July 19, 2004
Can Buyer Know Too Much?
Can Buyer Know Too Much?
Speaking of buyer’s investigation, did you think that I’d miss this opportunity to plug our Deal Points Study?
The question: how does the buyer’s knowledge acquired in the due diligence process (or otherwise) affect the buyer’s right to rely on the seller’s representation and warranties with regard to indemnification, walk rights, and other remedies? Specifically, what did the parties actually negotiate on the allocation of this risk?
Our Study shows that 49% of deals expressly reserved to the buyer the right to rely on the seller’s representation and warranties – notwithstanding the buyer’s knowledge of an inaccuracy in the seller’s representation and warranties. Because such provisions may be viewed by the cautious seller as an invitation for the buyer to “close-and-sue,” these types of provisions are sometimes affectionately known as “sandbagging” clauses (the buyer would, of course, prefer to call them “benefit-of-the-bargain” clauses).
Typical “sandbagging” language runs the gamut from stealthy provisos stating that “the seller’s representations and warranties survive the Closing and any investigation conducted by the buyer” to the more detailed provisions that also deal with issues of constructive knowledge, such as the following from the ABA’s Model Asset Purchase Agreement:
“The right to indemnification, reimbursement or other remedy based upon such representations, warranties, covenants and obligations shall not be affected by any investigation (including any environmental investigation or assessment) conducted with respect to, or any Knowledge acquired (or capable of being acquired) at any time, whether before or after the execution and delivery of this Agreement or the Closing Date, with respect to the accuracy or inaccuracy of or compliance with any such representation, warranty, covenant or obligation.”
On the other hand, an aggressive seller may attempt to include a so-called “anti-sandbagging” provision that precludes an indemnity claim by the buyer for breaches known by the buyer before closing. An example of such a clause is:
“[t]he Company Stockholders and Company Optionholders shall not be liable under this Article VII with respect to any Damages arising out of or related to matters within the knowledge of Parent at the Effective Time…”
(Proton Energy Systems, Inc. acquisition of Northern Power Systems, Inc.)
Our Study found 6 deals in 2003 (7.2% of the deals reviewed) with anti-sandbagging clauses compared with 6 deals in 2002 (6.8%), 5 deals (5.88%) in 2001, and only 1 deal in 2000. As such, we’ll stick our necks out with the observation that this slight upward trend may be an indication of sellers having more success at the negotiation table. On the other hand, are there just more MBOs in the study sample (where knowledge-based limitations may be a more frequent topic of discussion since seller’s key management just flipped to buyer’s side)?
Interestingly, about 43% (up from 34% in 2002) of the deals in our Study were silent on this investigation-survival issue. Assuming that it is a virtually standard practice for the buyer’s first draft to include a benefit-of-the-bargain provision, silence on this issue may still be a “win” for the seller because it could mean that the seller was successful at negotiating out that clause. At the very least, we can expect this issue to continue receiving more attention at the negotiation table.
Before you blindly pull the trigger on a close-and-sue option, check out the detailed analysis of the legal and practical arguments regarding benefit-of-the-bargain and anti-sandbagging clauses in the Commentary to Section 11 of the ABA’s Model Asset Purchase Agreement.
If you’d like a free copy of our Deal Points Study, just email me or Larry.