A recent decision in John D. Arwood et al. v. AW Site Services, LLC from the Delaware Court of Chancery stated that Delaware is a pro-sandbagging jurisdiction.
In a pro-sandbagging jurisdiction, a buyer may bring a claim for breach of a representation, notwithstanding the fact that the buyer knew of such breach prior to entering into the purchase agreement, unless there is an express anti-sandbagging provision prohibiting the buyer from making a claim for a known breach. In Arwood, the buyer approached the seller on an unsolicited basis and expressed interest in purchasing the seller’s business. The seller, who lacked the know-how to prepare financial records or useful valuations, gave the buyer extensive access to the business so that the buyer could determine the value of the business. Following closing, the business did not perform as the buyer expected, and the buyer claimed to have been defrauded by the seller’s concealment of a billing scheme that caused a substantial overstatement of company revenue. The buyer also claimed that the seller breached its representations in the purchase agreement regarding the financial conditions and lawful operations of the business.
On the issue of fraud, the court found that the buyer could not prove that he justifiably relied on a representation. Because the buyer knew or should have known, given his extensive access to the business prior to entering into the deal, that the business’ revenues were overstated, the court rejected the notion that the buyer was justified in relying on the seller’s representations relating to the business’ financial condition and operations. Where the buyer could not justifiably rely on the seller’s representations, the buyer could not prevail on a claim of fraud.
However, the court did find that the seller’s representations in the purchase agreement were not accurate. Since the court suspected the buyer knew or should have known that the seller’s representations were false when made, the court assessed whether the buyer’s claim for breach of representation should be disallowed under Delaware law by virtue of the buyer’s knowledge of a potential breach.
The Chancery Court concluded that “Delaware is, or should be a sandbagging jurisdiction.” This holding should be read in light of the dicta in the 2018 case Eagle Force Holdings, LLC, et al. v. Stanley V. Campbell, where the Delaware Supreme Court acknowledged that a debate exists on whether a buyer can recover for a breach of warranty claim when the buyer knew at signing that the representation was not true. Importantly, the Delaware Supreme Court has not yet definitively ruled on the sandbagging question.
The Arwood holding should not be viewed to resolve the uncertainty introduced by Eagle Force. While Vice Chancellor Slights decided, in line with existing Delaware precedent, that reliance is not a prima facie element of a contractual breach of representation claim, the Delaware Supreme Court in Eagle Force, presumably aware of the existing Delaware precedent, questioned whether reliance is needed in a contractual breach of representation claim. Arwood does not make clear whether actual knowledge at the time of signing, rather than closing, undoes a plaintiff’s right to a claim for breach of warranty. Mindful of this, a cautious buyer in Delaware may still seek to include pro-sandbagging language in a purchase agreement, though such provisions remain rare in agreements governed by Delaware law.
The American Bar Association publishes a Private Target Mergers and Acquisitions Deal Point Study every other year that analyzes various terms in middle-market M&A transactions. The 2021 study found that 29% of the purchase agreements it analyzed included a pro-sandbagging provision, 2% included an anti-sandbagging provision, and 68% were silent on the issue. In the absence of an explicit provision addressing sandbagging, the issue defaults to applicable state law. The Arwood decision should alert sellers who want to avoid being sandbagged in a Delaware deal to include an explicit anti-sandbagging provision in their agreement, though such provisions remain uncommon.
It is worth highlighting that this sandbagging analysis loses its significance in the now common construct where, absent fraud by the seller, representation and warranty insurance (“RWI”) is the buyer’s sole and exclusive remedy for breaches of representations. RWI policies are estimated by the ABA to be present in 65% of M&A deals, and these policies uniformly include an express anti-sandbagging clause prohibiting the buyer from making a claim for a breach of a seller representation if the buyer knew that the statement was false when made. This express anti-sandbagging language would bar a claim of the nature made by the buyer in Arwood, and, as the court clarified, provisions preserving a buyer’s ability to make a fraud claim are of little help to a buyer that knows of a breach. Nonetheless, in deals governed by Delaware law where a seller is contractually responsible for its breaches of representations, sellers should expect that a buyer will not be barred from sandbagging the seller, absent an express anti-sandbagging provision in the purchase agreement.
 John D. Arwood et al. v. AW Site Services, LLC, C.A. No. 2019-0904-JRS (Del. Ch. March 9, 2022).
 Eagle Force Holdings, LLC, et al. v. Stanley V. Campbell, 187 A.3d 1209, 1236 n.185 (Del. 2018).
 For purposes of the Study, “pro-sandbagging” excludes clauses that merely state, for example, that the target company’s representations and warranties “survive the buyer’s investigation” unless they include an express statement regarding the impact of the buyer’s knowledge on the buyer’s post-closing indemnification rights.