Leave no stone unturned. Cover all the bases. Cross your Ts and dot your Is. You’ve heard it said dozens of ways, and before you buy or sell a business, friends and colleagues will probably warn you dozen of times.
Ever wonder why most business sales involve buying assets and not buying a company’s stock? Two words: successor liability. When buying or selling a company, both parties should use carefully prepared agreements to avoid this issue.
Generally, there are three options in buying or selling companies. Buyers may buy stock directly from shareholders; do a statutory merger; or buy only specific assets (and assume only some liabilities) from the selling company. In the latter scenario, also known as an asset purchase, the seller usually dissolves and distributes the purchase price to shareholders after the sale while the buyer continues the business.
Most buyers prefer an asset purchase because it typically keeps them from being liable for the seller’s unknown liabilities. In a stock purchase or merger, buyers can’t avoid responsibilities for all selling company liabilities, known or unknown.
Even in asset purchases, however, courts sometimes hold the buyer responsible for the selling company’s unassumed liabilities. A lawyer can help assess, and hopefully minimize, this risk.
How to Beware
Because courts have developed theories known to hold buyers responsible for the selling company’s liabilities, buyers should not blithely assume that asset purchases shield them from liability.
One of the theories is the de facto merger doctrine, developed to impose successor liability on buyers in asset purchases where they tried to avoid legal obligations like those under dissenters’ rights statutes.
The de facto merger doctrine applies if key elements stay in place, such as management, personnel, physical location and business operations, and some of the same shareholders (owners of the selling company became part-owners of the buyer). If the buyer looks too much like the selling company, courts may impose its liabilities on the buyer, but it applies only if the selling company halts business, dissolves and the buyer assumes the selling company’s business operations.
In recent decades, some courts relaxed the de factor merger doctrine, making buyers liable even if all elements weren’t present. Some states rejected the de facto merger doctrine. In Ohio, the doctrine remains viable in some form.
A second theory of successor liability is the continuity of enterprise doctrine, imposing liability on buyers even if the seller does not get stock. Adopted by courts in Alabama but rejected in at least nine jurisdictions, Ohio courts have yet to rule on this theory.
The duty to warn doctrine says buyers must know about defects in the sellers’ products if a continuing relationship exists with the seller’s customers. The selling company’s goodwill, usually acquired in an asset purchase, is held to include an obligation to assume liability for preexisting product liability claims filed after the sale.
Under the theory of implied assumption, usually resulting from sloppy drafting or ambiguity in a purchase agreement, courts hold buyers implicitly responsible for seller liabilities under an asset purchase agreement, even if the liabilities weren’t known at the time of sale.
The last theory, fraud, is an old one. Courts have long held transactions entered into to avoid liability to creditors. In cases with inadequate consideration or demonstrated intent to defraud creditors, courts impose successor liability on buyers even if the form of transaction is an asset purchase.
How to Prepare
Though Ohio courts haven’t adopted a specific successor liability theory, it doesn’t mean a sympathetic plaintiff won’t convince a court to put liability on buyers in the future. To minimize the potential of this, the buyer’s lawyer should conduct due diligence on the selling company’s business, particularly in product liability, environmental and tax areas.
Asset purchase agreements should be drafted carefully to avoid broad or ambiguous language and specify the exact liabilities being (and not being) assumed. In some cases, insurance coverage may be available to protect buyers from responsibility for excluded liabilities.
Buyers should also state that they are buying only specified assets of the selling company and assuming only specified liabilities. In certain situations, buyers can pay all cash, forgo the seller’s product names, and conduct business in a way not identical to the seller before the acquisition.
Using these guidelines and careful agreements, buyers can reduce the chances of successor liability in asset purchases. You have to look over your shoulder twice, but in the end, you and your business will be glad you took the proper precautions.