Most savvy purchasers of a business prefer to acquire the underlying assets of a business over its equity. Although there can be a multitude of reasons for a purchaser to prefer an asset purchase, one of the more common justifications is the avoidance of the historical liabilities associated with the seller’s business. As a result, a purchaser typically takes great care in drafting a purchase agreement to specifically disclaim any liability and responsibility for the historical tax liabilities of a seller. In doing so, a purchaser can avoid any liability with respect to the historical state tax liabilities of a seller, correct? Unfortunately, it is not that simple.

Notwithstanding the terms of a well-crafted tax liability allocation and disclaimer provision in a purchase agreement, in a number of states as a matter of state law, a purchaser may nevertheless be liable for the historical state tax liabilities of a seller. Of course, a purchaser may have the indemnity provisions in the purchase agreement to rely upon, however, an indemnity provision still has to be enforced and may not have much value if there is no readily available source of recovery or if the seller is not creditworthy.

Although liability for a seller’s state tax obligations can be draconian, fortunately, most states provide a mechanism to avoid successor liability. Typically, this involves requesting tax clearance from a state and/or placing funds into an escrow account pending a purchaser’s receipt of a tax clearance certificate. Unfortunately, this can be a time consuming process, especially when the parties are rushing to close a deal and may view state tax matters as ancillary to the core business deal.

The scope of each state’s law on successor liability and the taxes for which a purchaser may be held liable varies by state, and a state by state analysis and thorough due diligence is required to obtain a clear grasp on a purchaser’s potential exposure.