Chancery Court Affirms Delaware’s Status as “Pro-Sandbagging” Jurisdiction

March 31, 2022

In a March 9, 2022, opinion, the Delaware Chancery Court examined a seller’s argument that the buyer in an asset purchase agreement was prohibited from asserting claims for contractual breach of representations in the agreement because it knew that such representations were false prior to closing. In rejecting the seller’s position and granting the buyer’s claim for breach of contract, the court affirmed Delaware’s position as a “pro-sandbagging” state, advising parties that any understanding to the contrary should be clearly set forth in a purchase agreement.

In Arwood v. AW Site Services, LLC, the Chancery Court had occasion to address Delaware’s status as a “pro-sandbagging” jurisdiction. As the court explained, “sandbagging” in the context of a business or asset acquisition occurs when a buyer closes on a transaction with full knowledge of the falsity of a seller’s representation and then seeks damages for the seller’s breach after the close of the deal. In his Arwood opinion, Vice Chancellor Joseph Slights held that, in his view, Delaware remains a “pro-sandbagging” jurisdiction and that, in the absence of contractual language to the contrary, buyers are entitled to enforce the representations they purchase. Because breach-of-contract actions, unlike claims for fraud, do not contain an element of reliance, buyers are entitled to bring suit for breaches of representations and warranties even if they are aware of the alleged breach prior to closing.

The Arwood opinion further held that, even if a seller were permitted to assert a sandbagging defense to prohibit a buyer’s breach-of-contract recovery, in order to be successful, a seller must show that the buyer “actually knew pre-closing that the seller’s representations were false,” and that reckless indifference to the truth, or a claim that the buyer should have known of the falsity, is insufficient, as it is less than the actual knowledge required.

To avoid the default “pro-sandbagging” rule, sellers negotiating purchase agreements governed by Delaware law should seek to include “anti-sandbagging” clauses in their contracts that specifically prohibit claims for breach if the buyer (or specifically identified individuals at the buyer) knew, or should have known, about the alleged falsity of the representations and warranties at issue.