This article, the second in a series on Buy/Sell basics, discusses the basics of asset purchase agreements. An asset transfer is the most common means of transferring all of a privately owned business. Buyers prefer to buy assets, because it limits exposure to the seller’s liabilities if handled properly. Rather than just stepping into the seller’s shoes, the buyer typically forms a new entity for the purchase, usually a S corporation or limited liability company. The new entity buys the assets of the seller in place and in use, including the fixed assets, new vehicle inventory, used vehicle inventory, parts and accessories inventory, intellectual property, phone numbers, customer lists and records.
The seller terminates employment of all its employees at the closing so the buyer can then hire some or all of them. The buyer can pick and choose the employees it wants to hire and the liabilities it wants to assume. However, if the agreement is not drafted properly or if the transaction is handled incorrectly, the buyer can become liable for all of the seller’s obligations as a successor in interest.
Bulk sales laws protect a buyer from liability for the seller’s unsecured creditor claims if, and only if, the parties comply with the state’s bulk sales laws. If nothing needs to be done to comply, which is often the case, then doing nothing is still complying – unless the parties waive compliance. Waiving bulk sales law compliance is an agreement not to comply. People often waive compliance when nothing needs to be done to comply. A better approach than waiving compliance is to agree to comply. Otherwise, the buyer no longer has anything showing it complied with the bulk sales law to send to the attorney for a creditor who claims successor liability. Worse, the creditor has evidence that the buyer did not comply when all the buyer had to do was agree in writing that the parties would comply in order to have that protection.
A UCC search in the state where the seller is located and in the state where the seller entity was formed will tell a buyer if any of the assets to be purchased are security for obligations of the seller. Typically, all assets will be security for the seller’s flooring line of credit, which must be paid off at closing so that the buyer can get the assets free and clear of those liens.
Tax liens can also attach to assets. Sales, use, franchise and employment taxes do not need to be recorded in any public record for a buyer to become responsible for them if they are not paid by the seller prior to closing. To be sure a buyer will not be responsible after closing, a buyer must obtain tax clearance certificates or releases from the State Board of Equalization, Employment Development Department and Franchise Tax Board. Money is often held back in escrow if the releases or certificates cannot be obtained prior to closing so that any balance due can be paid by escrow to obtain the release or tax clearance certificate after closing.
It is important to include in an asset purchase agreement a statement that the buyer is not assuming any obligations of the seller, except as specifically set forth in the purchase agreement. The buyer must then also act consistently with that statement. Agreeing to carryover vacation time accrued by seller’s employees to the employment by buyer of the same employees is one example of not acting consistently. Failure to act consistently can result in successor liability.
Avoiding successor liability is the reason for purchasing assets instead of capital stock of a business. When you purchase capital stock you get all the liabilities. When you purchase assets, as long as you don’t inadvertently step into successor liability, you don’t purchase any liabilities of the seller except those you specifically agree to assume. Typical liabilities that are assumed are things like a lease for the building, or an equipment lease or DMS or maintenance contract.
A buyer typically pays more for assets than for stock because no liabilities are being assumed. The last thing a buyer wants is to end up with successor liability when buying assets. Learn more about successor liability from our next Gray Duffy newsletter and about asset purchase agreement basics by attending our free webinar on May 26th.