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Date: March 11, 2021
Posted by: CPDMA team

The practice of "sandbagging" in M&A contracts

According to a survey carried out by large auditing companies, involving the number of mergers and acquisitions or M&A transactions. Mergers and Acquisitions) in Brazil, the years 2017, 2018 and 2019, consecutively, were extremely significant. To give you an idea, 2019 had been considered the most expressive in mergers and acquisitions of companies in Brazil in the entire historical series.

In 2020, with the rapid advance of COVID-19, several economic sectors were hit, which led to a strong impact on the level of business activities across the planet.

Despite this complex global scenario, according to a recent survey published by PWC, in 2020, 1038 M&A transactions were announced in Brazil, a volume 48% higher than the average for the same period of the last 5 years (701 transactions), with an increase of 14% compared to the previous year (912 transactions). 

In 2020, therefore, there was a record of the historical series (which, until then, had been reached in December 2019), reinforcing a trend of accelerated recovery of the M&A market, strongly affected by the effects of COVID-19 between April and June 2020. 2020

In this context, the State of São Paulo concentrated approximately 50% of the transactions announced in 2020, represented by 521 transactions (2019 - 466 transactions), with 448 transactions in the metropolitan region of São Paulo and 73 in regions of the interior of São Paulo. In the South Region, 168 transactions were announced, an increase of 24% compared to the same period in 2019 (135 transactions).

It is worth noting that the mergers and acquisitions (M&A) process has many steps and can take anywhere from 3 months to several years to complete. Such transactions are among the most complex and significant events in the life of a company - the consequences of which reverberate internally and externally.

And, for this reason, the contract that governs these operations, commonly known as SPA (acronym in English for Share Purchase Agreement), is one of the fundamental parts of this complex gear.

Among the numerous clauses provided for in an SPA, it is worth mentioning, in brief, some considerations in relation to those that comprise the declarations (representations) and guarantees (warranties) provided by the seller and, consequently, the possible practice of sandbagging.

It can be said that, in an ordinary M&A contract, it is extremely common for the seller to make an extensive list of statements of fact that, if proven incorrect or untrue, entitle the buyer to compensation. On the other hand, from the seller's point of view, as important as the representations and warranties for the buyer, are the exceptions to the representations and warranties that are already known and informed by the seller to the buyer (disclosures), and, in theory, , may or may not be embedded in the transaction price.

Thus, the purpose of these representations and warranties is to minimize the asymmetry of information between seller and buyer, assuring the acquirer the right to indemnification in case the information disclosed by the seller in the contract is not true or accurate, in whole or in part, regarding the good or acquired right and the costs, expenses and contingencies linked to it.

However, in certain situations, it is possible that the buyer, even aware of information that represents a violation of the respective declaration and guarantee, allows the negotiation to continue until the SPA is signed or the transaction is closed, in order to subsequently claim the respective indemnification. provided for in the contract, based on this same breach.

This buyer's conduct is called in the Anglo-Saxon system of sandbagging. The origin of the term sandbagging has been the subject of some speculation. Glenn D. West and Kim M. Shah suggest that the term may have derived from the use of a sandbag as a weapon, often in a surprise attack. On the other hand, there are authors who claim that the expression is used in golf to designate the player who pretends to be worse than he really is in order to gain advantages over his opponents, increasing his chances of winning.

For Rick Climan, the term sandbagging is used to describe a buyer who, knowing of a material breach of a seller's warranty, would wait for the transaction to close, then sue the seller on the basis of this breach. That is, instead of the buyer negotiating a price reduction or withdrawing from the operation, due to the breach of the guarantee, he awaits the closing of the transaction to request compensation for the material breach of the guarantee.

As can be seen, the issue is complex and does not find an easy solution, even when analyzed from the perspective of comparative law. In the United States, where this issue appears with high frequency, it is possible to identify different positions on the subject, depending on the jurisdiction that analyzes the specific case. On the one hand, there are those who follow the traditional rule anti-sandbagging (California), while others (New York and Delaware) tend to follow the trend. pro-sandbagging Modern.

According to Ricardo Morais Tonin, in jurisdictions that adopt the traditional rule anti-sandbagging, the buyer must have relied on the declaration and warranty, and therefore, if he knew of the breach, there was no such reliance at the time he decided to sign (signing) or close (closing) the operation. On the other hand, in jurisdictions pro-sandbagging, the purchaser will be able to maintain its right to indemnification based on contractual principles, whether or not it is aware of it at closing.

In Brazil, discussions involving the practice of sandbagging are increasingly common in M&A contracts. It is necessary, however, to analyze this issue from the perspective of objective good faith and the ethics that must underlie business relations. In any case, there is no way to avoid the necessary attention on the part of the seller and the buyer, both when drawing up the contract and in the execution of its clauses. Accurate analysis and careful monitoring of the entire M&A process are essential for success in this type of corporate transaction.

Source: Geovane Machado Alves, attorney at Cesar Peres Dulac Müller, is a Master in Public Law and a specialist in Tax Law.

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