be little comfort to the buyer after he realizes that he may be required to spend several years and tens or hundreds
of thousands of dollars in litigation to obtain a judgment against the seller – a judgment that might not even be
collectible. Because of the hidden liabilities that exist when a buyer acquires ownership of the company itself,
buyers overwhelmingly prefer to acquire only the assets of a company.
Buying a Business or Buying Trouble?
4 Tips to Minimize Risk
•
Originally Published July 2018
By John L. Egloff, RBE Attorney
Buying the assets of the company. In connection with an asset purchase, the asset purchase agreement will
generally include a clear statement that the buyer is NOT assuming any liabilities of the seller, with the exception
of liabilities that are expressly assumed by the buyer under the terms of the agreement. As a result (with certain
exceptions discussed below), a buyer of assets has the option to pick and choose what debts and liabilities of the
company he wants to assume, if any. For example, it is common for a buyer to assume the seller’s liability for
current trade payables and current payroll obligations (so as not to disrupt relationships with the company’s vendors
and employees), as well as any leases for the seller’s equipment and facilities – all of which are items that should
be readily identifiable and quantifiable at the time of the acquisition. However, it would be extremely unusual for
a buyer to agree to assume the seller’s tax liabilities, or any potential product liability, warranty, environmental, or
employment-related claims, or to assume any other claims or liabilities that are not specifically identifiable and
quantifiable.
2. Do your due diligence.
B
uying a business should not be like buying a used car. While it may be common for
someone to buy a used car “as-is,” it would be highly unusual for someone to buy a
business with that disclaimer. Instead, when purchasing a business, buyers will want to avoid
assuming responsibility for the existing problems and liabilities associated with the business –
except for those liabilities that the buyer specifically agrees to assume.
So what should a buyer do to avoid (or at least minimize) the risk that he or she will be
unexpectedly saddled with liabilities of the acquired business?
Imagine that two weeks after your closing you were to discover that the assets you bought were subject to lien by your
seller’s lender, or that a court case involving your seller had been decided a month ago in which the court had ruled that the
seller’s principal product violated a competitor’s patent, or that the biggest customer of the business had notified your seller
a month earlier that the customer was placing its final order and would be taking its business to a competitor. To prevent
those sorts of costly surprises, your goal in a business acquisition should be to learn as much as is reasonably possible about
the business, its assets, and its liabilities before concluding the sale. That process is typically referred to as “due diligence”
and has two primary components:
• Undertaking a comprehensive lien/judgment search. As most experienced business people know, the holder
of a lien has the right to seize the property that is subject to the lien (real estate, equipment, accounts receivable,
intellectual property rights, bank accounts, etc.) to satisfy the debt that the lien secures. Liens can be granted
voluntarily by the owner of the property (such as a mortgage lien), or imposed involuntarily by law, such as a
tax lien or a judgment lien. If a buyer purchases property that is subject to a lien, the lien stays on the property
irrespective of the transfer. Moreover, in the case of a voluntary lien, it is almost always the case that the document
creating the lien (a mortgage in the case of real estate, or a security agreement in the case of most other types of
property) will state that any sale of the property by the seller is itself a “default” that allows the lienholder to seize
the property. Although the law requires a public notice to be filed for nearly every type of lien, the problem is that
different types of liens are filed in completely different government offices, and a court judgment may only appear
in the records of court where the judgment was rendered (which could be anywhere in the country). As a result,
identifying the liens and judgments to which a business is subject can be a very complicated task requiring the
services of a professional lien search company.
• Undertaking a detailed review/inspection of the company’s records and operations, with supporting warranties
and representations in the purchase agreement. Most law firms who represent business clients have developed
a standard “due diligence checklist” that is used to assist clients with business acquisitions. These checklists detail
the information and documents that the seller should be requested to provide regarding every facet of its business,
including copies of the seller’s tax returns and financial statements for at least the last five years; copies of all
contracts relevant to the operation of the business (such as leases, customer contracts, software and other intellectual
property licenses, vendor contracts and employment agreements); a roster of employees together with wage rates,
1. Buy the Company’s assets and not ownership of the
Company itself.
There are two ways to buy a business – you can either: (a) buy the seller’s ownership interest in the business itself (meaning
the seller’s stock if the seller’s business is a corporation, or the seller’s ownership units if the business is a limited liability
company); or (b) buy only the assets of the business (the equipment, inventory, furniture, intellectual property and even the
name of the business).
•
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Buying ownership of the company. A change in the ownership of a company in no way affects the company’s
liability for its debts and other liabilities. As a result, if you elect to acquire ownership of a company by purchasing
the stock or ownership units of the company from the seller, you are not only acquiring its assets, but also any and
every obligation and liability of the company. This includes readily identifiable obligations and liabilities, such as
the company’s bank debt and trade payables, as well as every potential or even concealed liability arising out of the
seller’s prior operation of the business, such as income or sales tax deficiencies (or even tax fraud), potential product
liability, warranty, environmental, and employment claims, and others. While a well-written stock/unit purchase
agreement might give the buyer the right to file suit if the seller fails to disclose existing or potential claims, and the
buyer might also have rights against the seller under applicable federal and state securities laws, those rights may
Riley Bennett Egloff LLP - October 2018
RBELAW.com
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