copies of commission programs, bonus programs, and the seller’s employee handbook; a description and copies of
all pension, health, and other employee benefit plans and programs; customer lists and sales records and forecasts;
vendor lists and records; equipment lists and depreciation schedules; an inventory listing; a listing and copies of all
licenses and permits; a description and documentation regarding any past, existing, threatened or potential claims
and litigation involving the company, and much more. The buyer’s legal counsel and accounting firm typically
assist the buyer in reviewing and evaluating the information provided by the seller from the due diligence process.
Additionally, a well-written stock/unit purchase agreement will then include “warranties and representations” by
the seller, in which the seller assures the buyer that all of the information and documents provided to the buyer are
accurate and complete – such that the seller would potentially be liable for “fraud” (including a possible award of
punitive damages) if false or misleading information has been provided to the buyer.
3. Watch out for liens and liabilities created by law as a result of the
sale!
Although a buyer is not generally responsible for the seller’s liabilities (except as to any liabilities that the buyer expressly
agrees to assume), various state or federal statutes can create: (a) liens that automatically arise by reason of the seller’s
cessation of business; and (b) liabilities that are automatically imposed on the buyer. As a result, it is imperative that
the potential imposition of these automatic liens and liabilities be identified before the purchase of the seller’s assets is
consummated, so that the buyer can decide whether to proceed with the transaction, or to perhaps negotiate an adjustment
in the purchase price. These statutory liens and liabilities include the following –
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COBRA. Employers who employ 20 or more employees and provide a health insurance program are required to
give employees (and their covered dependents) the option to remain on that health plan for a period following the
employee’s termination of employment or after certain other circumstances where coverage would otherwise be
lost. Under the Internal Revenue Code, a buyer who “continues the business operations associated with the assets
purchased from the [seller] without interruption or substantial change” is required to allow anyone who has elected
COBRA continuation coverage under the seller’s plan to continue that coverage under the buyer’s plan, if the seller
discontinues its plan (which generally happens after a company’s assets are sold).
• Retirement Plan Liabilities. The Pension Benefit Guaranty Corporation (“PBGC”) is the federal agency that insures
workers’ pension benefits under certain types of pension plans. If a company sells its assets and ceases business
without fully funding any pension plan insured by the PBGC, a lien on the seller’s assets will be automatically
imposed under federal law in favor of the PBGC. Additionally, a company that employs union employees and
contributes to a national or regional union pension plan on behalf of its union employees may incur “withdrawal
liability” if it sells its assets and ceases operating. This withdrawal liability represents the amount of the accrued
pension liabilities attributable to the company’s former employees, and can be hundreds of thousands of dollars.
Federal courts have held that in appropriate circumstances, where there has been a continuity in the operations
before and after an asset sale, the buyer can be held liable for the seller’s withdrawal liability.
• Unemployment insurance. Indiana law provides that a buyer who acquires substantially all of the assets of
another company becomes liable for any deficiencies in the seller’s historical unemployment insurance payments.
In addition, the buyer becomes subject to a higher unemployment tax rate until the seller’s deficiency is eliminated.
• Wage-Hour laws. The federal courts have held that in certain cases where there has been a continuity of operations
before and after an asset sale, the buyer can be held liable for the seller’s violations of the federal minimum wage
and overtime laws (the “Fair Labor Standards Act”).
• Bulk Sales law. In any case where: (i) the seller’s principal business involves the sale of inventory from stock,
Riley Bennett Egloff LLP - October 2018
(ii) the buyer proposes to purchase of more than half the seller’s inventory, and (iii) the seller will not continue to
operate the same business after the sale, the sale may be subject to Indiana’s “bulk sales” rules. These rules require,
among other things, that certain notices be provided to potential creditors of the seller. If the buyer fails to comply
with these rules, then the buyer becomes liable for the seller’s financial obligations to the seller’s creditors.
•
General successorship principles. A court can impose “successor liability” on the buyer of a company’s assets,
and hold the buyer responsible for any or all of the seller’s liabilities, where the sale occurs under fraudulent or other
suspicious circumstances. For example, courts have imposed successor liability on a buyer where the owners and
management of the buyer were substantially the same as the owners and management of the seller. In addition, if
the buyer is owned by one or more persons affiliated with the seller and the asset sale is made at a bargain price, the
court may consider the transaction to be fraudulent.
4. Additional protections.
Depending upon the size and complexity of the transaction, it is not uncommon for a buyer to have to satisfy one or more
seller liabilities, whether as a result of an oversight or as a result of outright fraud on the part of the seller. Therefore, a well-
crafted asset purchase agreement should include two protections for the buyer:
• A “hold-back”. One of the best protections a buyer can have to absorb the financial expense of a seller liability is
to insist on holding back a portion of the purchase price. This hold-back is generally reflected in a promissory note
payable to the seller after a period of at least one year. Both the promissory note and the purchase agreement would
then contain language expressly stating that in the event that the buyer is called upon to pay any seller liability
not expressly assumed by the buyer, the buyer will have the right to deduct the amount of that payment from the
amount payable under the note. In effect, this promissory note becomes the buyer’s “insurance policy” against
liability for the seller’s obligations.
• Comprehensive indemnification provisions backed by both the seller and its owners. A purchase agreement
should contain indemnification provisions, describing in detail the seller’s obligation to indemnify and hold the
buyer harmless with respect to any claims against the buyer (including the buyer’s attorneys’ fees) arising out of
any seller liabilities that were not expressly assumed by the buyer. In addition, is important to make certain that
the seller’s owners, are: (i) specifically identified as parties to the agreement in their individual capacities and sign
the agreement in their individual capacities; (ii) specifically join in the representations and warranties being made
by the seller; and (iii) specifically obligated, along with the seller, to fulfill the indemnity obligations under the
purchase agreement. Why is this important? Consider what will happen as a result of and immediately following
the closing. At the closing, the seller will convey all of its assets to the buyer for the purchase price, such that
immediately after the closing the seller will have no assets other than the cash paid by the buyer. Then, either at
or immediately after the closing, the seller will use the sale proceeds to pay off whatever obligations the buyer
did not assume, and will immediately distribute the balance to the seller’s owners. That means that if the buyer
subsequently has an indemnity claim, and the only one obligated by the indemnity provisions of the purchase
agreement is the company that was the seller, the buyer will be presenting its indemnity claim to a company with no
cash or other assets! The moral of the story is to follow the money: since the owners will end up with the money,
they should be parties to the purchase agreement and be legally obligated under its indemnity provisions.
The process of buying a company is complicated and fraught with many risks. A cautious buyer will make wise use of
competent legal and accounting professionals to assist with that process, and to help identify and minimize those risks.
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