Sandbagging is a term used in M&A to describe a situation in which the buyer, having learned during due diligence that one of the seller’s representations is inaccurate, nonetheless closes the transaction and then brings an indemnification claim against the seller for the discovered breach. The buyer knows about the problem, proceeds anyway, and then seeks to recover from the seller as if it had not known. The term “sandbagging” has a negative connotation, but whether this practice is permissible — and whether knowledge of a breach should bar a buyer from bringing an indemnification claim — is one of the most contested questions in private M&A law, and one that has very practical financial consequences for both buyers and sellers.

The Pro-Sandbagging Position

The pro-sandbagging position holds that a buyer’s pre-closing knowledge of a breach should not prevent it from bringing an indemnification claim. The argument is straightforward: the seller made a contractual representation; that representation was false; and the buyer suffered a loss as a result. Whether the buyer learned of the falsity before or after closing should not affect the seller’s contractual obligation to indemnify. The parties negotiated an indemnification right, and that right should be enforceable regardless of what the buyer happened to discover during due diligence.

Pro-sandbagging provisions in purchase agreements typically state explicitly that the buyer’s right to indemnification is not affected by any investigation the buyer conducted, any knowledge the buyer acquired, or any information the buyer received before or after the date of the agreement. These provisions are designed to eliminate any ambiguity about whether pre-closing knowledge is a defense to an indemnification claim.

The Anti-Sandbagging Position

The anti-sandbagging position holds that a buyer who knew about a breach before closing should not be entitled to indemnification for that breach, on the grounds that the buyer’s decision to close with knowledge of the problem constitutes either a waiver of the claim or an assumption of the risk that the problem creates. The policy argument is that it is inequitable to allow a buyer to induce a seller to close by not raising a known issue, and then to turn around and demand indemnification after the transaction is consummated. Sellers argue that this conduct amounts to bad faith and that the indemnification obligation was never intended to cover matters the buyer knew about before deciding to proceed.

Anti-sandbagging provisions state that the buyer has no right to indemnification for any breach or matter of which the buyer had actual knowledge before closing. The scope of knowledge imputed to the buyer is an important definitional issue in these provisions: does it include knowledge of any employee or agent of the buyer, or just knowledge of specified senior officers? Does it include information contained in reports prepared by the buyer’s advisors, even if not actually reviewed by any individual on the buyer’s team?

How Courts Have Treated the Issue Absent Contractual Clarity

In the absence of an explicit pro- or anti-sandbagging provision in the purchase agreement, the outcome of a sandbagging dispute depends heavily on the governing law of the contract. States have different default rules, and the case law is not uniform. Delaware, which governs a large proportion of private M&A transactions, has generally applied a pro-sandbagging default rule: absent a contrary provision in the contract, a buyer’s indemnification rights are not defeated by its pre-closing knowledge of a breach. Other states apply different default rules, and the law of some states is ambiguous.

Given the uncertainty that exists in default rules across jurisdictions, the most important advice for both buyers and sellers is to ensure that the purchase agreement expressly addresses the sandbagging issue rather than leaving it to default. An explicit provision eliminates the risk of an expensive and unpredictable judicial determination of an otherwise avoidable question.

Interaction with Representations and Warranties Insurance

The availability of representations and warranties insurance has added a new dimension to the sandbagging analysis. RWI policies typically contain a knowledge exclusion that denies coverage for matters the buyer actually knew about at the time the policy was bound. Under most RWI policies, the buyer’s knowledge is assessed at the underwriting team level — the individuals directly involved in negotiating and closing the transaction — and information in due diligence reports prepared by the buyer’s advisors is typically considered to be within the buyer’s knowledge.

This means that in an RWI-covered transaction, a buyer who discovers a representation breach during due diligence and then closes the deal knowing about the breach is likely to find that the RWI policy denies coverage for that specific breach, regardless of whether the purchase agreement contains a pro-sandbagging provision. The buyer might have a direct indemnification right against the seller (under a pro-sandbagging clause), but if the seller has no escrow and the general indemnification cap is low (as is typical in RWI transactions), the practical value of that right may be limited.

Drafting Recommendations

For sellers, the anti-sandbagging provision is a meaningful protection that limits exposure for matters the buyer learned about during due diligence and chose to accept by proceeding to close. Sellers should push for a clear anti-sandbagging provision and should define the scope of the buyer’s knowledge as broadly as possible — including constructive knowledge from due diligence reports — to maximize the scope of the protection. Sellers should also ensure that the definition of knowledge is imputed to the buyer’s entire due diligence team, not just its senior executives.

For buyers, the pro-sandbagging provision preserves the full value of their indemnification rights even for matters discovered during due diligence. Buyers who use RWI should recognize that the pro-sandbagging provision in the purchase agreement and the knowledge exclusion in the RWI policy create an asymmetry: the buyer has a contractual right against the seller for known issues, but the insurance will not cover those known issues. In a low-escrow RWI transaction, the buyer’s practical recovery for known-issue indemnification claims may be limited to whatever escrow exists and whatever the seller can personally pay. Buyers who have identified specific issues during due diligence that could give rise to meaningful claims should address those issues directly — through a price adjustment, a specific indemnification with separate carve-out from the cap, or a coverage endorsement from the RWI insurer — rather than relying on a general pro-sandbagging clause.