Authors
In Colombia, as in many other Latin American jurisdictions, it is customary to include provisions of Common Law in share purchase agreements. Such is the case of the representations and warranties, and the pro and anti-sandbagging provisions.
As well as in Common Law legal systems, representations and warranties are intended to distribute the risks of the transaction between the parties (i.e., seller and buyer). Thus, these provisions seek to provide buyer with a better understanding of the company that is being acquired and constitute the basis for the contractual liability of the parties in a post-closing scenario of the transaction.
In Colombia, as in many other countries where the legislation on the purchase of shares is not extensive and detailed, the inclusion of representations and warranties in share purchase agreements has been well received by the legislative branch, the courts, and the arbitration tribunals, which has resulted in the consolidation of their use as a strong contractual practice. The foregoing, since, by distributing the burdens and obligations between the parties to the agreement, the agreements become more robust, providing the parties with greater legal certainty.
Contrary to the latter, the also growing tendency to include pro-sandbagging and anti-sandbagging provisions in the referred transactions has not had the same acceptance. Unlike the representations and warranties, the purpose of the pro-sandbagging and anti-sandbagging provisions are, respectively, to (i) allocate all risks from the transaction to seller, regardless of whether buyer knew, could have known, or should have known of their existence; or, (ii) to prohibit that such allocation falls entirely on seller; and in that sense, that the risks are distributed between the parties and that the balance of such distribution is governed by the representations and warranties and the indemnity and specific indemnities provisions.
Hence, the progressive intention to use these sandbagging provisions in share purchase agreements leaves the door open for several interesting debates.
Bearing in mind the foregoing, the purpose of this article is to rapidly review the feasibility of including and the best way to include these sandbagging provisions in share purchase agreements, all within the framework of the Colombian legal system.
Prima facie, it can be said that, under Colombian law, it is feasible to agree on sandbagging provisions in share purchase agreements. This, considering that these types of provisions have their origin in the exercise of the principle of freedom of contract; provided, however, that they do not contravene the precepts and standards of law and order.
Notwithstanding the foregoing, it is worth considering that, in Colombia, the principle of good faith has great relevance within the contractual practice, and, therefore, it may constitute the actual limit to these provisions.
In this sense, it is important to assert that it is not admissible for buyer to act disloyally, for example, by agreeing on a pro-sandbagging provision knowingly that the company that is being acquired has potential contingencies and choosing not to disclose this knowledge to seller; nor is it admissible for the latter to agree on an anti-sandbagging provision knowingly that the company has potential contingencies that have not been disclosed to buyer during the due diligence process. The foregoing, as the behavior of the parties to a share purchase agreement, as to any other commercial agreement, must be subject to the duty of loyalty and utmost good faith principle (uberrima fides) throughout the transaction. (i.e., negotiation, execution, closing, and post-closing).
On this basis, the relevance that the principle of good faith has in the contractual practice in Colombia imposes on the parties to the agreement the burden of drafting the sandbagging provision, in any of its variants (pro or anti-sandbagging), in the most careful and precise manner, so that it is adapted to the utmost good faith principle, and it is not the result of an exact translation of the Common Law provisions. Importing the content of sandbagging provisions verbatim could result in the use of a wording that could be construed as a way of validating unfair conduct of the parties, which is contrary to the utmost good faith principle, and could ultimately render the provision void.
Finally, it is important to consider that the inclusion of sandbagging provisions in share purchase agreements must be express, in the sense of being clear as to whether the provision is pro or anti-sandbagging. This, considering that, when it comes to share purchase agreements, arbitration case law has been unclear in determining how the risk of the agreement should be distributed between the parties.
On the one hand, the “pro-buyer” position has imposed on seller the liability for misrepresentations or breach of warranties contained in the agreement, regardless of whether buyer knew or should have known about such misrepresentations or breach of warranties. Therefore, under this case law interpretation, if seller makes misrepresentations in favor of buyer, or breaches the warranties provided in the agreement, the former will always be liable, and the latter will always receive the corresponding indemnification.
On the other hand, the “pro-seller” position has imposed on buyer a heavy burden of due diligence throughout the transaction. In this sense, having buyer the burden of performing thorough due diligence, if seller makes misrepresentations in favor of buyer and/or breaches the warranties provided in the agreement, and the latter fails on its duty to conduct thorough due diligence, the indemnification to which he is entitled to (buyer) by virtue of said misrepresentations and/or breaches, may be diminished.
It is, therefore, due to this interpretative risk (i.e., that the tribunal may opt for one position or the other) that we suggest, in observance of the principle of good faith, including the sandbagging provision, in either of its forms, (pro or anti-sandbagging) expressly and clearly in the agreement. The foregoing, considering that, according to Colombian contract theory, the use of this provision is sustained in the principle of freedom of contract; provided, however, that the utmost good faith principle is observed.
Having established the above, it is therefore advisable that, when agreeing on sandbagging provisions in share purchase agreements in Colombia, (i) the behavior of the parties throughout the transaction should always comply with the utmost good faith principle and the duty of loyalty; (ii) the wording of the provision should be adapted to the aforementioned principle and duty and should not be an exact translation from Common Law, so that no unfair intention of the parties may be derived from its interpretation; and (iii) the provision should be express (i.e., pro or anti-sandbagging) in order to avoid disadvantageous interpretations for clients by an arbitration tribunal.
