The first question a business will ask when approached by a buyer is whether the transaction will be structured as a merger, stock sale or asset sale.
In a merger, the surviving entity assumes all the liabilities of the former entity. In a stock sale the seller sells stock or an interest in the entity and retains the liabilities.
When the buyer purchases assets, the general rule is that the buyer is not liable for the seller’s obligations – subject to four well-established exceptions that leave a buyer vulnerable to successor liability.
- The buyer can agree, either expressly or impliedly, to assume some or all of the seller’s liabilities.
- The transaction is really a merger but the parties did not follow the statutory merger requirements. Several factors are considered when determining if the transaction is a merger including whether the buyer assumes the seller’s obligations, continues the business with the same personnel, location, and stockholders and the seller dissolves soon after the sale.
- There is a continuation of corporate control and ownership – one company with the same stocks, stockholders and directors. In this case, some states assume strict tort liability for defects in units of the same product line previously manufactured by the seller when a buyer acquires manufacturing assets and continues the output of the same product line.
- The transaction was fraudulent to evade liability such as when the assets are purchased for inadequate consideration.
With the exceptions, an asset sale is not the safe option it used to be since successor liability is largely an unsettled area and vary from state to state. Of course, the buyer and seller should always first consult with their trusted legal and financial advisor’s and strive for a well-structured purchase and sale agreement that considers the following and much more:
- Clearly address the exceptions to the general rule.
- Clearly identify all liabilities and obligations of the seller and those liabilities and obligations the buyer agrees to assume and not assume.
- Review applicable law with a trusted legal advisor to identify and address successor liability particularly when the seller takes an interest in the buyer’s company in exchange for the assets, the seller’s business will be dissolved after the transaction and when purchasing manufacturing assets.
- Mutual indemnification in which the seller indemnifies for obligations arising pre-closing and the buyer indemnifies for obligations post-closing.
- Negotiate for the seller to continue any insurance coverage for post-closing occurrences or product liability.