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.

When you are paying for advice listen to it! Recently I had a client who was working as a pharmacist for huge retail chain and just could not stand it any more so he wanted to buy a pharmacy. We came across what initially looked like a great deal—the seller had just been through a divorcee, was desperate to sell and was willing to finance the entire purchase price. The seller made numerous representations to that business was operating just fine and that it would be a turn key operation. Despite the rosy picture the Seller was painting after some digging we discovered that the store was almost 6 months behind in its rent, was in default to it main vendor who had initiated litigation and the ex-spouse would need to sign off on the deal since she was still part owner of the company. I don’t know what more could have been wrong with the deal.

Though my guy was anxious to leave his current employer, he did the right thing he listened to his team when we told him he would be crazy to move forward with this transaction. Too many times though a buyer gets a case of the “first time home owners syndrome.” The syndrome often afflicts first time home buyers who are so desperate to close on that first house that they will overlook any problems with the property—only to have buyers’ remorse down the road.

Just like buying a house, often buyers who are unhappy with their present situation and are longing to move on will catch the syndrome and overlook material problems with the deal just to close or leave or whatever. They always regret the day they decided to move forward instead of listening to the people they hired to look out for them. Buying a business is one of the most significant steps than a person can take. The transition from employee to owner is stressful enough without the added headaches of a company rife with problems from day one.

How do you know if you have the “first time home owners’ syndrome”? One test I use is to see if the client can get up and walk away from the table without looking back. If you can’t get up and walk away, then you’ve probably got the syndrome since and will probably do something you will regret down the line. What is the cure? Simple, listen to the people you’ve hired to guide you through the process—they have an objective perspective and can see more clearly than you.