In almost every share purchase agreement, the seller makes representations and warranties about the target company: that its financial statements are accurate, that it complies with the law, that there are no undisclosed liabilities. A recurring question is what happens when the buyer already knew, before closing, that one of those statements was untrue. Can the buyer still close the deal and then claim damages for the breach? This practice is known as “sandbagging.” Korea’s Supreme Court has addressed it directly, and its answer matters for how foreign buyers and sellers draft Korean deal documents.
1. What Sandbagging Means
Sandbagging describes a buyer that learns of a breach of the seller’s representations, typically during due diligence, but does not raise it or renegotiate the price. It closes the deal and then claims indemnification for that breach afterwards.
Contracts usually take one of three approaches:
- Pro-sandbagging clause. The buyer may claim regardless of what it knew. Its rights are not affected by any investigation or knowledge.
- Anti-sandbagging clause. The seller is not liable for breaches the buyer knew of before signing or closing.
- Silence. The agreement does not address the buyer’s knowledge. This is where the governing law decides the outcome.
2. The Leading Case: The Supreme Court’s October 2015 Decision
The facts
The case arose from the acquisition of a Korean oil refiner by another refiner. The seller had represented that the target company had complied with applicable laws. In fact, the target had taken part in bid-rigging for military fuel supply contracts. After closing, the Korea Fair Trade Commission imposed sanctions on the target, and the buyer claimed damages from the seller under the representations and warranties.
The buyer had known about the collusion before the transaction. The purchase agreement did not say whether the buyer’s knowledge would affect its right to claim.
The lower court
The appellate court rejected the claim. It reasoned that the buyer had known about the bid-rigging and had the opportunity to reflect the risk of sanctions in the purchase price. Allowing a knowing buyer to claim afterwards would, in the court’s view, be contrary to fairness and the principle of good faith (신의성실의 원칙).
The Supreme Court
In October 2015, the Supreme Court reversed the decision and sent the case back. Its reasoning rested on three points:
- The contract is read as written. Where the language of a written contract is clear, the parties’ intent should be found from that language. A stricter standard applies when an interpretation would significantly affect the parties’ legal relationship.
- The representations allocated risk. Read in light of their purpose, which was to allocate economic risk and adjust the price after closing, the representations meant that the seller would compensate the buyer for losses arising from a breach discovered after closing. This applied whether or not the buyer had known of it. Because the agreement contained no clause excluding liability for matters the buyer knew, the buyer’s knowledge did not bar the claim.
- Good faith is a narrow exception. The buyer’s knowledge alone did not make the claim contrary to fairness or good faith. Limiting a validly agreed contractual liability through general principles undermines freedom of contract and legal certainty, so it should be allowed only in highly exceptional cases.
Key takeaway: Under Korean law, if the agreement is silent, a buyer’s prior knowledge of a breach does not, by itself, prevent the buyer from claiming damages.
3. The Follow-Up: What Counts as the Buyer’s Loss
The same dispute returned to the Supreme Court and produced a second important ruling.
On remand, the appellate court found a breach. However, it held that the fines and related costs were losses of the target company, not of the buyer as shareholder. It awarded only a small fraction of the amount claimed.
In October 2018, the Supreme Court reversed that decision too. It held that sanctions, damages, and litigation costs paid by the target company could fall within the buyer’s recoverable loss under the representations and warranties. After the second remand, the buyer recovered a substantially larger amount.
Key takeaway: Winning on knowledge is only half the battle. The agreement should state clearly whether losses suffered by the target company count as losses of the buyer, and how they are measured.
4. Why the Civil Code’s Warranty Rules Do Not Decide the Issue
Korea’s Civil Code contains statutory warranty rules for defects in purchased goods and rights. Under those rules, a buyer who knew of a defect at the time of purchase generally cannot rely on the statutory warranty.
The Supreme Court did not apply this approach to contractual representations and warranties. It treated them as a separate risk-allocation agreement, whose effect depends on the terms the parties chose, not on the statutory warranty regime. This is why the parties’ drafting, rather than default rules, is decisive.
5. What Remains Uncertain
The 2015 decision settled the main question for silent agreements, but several issues remain less clear:
- The good-faith exception. The Supreme Court left room for highly exceptional cases. One example might be a buyer that deliberately concealed its knowledge to set up a claim, or induced the breach itself. Where exactly that line lies has not been fully defined.
- Knowledge reflected in the price. Where it can be shown that a known risk was expressly priced into a discount, a seller may argue that allowing a claim gives the buyer double recovery. The outcome will depend on the evidence and the drafting.
- Reduction of damages. Whether a court may reduce the damages on account of the buyer’s knowledge, as opposed to denying the claim, is not fully settled.
- Deemed disclosure. Many agreements treat matters disclosed in the data room or a disclosure schedule as known to the buyer. How broadly Korean courts will apply general “data room” disclosure, as opposed to specific disclosures, depends on the wording.
6. Drafting Options
Because the outcome turns on the contract, both sides should address knowledge expressly.
| Approach | Typical wording | Effect under Korean law |
|---|---|---|
| Pro-sandbagging | The buyer’s rights are not affected by any investigation, knowledge, or disclosure | Generally enforced. Consistent with the 2015 decision |
| Anti-sandbagging | The seller is not liable for any breach of which the buyer had knowledge before closing | Generally enforced as written. Define “knowledge” carefully |
| Disclosure-based | The seller is not liable for matters fairly disclosed in the disclosure schedule | Enforced. Specific, item-by-item disclosure is more reliable than a general data-room reference |
| Silent | No provision | The buyer may claim despite its knowledge, absent highly exceptional circumstances |
If an anti-sandbagging clause is agreed, the key drafting points are:
- Whose knowledge. Specify the named individuals whose knowledge counts.
- What kind of knowledge. State whether it means actual knowledge only, or also what the buyer should have known.
- The cut-off date. Set the relevant date, usually signing or closing.
- Interaction with specific indemnities. Clarify whether the clause applies to specific indemnities as well as general representations.
7. Practical Guidance for Buyers and Sellers
For buyers:
- Insist on a pro-sandbagging clause, or at least avoid an anti-sandbagging clause.
- Use a specific indemnity for serious known issues. Where diligence uncovers a significant problem, do not rely only on the general representations. Negotiate a specific indemnity for that issue, ideally with an escrow or holdback, so that recovery does not depend on arguments about knowledge.
- Define loss broadly. Make clear that losses of the target company, including fines, damages, and defense costs, count as the buyer’s loss.
For sellers:
- Negotiate an anti-sandbagging or disclosure-based clause. Make full, specific disclosures in the disclosure schedule.
- Agree a cap, basket, and time limit, and exclude losses already reflected in the price.
- Consider warranty and indemnity insurance. It is increasingly used in Korean transactions, but insurers typically exclude matters known to the buyer. It complements careful drafting rather than replacing it.
8. Conclusion
Korea’s Supreme Court has taken a contract-based approach to sandbagging. Unless the agreement says otherwise, a buyer that knew of a breach before closing can still claim damages, and losses suffered by the target company can count as the buyer’s loss. A buyer that depends on the agreement being silent is relying on the default rule. A seller that depends on fairness arguments is relying on an exception the courts apply only rarely. Both should address the buyer’s knowledge, disclosure, and the measure of loss expressly in the share purchase agreement.
Key takeaway: In a Korean deal, the sandbagging question is answered by the contract. Decide your position and write it down.