The contractual liability concept within the framework of a company purchase agreement differs to a large extent from the statutory provisions of the law on the sale of goods. It is a combination of warranty declarations, disclosures by the seller, knowledge of the buyer and the definition of the facts that fulfil liability (concept of damage, maximum liability limits, de minimis, exemption amount, etc.). According to Section 442 (1) BGB, the buyer's rights are excluded if he is aware of the defect when the contract is concluded. This provision is dispositive, but the concept as such corresponds to the market standard, at least for transactions in Germany. In the international context, however, this is the subject of intensive and open-ended negotiations. In the USA, so-called pro-sandbagging clauses are also regularly agreed, according to which buyer knowledge at the conclusion of the contract is harmless. The concepts are often (unintentionally) mixed up. The following article provides an overview and offers a suggestion as to how the concepts can be contractually modelled.
Knowledge of the buyer vs. "sandbagging" - regulatory concepts and liability risks
The liability concept in company purchase agreements is initially simple. The seller makes so-called independent warranty promises and if these turn out to be false, he is liable to the buyer up to an agreed maximum liability limit.
However, this liability concept is supplemented by other aspects, all of which are interlinked. The buyer carries out (legal) due diligence (DD for short), the results of which have a significant influence on the guarantee catalogue and the buyer's risk appetite. The disclosure of a wide range of information as part of the DD and the negotiation of the purchase agreement should have an exculpatory effect from the seller's point of view. This is done either by limiting or specifying the respective guarantee or by way of an exclusion of claims if the buyer is aware of them. The latter is flanked by certain clauses according to which information, in particular the data room content, is deemed to be positively known to the buyer.
In the international (predominantly US-American) context, the concept of so-called sandbagging can be found. Pro- or anti-sandbagging clauses regulate whether and to what extent the buyer's knowledge leads to the exclusion of his claims. Sandbagging clauses are therefore the counterpart to the German regulation of exclusion of liability in the event of the buyer's knowledge. In some cases, the term "anti-sandbagging clause" is also used in relation to a specific buyer's warranty, according to which the buyer confirms that he was not aware of circumstances that contradict the seller's warranty when the purchase contract was concluded (more on this below).
Overall, the contractual liability regime will then continue to be accompanied by legal figures that are not dispositive by law, such as the statement in the blue, which - if the conditions are met - leads to unlimited liability on the part of the seller. The goal of a clear, balanced concept between buyer and seller can only be achieved by maintaining an overview of the various instruments.
Guarantee declarations and legal consequences
The key elements of the contractual liability concept are the independent warranty promises in connection with the legal consequences of a breach of warranty. The seller declares that a number of statements (the warranties) are correct on the date of signing (conceivably also on the date of execution). If these statements subsequently turn out to be incorrect, the seller is generally liable to the buyer for restoring the goods to their lawful condition (in rem restitution). Since the lawful condition can generally no longer be restored, the buyer can demand monetary compensation from the seller.
The calculation of damages is then initially based on the definition of compensable damages. We have already written an article on this, to which reference is made. As a rule, it will be a question of compensation for direct and indirect damage. The latter often only insofar as it was reasonably foreseeable.
Other regulations relevant to the assessment of damages include any maximum liability limits, de minimis amounts, allowances or limits and limitation rules.
Role of disclosures by the seller
In connection with a buyer's knowledge that prevents a claim, the question of the role of disclosures by the seller arises time and again. Disclosures can be made in a variety of ways. The majority of disclosures are made as part of the DD via the data room, the Q&A process or expert calls. However, this refers to disclosures in the form of annexes (so-called disclosure schedules) to the guarantee catalogue in the SPA (Share Purchase Agreement).
These disclosure systems are also intended to bridge any information asymmetry between buyer and seller. However, they have nothing to do with the principle of exclusion of liability if the buyer is aware.
Warranty declarations are usually formulated in abstract, general terms. However, abstract-generally formulated statements rarely apply to a company to be sold. Guarantees are therefore accompanied by annexes that serve to concretise the guarantee.
They can be structured in such a way that they give the guarantee declaration its meaning in the first place (e.g: Schedule [●] contains a complete list of...). Without the corresponding attachment, the guarantee declaration is therefore meaningless.
However, the disclosure can also be formulated as a limitation of an otherwise blanket guarantee (Ex: The Company owns all of the Owned Real Property free and clear of encumbrances, other than as listed in Schedule [●]). In these cases, it is not a question of defining the meaning of the guarantee, but of formulating an exception to an abstract guarantee declaration. Since the disclosure annex restricts the explanatory content of the guarantee declaration, the circumstance disclosed here cannot justify a breach of guarantee. There is therefore no claim for breach of warranty, which could be excluded in a second step due to the buyer's knowledge.
Exclusion of liability with knowledge of the buyer
The principle of exclusion of liability with knowledge of the buyer states that a buyer cannot assert any claims in the event of a breach of warranty if he was aware of the circumstance giving rise to the breach of warranty when the purchase contract was concluded.
For German lawyers, this concept is completely natural and already follows from the law.
§ Section 442 (1) BGB: The buyer's rights are excluded if he was aware of the defect when the contract was concluded.
This is probably in line with the "German" understanding of guarantees. They are intended to provide cover for unknown events or circumstances that existed when the contract was concluded but only became known after the contract was concluded. However, Section 442 BGB is regularly excluded in the purchase contract. This is due to the fact that Section 442 para. 1 sentence 2 BGB also extends to grossly negligent ignorance, which is not the rule for company purchase agreements. However, the concept is otherwise reflected in the contract.
In addition to this provision, the purchase agreement will contain agreements as to whose knowledge on the buyer's side is important here. The relevant persons will be at least the members of the deal team. It is also possible to include advisors of the buyer with whom significant deal-related communication took place during the transaction (e.g. M&A advisor or lead lawyer).
In terms of content, it is primarily about information that was shared with or known to the buyer as part of the transaction. The purchase agreement will often even contain a fiction that certain information is deemed to be known to the buyer. This includes the content of the purchase agreement, the content of the data room, the content of the Q&A process and the content of the information material provided by the seller (CIM, vendor reports, fact books, etc.). For a range of information, the positive knowledge of the buyer is therefore not important at all. This is an extremely unfavourable provision for the buyer, but it can be balanced out with the following compromise: The knowledge fiction should only apply insofar as the relevant content has been "fairly disclosed", i.e. disclosed in an appropriate manner. The definition of "fair disclosure" can then be adjusted almost infinitely between seller- and buyer-friendly.
As already indicated, however, this principle is anything but self-evident in an international context. In the USA, for example, negotiations on the equivalent, so-called "sandbagging", are open-ended.
Sandbagging - exclusion of knowledge from an international perspective
The concept of the Sand dredgers supposedly comes from golf and refers to a player who pretends to be worse than he is in order to obtain a more favourable handicap and thus better chances of winning. Applied to the purchase of a company, it refers to a buyer who conceals any knowledge of contradictions to the warranty declarations before the contract is concluded. He does this in order to claim damages after the purchase agreement has been concluded and thus subsequently reduce the purchase price.
While for German lawyers the exclusion of liability in case of knowledge is almost self-evident, in the international context there are often intensive negotiations as to whether sandbagging should be excluded or generally possible. Arguments in favour of sandbagging include the fact that there should be no later dispute as to whether the buyer had knowledge or whether information was "fairly disclosed" or not. Furthermore, a pro-sandbagging clause encourages disclosure within the guarantee declaration, which provides clarity as to which circumstances should not be covered by the guarantees. Finally, M&A processes are complex and no due diligence is perfect. Accordingly, a buyer will not want to accept the blanket disclaimer on knowledge because he cannot conclusively process or evaluate the available information in a short period of time.
As a result, the so-called sandbagging and the exclusion of liability in the case of knowledge of the buyer have the same subject matter, except that the concept of sandbagging is actually negotiated open-endedly. With regard to the exclusion of liability in the event of knowledge on the part of the buyer, the negotiation is regularly limited to the persons relevant to knowledge, the fiction of knowledge and the definition of Fair Disclosure.
Excursus: So-called "anti-sandbagging" guarantee
In some "German" transactions there is a guarantee declaration by the buyer, according to which the buyer confirms that at the time the contract is concluded he has no knowledge of circumstances that would lead to the seller's guarantee being incorrect. This buyer's warranty is often also referred to as an "anti-sandbagging" clause.
However, the intended function of this clause is not entirely clear. It is possible that the intention is that the buyer would be liable for damages if he asserts a breach of warranty based on a circumstance that was known to the buyer when the contract was concluded. The seller's claim for damages would then presumably coincide with the buyer's claim for damages for breach of warranty. The claims would then theoretically be mutually exclusive.
If this effect is actually intended, the guarantee makes no sense if the seller's liability is excluded anyway when the buyer is aware of it. However, if this is not the case or, on the contrary, the contract provides for a pro-sandbagging clause, a corresponding buyer's guarantee could be considered. It may be possible to reach a compromise whereby the buyer's knowledge should not be detrimental, unless the buyer has a specific breach of warranty in mind when concluding the contract and wants to reduce the purchase price afterwards. However, this would require a precise contractual coordination of the pro-sandbagging regulation and such a buyer's guarantee.
Conclusion
The term "sandbagging" refers to nothing other than the contractual provisions as to whether or not the buyer's knowledge at the time the contract is concluded should exclude potential claims for breach of warranty. In the context of German transactions, the exclusion of liability if the buyer is aware is the market standard. In the international context, this is the subject of intensive negotiations. A buyer's warranty according to which the buyer has no knowledge of circumstances infringing the warranty when the contract is concluded makes no sense in conjunction with an anti-sandbagging provision. The purpose of the provision should also be critically scrutinised and, if necessary, precisely defined in the contract in order to avoid contradictions.