BUYING A BUSINESS

May 15, 2022

Assumed & Excluded Liabilities in an Asset Purchase

When buying a business, you may want to structure the transaction as an asset purchase. A key benefit of this approach is not inheriting the seller’s business liabilities. The general principle of non-liability for asset purchases applies. That is, just because you are buying the assets of a business does not mean you become responsible for the business liabilities.

Over the years though, courts have identified certain exceptions to this rule in order to ensure asset acquisition does not become an easy path for sellers or buyers looking to shirk responsibility. These exceptions will vary by jurisdiction but will typically include some or all of the following.

1. Buyer Expressly Assumed or Implied Assumption of Liabilities

A buyer may imply or expressly assume liabilities for the seller. You may consent to the assumption of particular liabilities. For example, the liabilities are considered current liabilities that are related to an adjustment of working capital. You may also decide to settle the seller’s accounts payable in order to maintain a positive working relationship with vendors you intend to use after transaction closure.

For the most part, you want to avoid assuming all other liabilities. Clarity in the asset purchase agreement is vital. If the agreement explicitly disclaims you from liability, then this assumption is unlikely to hold in a court of law. On the other hand, ambiguous language in the agreement places you at a higher risk of being found to have assumed the seller’s liabilities.

Still, as the other exceptions show, you cannot be shielded by the strength of the agreement alone.

2. Transaction is a De Facto Merger

The transaction may be deemed a de facto merger if it is assessed as a consolidation of seller and buyer. In other words, all the seller’s liabilities become yours even if there is clear language in the agreement stating the contrary. This is the most common reason courts assign liability to a buyer. 

Factors that determine if an asset purchase constitutes a merger include continuity of business operations, directors, staff, and location. The likelihood of an asset purchase being perceived as a de facto merger significantly increases with the adoption of the same domain name, business name, trade names, trademarks, phone numbers, and vendors. Sometimes, the seller’s company would even be dissolved or cease operations.

An asset purchase could also be deemed a merger based on the assumption of liabilities needed for the smooth continued running of the business.

3. Buyer is Mere Continuation of Seller’s Enterprise

The buyer of a company’s assets may be a continuation of the seller in much or all of the seller’s enterprise except in name and ownership. This would be a continuation of executive officers, directors, and ownership structure. Effectively, the buyer company may be viewed as the same legal entity as the seller company.

Note that this is not about the continuity of operations as it is of the corporate entity. If there is continuity of enterprise control or you position yourself as a continuation of the seller’s entity, you may be deemed as bearing continuity of liability as well.

4. Fraudulent Asset Transfer

A seller may decide to transfer assets to you as a means of defrauding creditors. Such bad faith transactions may include a seller disposing of assets that may be the target of a pending lawsuit, property transfer that may lead to the seller’s insolvency, secret transactions, and those that do not follow the conventional method of such asset sale.

An asset purchase transaction cannot be structured with the sole aim of avoiding liabilities. If a transaction is designed to swindle creditors or if the selling price of the asset is not a fair consideration, the buyer could inherit the liabilities therein. Fraudulent transfer exceptions are often applicable in ‘fire sales’ where you can negotiate an unusually favorable position when compared to less strenuous circumstances.

5. Buyer Continues Same Product Line as Seller

On acquiring the asset, if you continue the same product line as the seller, you may be considered to have taken up the potential liabilities as well. This exception is not as common as the first four. It is most often applied where you continue to manufacture and sell a product line that was defective before the transaction.

The argument is that since you inherited the goodwill and brand value from the seller, it may be appropriate that you carry the liabilities for past defects too. There is the understanding that since the product line is still active in the market, you could spread any costs arising from defective product liability across current and future profit margins. This is meant to give past buyers of the defective product an avenue for remedy.

6. Regulatory and Statutory Exceptions

Certain state and federal statutes may make you liable for seller liabilities irrespective of whether the transaction does not fall under the five forms of buyer liability exceptions covered above.

Liabilities that you may have to take up for regulatory and statutory reasons include unpaid sales, payroll tax noncompliance, labor violations, unfunded pensions, and environmental liabilities.

Minimizing the Risk of Liability

As a buyer, it is vital that you are aware of the successor liability risks that an asset purchase transaction exposes you to. Strictly speaking, you cannot fully eliminate this risk. You can however take steps that keep the risk to a minimum. Other than strong contractual language, the following can be helpful.

1. New Subsidiary

Purchase the asset via a newly created subsidiary to protect the rest of your businesses and their assets from a successor liability claim in the future. It’s not impossible for a claimant to still impose liabilities on this new business entity but it is harder to do.

2. Due Diligence

Perform extensive due diligence on the acquired asset and seller operations with a focus on potential areas of successor liability risk including defective products, tax obligations, labor issues, and environmental factors.

3. Insurance Policies

Review the seller’s insurance policies that are relevant to the assets in question. This includes looking at claims history. Explore policies you could take up for unknown liabilities post-transaction such as environmental liability and intellectual property protection. You may also want to obtain warranties from the selling company.

Wrapping Up

Buying business assets rather than stock purchase is not as risk-free as it is sometimes assumed to be. The need to have carefully-drafted asset purchase agreements to protect you from assuming the seller’s liabilities cannot be overemphasized. It should make clear what liabilities you are assuming and which ones you aren’t.

Using broad, ambiguous language in the agreement may allow courts to rule in the future in favor of the plaintiff based on the theory of implied assumption. By all means, avoid using language that states or insinuates you’re buying the seller’s entire business.

You cannot make absolute predictions in successor liability lawsuits. Courts can take numerous factors into consideration. That said, the actions you take during negotiations and in drafting the agreement can help protect you from unwelcome surprises in the future.

Contemplating acquiring a business or a business asset purchase? Get buying alerts.

Will Simmons

Transaction Advisor

Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.