When You Are Buying A Business When Will The Buyer Be Liable . . .
I recently represented a purchaser of a business and we structured the transaction as an asset sale. All throughout the process my client kept asking if our corporation purchasing the assets of the seller be liable for its debts and obligations?
Well as a general rule, when one corporation sells or otherwise transfers all of its assets to another corporation, the purchasing corporation is not liable for the debts and liabilities of the selling company (unless the debts are specifically assumed by the purchaser). There are a few narrow exceptions to this rule of thumb:
(1) When the purchaser expressly or impliedly agrees to assume such debts or liabilities;
(2) When the transaction amounts to a consolidation or merger instead of the sale of assets;
(3) When the purchasing corporation is merely a continuation of the selling corporation; or
(4) When the transaction is entered into fraudulently in order to escape liability for the seller’s debts and liabilities.
Part of the first exception to the rule of thumb, where a purchaser expressly agrees to assume certain debts or liabilities is simple enough. However, there a little case law examining whether or not a purchaser impliedly agree to accept any debts or liabilities—probably because it would be a difficult case to make. Be that as it may, it obviously does not come up too often or courts would have examined it more thoroughly.
Generally (and each jurisdiction should be examined) the second exception to the general rule–i.e., that the transaction effectively amounts to a merger or consolidation (a de facto merger) are: (i) a continuation of the selling company’s management, personnel and general business operations; (ii) a continuity of shareholders resulting from the purchasing corporation paying for the assets with shares of its own stock so the selling corporation stockholders remain a shareholders of the purchasing corporation; (iii) the selling corporation’s ceasing ordinary business operations and dissolving as soon as possible; and (iv) the purchasing corporation’s assuming the obligations of the selling corporation necessary to continue normal, ordinary business operations. Some thing else to keep in mind that it is not necessary for a court to find all of these elements in order to find a de facto merger.
In finding de facto mergers, courts generally examine the following types of evidence in coming to their decision: (a) the agreement by which the purchasing corporation acquired the seller’s assets is silent about most of the sellers employees, but does provide employment of the seller’s officers and other higher level management while the purchaser continued the seller’s general business operations; (b) the seller’s assets were purchased by issuing stock of the purchasing company, which was given to the selling company’s stockholders, making them shareholders of purchasing entity; (c) the transaction agreement required the seller to be dissolved as soon as possible; and (d) the purchaser assumed the obligations of the seller that were necessary to continue the sellers ordinary course of business. These types of circumstances all point to a de facto merger.
The third exception to the general rule–i.e., when the purchasing corporation is a mere continuation of the selling corporation some jurisdictions use a narrow construction to the requirement the purchaser is a “mere continuation” of the selling party (in my opinion the better rule from a policy perspective). Otherwise simply the continuation of the enterprise or its product line might lead a court to conclude that the purchaser is a mere continuation of the seller.
In a jurisdiction which applied a narrow interpretation of the “mere continuation rule” the court rejected the claim that a purchaser was a “mere continuation” of the seller even when: (1) the purchaser did not purchase all of the seller’s assets; (2) the seller remained in business for more than a year after the transfer of its assets to the purchaser; (3) upon the liquidation of the seller, none of its remaining assets were sold to the purchaser; (4) the seller and the purchaser had no common incorporators, directors, officers or shareholders; and (5) the purchaser was not created to acquire the seller’s assets.
The fourth exception is also relatively self explanatory. Often called a “flush and switch” when the sale of assets is a mere shell game designed to enable the seller, through fraud, to escape liability for its obligations to its creditors, courts will impose successor liability on the purchasing entity.
In short, I assured my client that none of these circumstances applied to our transaction since it was completely above board. I am glad he asked though because it showed that he was really thinking through the consequences of buying this business—something too many clients don’t do.
Leave a Reply