Question: I am considering purchasing from a competing equipment dealer. I am told that I should buy the assets rather than the equity of the target business because, if I do, my business will not assume any of the seller’s obligations. Is it true?
Responnse: For most business buyers, buying a target’s assets rather than equity is a good place to start, but it does not necessarily protect the buyer from all of the seller’s responsibilities in most states.
The basics. When buying a business, you will usually have the option of buying either the equity or the assets of the selling or target business. From the perspective of most buyers of unlisted private companies, asset purchases tend to be more favorable than equity purchases with regard to both tax effects and exposure to the market. passive. To answer your question directly, I will focus only on liability issues for the purposes of this discussion.
- Purchases of shares. If you buy shares, you are buying the stakes in the legal entity that operates the business – for example, all of the shares of the issued and outstanding shares of a company. Therefore, all debts associated with the seller’s business that are not repaid at closing will continue to exist and will be binding on the purchased business entity after closing because that entity will continue to exist; it will simply be owned by you or your business, perhaps as an affiliate, rather than the former owners.
- Asset purchases. On the other hand, if you only buy the assets and do not expressly assume the responsibilities of the target business, then in theory only those assets would be transferred to you or your business. Therefore, a buyer – typically a joint stock company or limited liability company (LLC) – should be able to avoid liability for the liabilities of the selling entity because those liabilities remain with the seller and possibly based on the assumption that the money you use to pay off the assets would then be used by the selling entity to repay its debts. In any case, most people would assume that in a sale of assets, the retained liabilities of the target entity would remain the seller’s responsibility and not become the buyer’s liabilities simply because the buyer has. bought some or even all of the assets of the selling entity.
Liability of successor. For asset buyers, over the past two decades, the courts have negated the idea that business buyers can evade liability for the obligations of their target sellers simply by buying their assets rather than their capital. clean. Using a wide variety of facts and circumstances, courts across the country have now established successor liability as a legal theory which in an increasing number of cases allows the seller’s creditors to hold the buyer in full or of substantially all of the seller’s assets liable for the seller’s debts.
An exception for each rule. Successor liability typically rests on one of four exceptions to the general rule that buyers of assets are not liable for the debts of their targets:
- The buyer expressly or implicitly assumes responsibility for the target.
- The buyer is a simple continuation of the seller.
- The transaction constitutes a de facto merger – a transaction which, in whatever form, is in substance a merger or consolidation of buyer and seller.
- The parties to the transaction intended to defraud the seller’s creditors.
Add a pinch of subjectivity. Perhaps surprisingly, the de facto merger theory is one of the most frequently cited reasons by courts for applying successor liability. Although each case is different, the factors that tend to support these decisions include:
- Operation of the same or substantially similar business by the purchaser.
- Continued operation of the business at the same location used by the seller.
- Retention by the buyer of the same or more or less the same management personnel hired by the seller, that is to say the continuity of management.
- Assumption by the buyer of the seller’s current commercial debts.
- In some cases, ownership of common shares after closing.
- The insolvency of the seller, either before or shortly after closing.
- The dissolution of the seller following the closing.
Add more subjectivity. Adding to the uncertainty is the fact that state laws as well as judicial interpretations of theories of successor liability vary widely. Texas, for example, has eliminated successor liability altogether, except when a buyer expressly assumes such liability in a purchase contract. Indiana, on the other hand, passed a law that requires future owners of health clubs occupying the same locations as their predecessors to honor the memberships that those predecessors sold to their customers, this after the closure of a health club. health of a representative of the State. Somewhere in the middle are states like Delaware, which have adopted the de facto merger theory, but only apply it sparingly.
A dish to be eaten hot. This, coupled with the realization by commercial buyers and their lawyers that, except for bankruptcy court orders and certain court sales, a seller’s creditors will not be bound by the terms of most contracts. Asset Purchase Agreements, has resulted in a growing recognition that asset purchases no longer offer buyers the liability protections they once believed to exist. As a result, buyers have refocused their efforts to prepare in advance for the wide and growing range of potential post-close issues associated with asset purchases. Now more than ever, these efforts tend to include:
- Additional due diligence at closing.
- New, stricter requirements for representations and warranties to be made by sellers in asset purchase agreements.
- Increased use of holdbacks, earn-outs, promissory notes and other reserve retention mechanisms to fund undisclosed and / or unaccounted-for-closing after-sales liabilities, defaults, deductibles and self-insured deductions.
- Post-closing guarantees by sellers.
- Requirements that target entities remain in effect after closing until the expiration of the applicable limitation periods.
- Requirements that sellers maintain various forms of insurance, including general liability and product liability coverage, after closing.
- In some cases, the insistence that sales be conducted through bankruptcy, receivership, or other court-ordered processes that provide buyers with court-sponsored protections from creditors.
- Structural protections such as the use of Special Purpose Acquisition Entities (SPE or SPAC) that allow business buyers to protect their core assets against the liabilities of a given seller by hosting the purchased business assets, as well as the associated liabilities, in separate subsidiaries.
- Consistent with this, there is a resurgence of interest in section 336 (e) and 338 (h) (10) choices in which stock purchases are taxed as asset purchases, as well as tax-beneficial reorganizations, such as triangular forward and reverse mergers that effectively isolate the seller’s liabilities after closing while limiting taxes – perhaps a much bigger issue going forward if and when new tax arrangements The Biden administration’s accompanying Build Back Better Act will come into effect.
While asset purchases generally remain more favorable than stock purchases for most business buyers, the distinctions are starting to fade as the rules around taxes and successor obligations continue to evolve. . This makes careful planning, due diligence, negotiation, and drafting essential for buyers and sellers from the start.
On that note, be extremely careful when signing Letters of Intent (LOI), Condition Sheets, and other agreements that are seemingly harmless or unenforceable – they may not be either. Take, for example, the seemingly innocuous letter of intent which contains only two enforceable provisions: a watered-down confidentiality requirement and a requirement to make due diligence information available to the other party for at least 90 days.
Wait a minute. When signing the Letter of Intent, you will be legally required to disclose all of your financial, tax, contractual, customer, supplier, credit and other information to a potential competitor who is not obligated to purchase your business or pay you a deposit. Is that why you wanted to force yourself? This is where the strict non-use, non-disclosure and return requirements, deposits, limited or staggered disclosures, and attorney fee provisions can save lives by making it potentially too costly for the company. other part of hurting you.
For this and a long list of other reasons, it is recommended that you contact your Chartered Accountant (CPA) and an experienced M&A (M&A) lawyer well before you embark on this path. This can be extremely helpful in closing your deal and saving you a tremendous amount of time, money, and legal hassle if your deal ends up in the 70-90 percent of business sales that go unresolved.
James Waite is a business lawyer with over 25 years of experience in the equipment rental industry. He is the author of the American Rental Association’s Book on Rental Agreements and represents equipment lessors across North America on a wide range of issues. He can be reached at 866-582-2586 or [email protected]