DealMakers - Q1 2025 (released May 2025)
Helmets and clauses: protecting yourself against sandbagging
by Roxanna Valayathum and Keagan Hyslop
It is a strange thought that an outsider may know more about the affairs of a company than the company’s own management team. However, this phenomenon is not uncommon in the M&A space, where comprehensive due diligences are undertaken by armies of experts hired by a purchaser to scrutinise every aspect of the business operations of a target company. The result is that a seller may reasonably believe that it can offer a warranty regarding the target, but the purchaser – after its due diligence – may be aware that the seller’s representation is not true. The practice of the purchaser remaining silent and accepting such a warranty despite knowing it is not actually true, in order to retain a claim for breach following closing, is referred to as “sandbagging”.
Historically, the term “sandbagging” is believed to refer to the practice of hitting an unsuspecting victim over the head with a sandbag before robbing them. Clearly, the spirit of the practice remains the same, despite the change in methodology over the years. Sandbagging within the M&A space is well fleshed out in other jurisdictions whose laws have evolved to address it, in one way or another. However, this concept has not yet been properly explored within South African law and remains a grey area.
South African contract law is informed by values such as Ubuntu, good faith, fairness and reasonableness. However, these values are not standalone requirements and must also be balanced against the need for certainty between parties and the equally recognised values that support the freedom to contract and to have such contracts be honoured.
Valayathum
Hyslop
Good faith and fairness
Consider a seller selling 100% of its shares in a target company. If the seller represents to the purchaser that the target complies with all applicable laws, despite knowing such representation is false, this is a misrepresentation. The law recognises that such conduct of the seller is in bad faith and offers various remedies to the purchaser. However, the situation differs where the purchaser, after conducting its due diligence, is aware of the target’s non-compliance, but the seller, acting in good faith and to the best of its knowledge, offers to warrant the target’s compliance. Arguably, it may be bad faith for a purchaser to agree to the warranty’s inclusion simply to have a claim for breach as soon as the contract is closed, particularly since the purchaser could seek protection from more appropriate legal mechanisms if it disclosed the non-compliance (such as an indemnity, or making the agreement conditional on such non-compliance being rectified). However, the law will not necessarily aid the seller for various reasons. Firstly, a warranty is a representation made by the seller – not the purchaser. The purchaser is not responsible for the representations that the seller chooses to make, even if the seller is acting in good faith and is unaware of its misrepresentation. Secondly, there is no standalone requirement that contracts must be concluded in good faith, and merely concluding an agreement in bad faith will not render it unenforceable. The court would only set aside such a contract if, due to the bad faith of the purchaser, the enforcement of the terms of the contract would be so unreasonable and unfair that it would be against public policy and therefore unlawful, which is not a guarantee where sandbagging is involved.
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Commercial and legal certainty
South African courts recognise the importance of commercial and legal certainty in the law of contract. Parties who negotiate, bargain and agree on something should be able to rely on such agreement, even if it is not entirely fair or reasonable. It is not unlawful to contract to your own detriment. This is particularly so where the contracting parties are sophisticated, well-advised and hold relatively equal bargaining power – as is often the case in the M&A space. In such a situation, the courts have previously shown that they are more reluctant to interfere with the terms of the contract, as it is assumed the parties had the opportunity to protect their position during negotiations. This creates the difficulty that, as there is no clear legal position on sandbagging in South Africa, it will be for the parties to regulate the position through agreement. If a seller offers a warranty but does not limit its liability, where the purchaser was aware of the falseness of such warranty, it is possible that the courts will not interfere with those terms.
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The lack of specific legal rules dealing with sandbagging in South Africa means that the courts will likely apply general rules and principles if a case of sandbagging makes its way to a courtroom. The facts and circumstances of the matter will strongly influence the court’s decision. There may be greater sympathy for a seller with a weaker bargaining position and fewer resources than to the purchaser. However, the courts are likely to favour upholding the contractual terms where the bargaining positions and resources of the parties are relatively equal. The upshot: there is uncertainty on the topic of sandbagging in South African M&A. Where there is legal uncertainty, it is up to the parties to take matters into their own hands and regulate the position contractually in order to manage risk. A seller may wish to include anti-sandbagging clauses in a contract to limit its liability where a purchaser has knowledge of the breach of warranty prior to the signature date. A purchaser, however, may want to refine the anti-sandbagging clause to reduce the parameters of such limitation. Ultimately, both sides must be firm in protecting their position contractually instead of relying on a court coming to their rescue.
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Valayathum is a Director and Hyslop an Associate in Corporate and Commercial | Cliffe Dekker Hofmeyr
