When purchasing a business, buyers often prefer that the transaction be structured as an asset purchase rather than a stock purchase. In a stock purchase, the buyer purchases the target company as an entity, and therefore assumes the seller’s liabilities, since the company being acquired retains all of its liabilities as a matter of law. By restructuring the transaction as an asset purchase rather than a stock purchase, a buyer is provided with a much greater level of protection against liability for the target company’s obligations.
The law in most jurisdictions has traditionally held that when one company sells all of its assets to another, the buyer does not become liable for the debts and liabilities of the selling company. This is still true to a large extent, and we frequently recommend structuring a transaction as an asset purchase in order to protect the buyer from the liabilities of the business being acquired.
However, over the past several years, the theory of successor liability has evolved and expanded as a result of a series of clashes between the policy in favor of allowing a company to sell its assets in an unrestricted manner, balanced against other policies, such as providing a source of relief for injured parties or other claimants. As a result, in some cases, a purchaser of assets may be held liable for certain liabilities of the seller. Whether or not an entity buying the assets of another may be held liable for the liabilities of the seller is highly fact specific, and may depend upon the type of liability at issue, the jurisdiction in which the claim is made, and other factors which the courts may take into account in balancing these conflicting policies.
In this eight part series, we review exceptions to the general rule that a purchaser of the assets of a business is not responsible for liabilities incurred by the seller prior to the sale.
Part Eight: Statutory Liability
Some federal courts have imposed successor liability in limited circumstances dealing with the application of broad federal statutes involving environmental liability, employee benefits, employment rights and civil rights. Typically, these courts rely on factors similar to one or more of the previously discussed exceptions to find that the buyer is a successor under the statutory definition and then impose liability. Due diligence prior to the purchase of assets and adequate indemnification provisions in the Asset Purchase Agreement can help the buyer protect itself from these broad federal statutory claims.
Under federal environmental laws, a purchaser of real estate can be held liable for cleanup costs for contamination that existed prior to the purchase. However, the law provides that the purchaser may not be held liable for these costs if it conducts a Phase I Environmental Assessment prior to the purchase, conducted in compliance with certain required standards, establishing that there was no reason to believe that any such contamination existed as of the time of the purchase. We frequently arrange for an environmental consulting firm to conduct a Phase I Environmental Assessment on our clients’ behalf, in order to establish this “innocent purchaser” defense to protect our client from liability for clean-up costs if real estate purchased is later found to be in need of environmental remediation.
Under federal law the Internal Revenue Service may attempt to impose successor liability if a purchaser is determined to be a successor under applicable state law. If the buyer’s due diligence determines that the seller may have significant federal income tax liability, it is important to minimize the risk of being considered a successor under applicable state law.
Under state law, the assets being acquired could be subject to the debts of the Seller, if liens have been properly filed or recorded on those assets. A title insurance policy should be obtained as part of the due diligence process, to ensure that real estate is being transferred to the purchaser free and clear of any liens relating to any debts or obligations of the seller. Uniform Commercial Code lien searches, together with tax lien and judgment lien searches, should be conducted to assure there are no liens on the personal property being acquired.
Under the laws of most states, the buyer can be held liable for up to either the purchase price or sometimes the entire amount of the seller’s unpaid state tax liabilities until those liabilities are extinguished. Thus, a buyer that does not perform the proper due diligence regarding the seller’s state tax history may incur liability for the seller’s unpaid state taxes and, in many cases, for the related penalties and interest.
In some states, the seller’s unpaid sales tax liability may transfer to the buyer when a business or assets are sold. In order to account for this, a buyer may request that the seller obtain a clearance letter (also called a certificate of clearance) from the state Department of Revenue as proof there are no outstanding delinquencies on the seller’s account. However, a clearance letter may not exempt the business from future audits that may cover periods before the business was sold. In some states, to identify potential tax liabilities, the buyer or seller may ask for a transferee liability certificate, which is proof that no tax is due or all taxes, penalties, and interest have been paid. Once the certificate is issued, the Department of Revenue will not audit the business again for the period covered by the certificate, but this requires an initial audit of the business before issuing a transferee liability certificate.
(Read Part 7: Duty to Warn…)
If you have questions about how to structure the purchase or sale of a business, please contact KDDK attorney Jeffrey K. Helfrich at jhelfrich@KDDK.com or (812) 423-3183, or contact any member of the KDDK Business Law Practice Team.
About the Author
Jeff Helfrich is a business attorney with more than 30 years’ experience whose practice includes mergers and acquisitions, real estate, commercial finance, business organizations, and healthcare law. Jeff represents businesses locally and nationwide in a variety of general business matters, including the formation of new businesses, the purchase and sale of businesses, the negotiation of business and real estate contracts, and resolving shareholder disputes. Jeff has also represented banks as well as commercial borrowers in the negotiation, preparation and review of loan documentation.