 121 of 2020

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