Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / How the Anti-Sandbagging Clause Traps M&A Sellers
Transcript
- Lucas: So you sign the purchase agreement, close the deal, wire hits your account. Then a month later the buyer comes back and says, 'Hey, your representation about customer churn was off by six points. We want money back.' Luna: And the question is — can they actually do that? Did they know before closing and just not say anything? Lucas: Exactly. That scenario is what the sandbagging debate is all about. And today we're talking about the clause that determines which side gets burned: the anti-sandbagging clause. Luna: I've seen these in almost every middle-market deal I've worked on. Most sellers barely glance at them. But they can decide whether you get paid twice or get nothing. Lucas: Let's start with the language. A typical anti-sandbagging clause says something like: 'Buyer may not bring a claim for breach of representations if Buyer knew or should have known of the breach prior to closing.' In plain English — if the buyer found the problem during due diligence but didn't raise it, they can't sue you later. Luna: That sounds fair on its face. If they knew and didn't flag it, why should you bear the cost? Lucas: Right. But the problem is the 'should have known' part. That's a knowledge standard that can be interpreted very broadly. A buyer's legal team can argue they didn't 'know' a specific statement was false — they just had enough data to suspect something. And then after close, they come after you for it. Luna: So the anti-sandbagging clause is meant to protect the seller from that kind of ambush, but if it's poorly drafted, it can actually give the buyer an out. Lucas: Or worse — it can be removed entirely. A 'pro-sandbagging' clause says the opposite: buyer can bring a claim even if they knew about the breach before signing. And that is the norm in many private equity-led deals. The buyer gets full indemnification regardless of their pre-signing knowledge. Luna: Let's talk about a real case that made this concrete. The 2018 Shutterfly acquisition by Apollo. Lucas: Apollo bought Shutterfly for about $1.6 billion, taking it private. Post-close, Apollo alleged that Shutterfly had misrepresented its compliance with data privacy regulations. Shutterfly said, 'You had access to our data room, you conducted diligence, you knew about these issues before signing.' Luna: The purchase agreement had a pro-sandbagging clause. So Apollo could sue even if they had pre-closing knowledge. Lucas: Exactly. The case eventually settled, but the key point is that Shutterfly's sellers — including management and prior shareholders — had to negotiate an indemnity pool. The anti-sandbagging provision they could have pushed for might have shut down the claim entirely. Luna: And that's the trap: most sellers don't realize that the default in a pe led deal is pro-sandbagging. You have to affirmatively negotiate for the anti-sandbagging language. Lucas: Let's get specific about the negotiation. If you're a seller, you want an 'exclusive remedy' clause that says the only basis for a post-close claim is a breach that the buyer did not know about and could not have known about with reasonable diligence. That shifts the burden to the buyer to prove they didn't know. Luna: And the buyer will push back hard. Their argument is: 'We bought your company based on your reps. If they're false, we should be made whole regardless.' Lucas: Which sounds reasonable until you realize that the buyer controls the data room timeline. They can choose to not ask follow-up questions or not review certain documents. Then they come back after close and say 'Oh, we missed this.' Luna: There's a famous line from a Delaware Chancery Court case — I think it was Abry Partners versus F&W Acquisition — where the judge said that sophisticated parties should be free to allocate risk as they see fit, even if that means one side bears the risk of its own negligence. Lucas: That case is huge. The court upheld a pro-sandbagging clause because the contract was clear. So the lesson is: if you sign it, you own it. And if you're a seller, you need to understand which version you're signing. Luna: I want to talk about the one negotiation tactic that can actually protect you here. And it's not just the language of the clause itself. Lucas: What's that? Luna: The disclosure schedule. If you can get the buyer to specifically acknowledge in the disclosure schedule that they have reviewed certain categories of risk, and that they accept them 'as is,' that effectively creates a carve-out from the reps. Then even a pro-sandbagging clause can't touch you on those items. Lucas: Yeah, that's a great point. The disclosure schedule becomes your shield. You list every possible issue — customer concentration, regulatory exposure, pending litigation — and the buyer signs off on it. Then any claim related to those items is dead on arrival. Luna: But the buyer's counsel will fight to keep the disclosure schedule vague. They want general statements like 'the company faces competition' rather than specific dollar amounts or names of at-risk customers. Lucas: So the seller's job is to push for specificity. And that's where a good M&A attorney earns their fee. They'll go line by line through the reps and say: 'Here's the data that could trip us up. Let's disclose it now.' Luna: There's also the issue of 'knowledge qualifiers.' Some anti-sandbagging clauses say the buyer only forfeits claims if they had 'actual knowledge' of the breach. That's a much higher bar for the seller to prove. Lucas: Right. 'Actual knowledge' means you have to prove that a specific person at the buyer — like the deal lead — was aware of the specific fact. That's tough to do in discovery. The seller-friendly version is 'constructive knowledge' — what the buyer should have known based on the diligence materials. Luna: And the buyer will argue that constructive knowledge creates uncertainty. They'll say, 'How do we know what our team should have seen?' Lucas: Which is why this is one of the most fought-over sentences in the entire purchase agreement. And it's often buried on page 40 of a 120-page document. Luna: If today was actually useful to you — and I hope it was — the reason this show stays ad-free is listener support. It's a small thing, but if these conversations have moved your work forward in some way, you can buy us a coffee at buy me a coffee dot com slash fexingo. Lucas: Yeah, it genuinely helps. Keeps us independent, keeps us focused on the traps that actually matter. And we don't have to shout over ad reads. Luna: Alright, back to the clause. So we've got the knowledge qualifier, the disclosure schedule, and the basic pro versus anti framing. But there's another layer: the 'bring-down' condition. Lucas: The bring-down condition is what forces the seller to re-certify their reps at closing. So even if you had an anti-sandbagging clause, if you re-certify a rep that you know is false, you're on the hook regardless. Luna: And that's where sellers get tripped up. Between signing and closing, something changes — a key customer cancels, a regulation shifts — and the seller's team doesn't update the reps. Then at closing, they sign off and boom, they've waived their protection. Lucas: So the anti-sandbagging clause only protects you if you're honest at closing. If you knowingly let a false rep stand, you're exposed. Luna: What about the case where the buyer discovers the breach before closing but doesn't say anything, and then after closing they try to renegotiate the purchase price? Does the anti-sandbagging clause block that? Lucas: It depends on the wording. Most clauses only bar claims for indemnification — they don't bar the buyer from walking away before closing if they discover a breach. And they don't prevent the buyer from asking for a price adjustment as a condition of closing. Luna: So the real danger for sellers is that the buyer uses knowledge of a breach as leverage to re-trade the deal at the last minute. Lucas: Exactly. And anti-sandbagging clause doesn't stop that. That's why you need a 'no-reliance' clause that says the buyer is not relying on any representations outside the purchase agreement. But that's a whole other conversation. Luna: Let's bring it back to practical advice. If you're a seller going into negotiations, how do you know which side you're on? Lucas: First, look at the indemnification section of the draft SPA. Find the language about 'knowledge of buyer.' If it says 'buyer's actual knowledge,' that's a red flag for sellers. If it says 'buyer's constructive knowledge' or 'buyer's awareness,' that's more seller-friendly. But the gold standard is a clause that says 'buyer's knowledge includes information in the data room and any diligence materials provided to buyer.' Luna: Second, check whether the reps are qualified by 'materiality' or 'material adverse effect.' If they are, the threshold for a claim is higher. Lucas: And third — and this is the one most sellers miss — look at the survival period. If reps survive for 18 months but the anti-sandbagging clause is tied to pre-closing knowledge, you might have a mismatch. The buyer could discover a breach after the survival period and argue they didn't know before closing. Luna: So the anti-sandbagging clause isn't just a binary switch. It interacts with every other part of the indemnification structure. Lucas: Right. And that's why you can't just copy-paste a clause from a template. The Shutterfly case shows that even a well-negotiated deal can blow up if the language isn't tight. Luna: I want to end with a question for our listeners. If you've sold a company before, have you ever seen a sandbagging dispute? How did your indemnity cap hold up? We'd love to hear about it — maybe we'll do a follow-up episode with real listener stories. Lucas: That's a great idea. Until then, keep your disclosure schedule specific, push for constructive knowledge, and never assume the buyer's team is working in your interest. They're not. Luna: Thanks for listening. Lucas: See you next time.