This blog post explores the critical and often overlooked “sandbagging” risk for M&A buyers in California. Learn why a buyer’s knowledge of a seller’s false representation can undermine post-closing claims under California law, a stark contrast to Delaware’s pro-sandbagging stance. We delve into how a simple contractual clause is essential for turning a potentially costly litigation battle into a clear, pre-closing risk management tool for lower middle market deals. This guide is a must-read for buyers, sellers, and advisors navigating the nuances of M&A contracts and state-specific legal principles.
M&A Stories
July 23, 2025
In the high-stakes world of mergers and acquisitions, representations and warranties serve a critical purpose, but their meaning can change depending on where the deal is done. For lower middle market buyers, sellers, and their advisors, understanding this nuance is crucial for managing risk and avoiding post-closing litigation.
The conflict often revolves around “sandbagging”—a buyer’s right to sue a seller for a breach of a representation even if the buyer knew about the inaccuracy before closing. While a buyer’s M&A team will naturally push back on a seller’s anti-sandbagging provision, they must be aware that under California law, a pro-sandbagging provision is essential, not just a preference.
The reason for this distinction lies in the foundational legal principles of each state. In Delaware, the preeminent jurisdiction for corporate law, a breach of a seller’s representation is viewed primarily as a breach of contract. As the Delaware Court of Chancery affirmed in Arwood v. AW Site Services, LLC, the buyer’s knowledge of the inaccuracy is irrelevant. The contract is the agreement, and if a contractual promise is broken, a remedy is available. Delaware’s “pro-sandbagging” position is a testament to its profoundly contractarian view, which prioritizes the terms of the agreement above all else.
California law, by contrast, often treats a breach of warranty more like a tort, or civil wrong. This approach requires that a buyer prove they reasonably relied on the representation when they decided to close the deal. As a result, if a seller can prove the buyer knew a representation was inaccurate before closing, the buyer’s post-closing claim may be dismissed for lack of reliance. This creates a dangerous trap for buyers. They may assume a representation is a simple contractual promise, only to find themselves embroiled in litigation over what they knew, when they knew it, and whether their reliance was reasonable. This legal reality has been established through cases like Hauter v. Zogarts and applied in M&A contexts, such as in Telephia, Inc. v. Cuppy.
For a buyer to effectively manage this risk in a California-governed deal, a mere promise in the agreement is not enough. The acquisition agreement must contain a clear, explicit provision stating that the buyer’s pre-closing knowledge of a representation’s inaccuracy does not diminish the buyer’s right to recover indemnification. Without such a clause, the buyer opens the door for a seller to assert the very defense the buyer sought to avoid: a post-closing litigation fight over the buyer’s state of mind. By taking this key pre-closing step, buyers and their advisors can ensure that the representations and warranties function as a true risk allocation tool and not an invitation to a costly legal battle.
See: Hauter v. Zogarts, 534 P. 2d 377 – Cal: Supreme Court 1975, Kazerouni v. De Satnick, 228 Cal. App. 3d 871 – Cal: Court of Appeal, 2nd Appellate Dist., 5th Div. 1991, and Telephia, Inc. v. Cuppy, 411 F. Supp. 2d 1178 – Dist. Court, ND California 2006, Arwood v. AW Site Services, LLC, C.A. No. 2019-0904-JRS, Court of Chancery of Delaware (March 31, 2022).
Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals..
By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5
and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM
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