'Sandbagging' not a sure thing in Canadian courts


Marlin Horst head shot

Sandbagging reflects poorly on all parties to a transaction, Toronto corporate lawyer Marlin Horst tells

Horst, a partner with Shibley Righton LLP, explains that the practice arises in mergers and acquisitions when a buyer becomes aware that the seller will be unable to meet all the representations and warranties made in the agreement.

That allows the purchaser to close the deal with the intention of later suing the vendor in court for damages related to the known deficiencies since contracts normally provide indemnities for buyers in the event promises can’t be met.

Horst says examples of sandbagging are relatively rare in Canada, but the issue is growing as parties on both sides take the risk of an episode into consideration when completing transactions. Nevertheless, he says the trend is concerning.

“If vendors are making representations and warranties that are not correct, then it means they’re not doing their own internal due diligence properly,” Horst says. “If the buyer discovers something that the vendor itself doesn’t know, it shows a lack of knowledge about their own business.”

On the purchaser side, he says they are generally better served by addressing any deficiency they uncover, rather than holding it back to use as a weapon after closing.

“If a buyer finds something that’s contrary to the representations and warranties and it’s brought up before the deal closes, the chances are it can be handled with a reduction to the purchase price or some other fix,” Horst says.

In most cases, he says a risk analysis would favour dealing with these issues up front rather than turning to the courts later.

“The problem with bringing a lawsuit afterward, and litigators might not like to hear this, is that there is no certainty about what is going to happen,” Horst says. “You can have a case that you and everyone agrees is iron-clad, except for the judge, who sees it differently. You’re always taking a risk.”

In any case, Horst says buyers should be put off by the whiff of bad faith that sandbagging leaves behind.

“In the end, I think the duty to negotiate in good faith — as weak as it is in Canada at the moment — will stop the practice,” he says.

Horst explains that, historically, such a duty was never recognized at common law, but that it has developed over time, influenced by similar requirements in nations that operate under a civil code.

“The idea has crept into common law countries to lesser or greater degrees,” he says, adding that Canada is at the lower end of the spectrum.

“It has come up in a few cases with horrifically bad facts where the judges felt they had to find a way to help the aggrieved party,” Horst says. “Although there is a sense of a duty to negotiate in good faith in Canada, the jurisprudence is not very well developed here. A vendor could certainly make a case based on it, but it wouldn’t be a sure thing.”

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