March 11, 2022

Delaware Law Allows Buyers to “Sandbag” Sellers

A recent decision out of the Delaware Court of Chancery in John D. Arwood et al. v. AW Site Services, LLC, sheds significant light on whether a party to a contract governed by Delaware law may “sandbag” its counter party: as Vice Chancellor Slights concluded, “Delaware is, or should be a pro-sandbagging jurisdiction.”[1]

The Arwood decision arose out of a post-closing dispute in which the buyer alleged that the seller committed fraud and breached an asset purchase agreement by concealing a sham billing scheme that caused a substantial overstatement of revenue, which in turn improperly inflated the purchase price the buyer paid for the seller’s assets. Ultimately, Vice Chancellor Slights found the buyer could not maintain its fraud claim because he found, the buyer knew or should have known that revenues were overstated. However, at the same time, the court found that seller’s representations in the asset purchase agreement were in fact not true. Given the vice chancellor’s finding that the buyer knew or should have known the seller’s representations were false, he asked the parties to submit post-trial briefs on the state of Delaware’s law regarding “sandbagging”.[2] The vice chancellor was particularly interested in the impact, if any, that the Delaware Supreme Court’s 2018 opinion in Eagle Force Holdings, LLC v. Campbell had on the question.

Prior to Eagle Force, it was commonly understood that Delaware was “a pro-sandbagging state” — a state that allowed a buyer to sandbag a seller, even when their agreement was silent on the issue. However, Eagle Force was seen by many commentators as casting a measure of “doubt” on the idea that a buyer can “turn around and sue because of what he knew to be false remained so,” and drew questions about the extent to which parties could recover on a breach of warranty claim in Delaware when it knew at signing certain warranties were not true. 

After considering the parties’ briefing, Vice Chancellor Slights concluded that sandbagging is and should be allowed under Delaware law because it is consistent with Delaware’s “profoundly contractarian predisposition,” including its public policy favoring private ordering, history of enforcing good and bad agreements, and exclusion of reliance as an element required to establish a breach of contract claim. The court also considered that a pro-sandbagging rule supports the notion that representations and warranties serve an important risk allocation function in transactions. 

As the vice chancellor summarized the issue:

Viewed through the lens of contract, not tort, the question is simple: was the warranty in question breached? If it was, then the buyer may recover — regardless of whether she relied on the warranty or believed it to be true when made.

The Court of Chancery’s decision in Arwood represents an important milestone, as it has removed some of the uncertainty that has shrouded Delaware law on sandbagging. Following Arwood, it is even more important that a seller wishing to avoid being sandbagged in a deal governed by Delaware law obtain an explicit anti-sandbagging provision in the parties’ contract.

[1]John D. Arwood et al. v. AW Site Services, LLC, C.A. No. 2019-0904-JRS (Del. Ch. March 9, 2022).
[2]“Sandbagging”, as it is known colloquially, is the act of a buyer or investor to close on a transaction despite knowing that the seller’s representations in the relevant agreement were not true, and then suing the seller for breach of contract following the closing of the deal.