January 17, 2023

Sandbagging: What About Deals With RWI Policies?

Kramer Levin recently published a memo on “sandbagging” that covers the various contractual approaches parties can take to the issue & the default rules that New York and Delaware will apply in the event that an acquisition agreement is silent on whether sandbagging is permitted. One aspect of the memo that I thought was particularly interesting was a section addressing sandbagging and rep & warranty insurance:

It is increasingly common for the parties to an acquisition to obtain representation and warranty insurance. These policies typically have their own form of anti-sandbagging clause: an exclusion from coverage if the insured had knowledge of the applicable breach, as commonly supported by a “no claims” declaration whereby buyer declares that, as of the time the policy is bound and at closing, it does not have such knowledge of a breach.

But such exclusions typically are drafted narrowly, excluding coverage only when a buyer had actual knowledge of the breach — not just knowledge of the facts underlying or causing the breach, and not covering any form of constructive knowledge or knowledge that would have been obtained upon due inquiry. And they are likely to exclude coverage only if a narrowly defined group of named deal team members had the requisite knowledge.

In addition, an insurer’s rights and obligations under the policy are (with some exceptions) typically derivative of those under the acquisition agreement. Thus, an insurer defending a claim could potentially invoke whatever sandbagging arguments would have been available to the seller under the acquisition agreement.

The memo finds it notable that pro-sandbagging clauses appear to be significantly more common in deals covered by representation and warranty insurance. In that regard, SRS Acquiom’s most recent Deal Terms Study found a pro-sandbagging clause in 59% of private target deals for which it identified an RWI policy, compared to only 33% of deals in which it did not identify such a policy.

John Jenkins