There are three ways a buyer can go about structuring the purchase of a company. First, the buyer can purchase all the assets of the company. Second, the buyer can purchase the stock (or interests, if you own an LLC) of the company. Third, the buyer can conduct a statutory merger, which is essentially a filing with the secretary of state that, by law, merges the companies together. Stock deals and statutory mergers tend to be a little simpler from a documentation standpoint. In stock deals and statutory mergers, all of the assets and liabilities of the company are transferred to the buyer when the buyer acquires the company stock or the statutory merger paperwork is filed. The buyer cannot pick and choose which assets and liabilities she wants – she gets them all when she steps into the shoes of the seller.
In an asset purchase, the sellers put together a long list of all the assets of the company – real estate, customer lists, equipment, etc. Those assets are then sold to the buyer. Thinking through and documenting all the assets can take some work. The buyer will want to be 100% certain she’s getting every asset needed to operate the business. Some of these assets will need to be transferred via deeds and transfers of titles (other documentation that can be avoided in a stock purchase).
One big advantage of an asset deal, from the buyer’s perspective, as least, is the buyer does not typically have to buy the liabilities of the company. So, if there is ongoing litigation, a buyer can sometimes avoid having to take over responsibility for it. You can imagine that would most buyers prefer the asset purchase approach, all things equal. If you’re the seller, though, you would probably prefer that the buyer take over the liabilities, if only so you don’t have to ever think about them again. Granted, following most asset purchases, the selling company is dissolved and the shareholders aren’t personally liable for the liabilities of the company anyway (unless they personally guaranteed or are otherwise individually implicated in the liabilities). However, sometimes the selling company can’t be easily dissolved without somehow addressing its open liabilities through a bankruptcy or other mechanism. In all, from the seller’s vantage point, it is clearly simpler if the buyer just takes responsibility for the liabilities. Keep in mind that if any of the liabilities are secured by liens on the company assets, the lien will stay with the asset when the buyer purchases it so there’s no getting around the liens other than paying them off.
Also, you should be aware that there are certain circumstances where a buyer will be responsible for liabilities of the selling company despite conducting an asset purchase and despite specifically not accepting the liabilities of the selling company. These circumstances tend to be ones where courts, over time, have crafted rules, or legislatures have enacted regulations, for public policy reasons. By that, I mean that the courts and legislatures felt like too many buyers and sellers were giving too many creditors a raw deal and they needed to make a few rules to prevent that from happening so often.
This area of the law is called successor liability because the buyer, as successor to the seller with respect to the acquired company, is liable for certain obligations of the seller by law. It’s a relatively new concept as courts prior to the 1970s just recognized whatever the buyers and sellers agreed to on paper. Most court cases expanding the scope of successor liability involving product liability or environmental claims. Rather than forcing an injured consumer to chase the scattered shareholders of the selling corporation, public policy has been used to craft theories by which recourse can be obtained against the buyer of the business.
Some courts have imposed successor liability on an asset buyer under a theory referred to as a de facto merger. As its name suggests, courts determine that in certain cases, the asset purchase is for all intents and purposes a merger and the buyer is deemed to have purchased all the liabilities of the selling company in addition to its assets. In making the de facto merger determination, courts generally look at a few factors, including whether or not owners of the selling company remain owners of the buyer, how quickly the selling company closes down and dissolves, if the buyer assumed liabilities it needed to assume to ensure uninterrupted continuation of the business (e.g., ordinary course of business trade payable, like accounts payable), and if there is continuity of management, personnel, physical location and the general business operation. To avoid falling prey to the de facto merger doctrine, an asset purchase agreement should be carefully drafted to specify exactly which liabilities of the selling corporation are and are not being assumed by the buyer and the parties should avoid broad language to the effect that the buyer is purchasing the entire business of the selling corporation, instead stating that the buyer is purchasing only certain specified assets of seller. We realize that business considerations generally drive how buyers and sellers structure M&A deals. But, to the extent possible and solely for purposes of considering the de facto merger implication, it’s preferable that the buyer pay in cash rather than its stock, change the names of the products it sells (i.e., makes efforts to show changes to the selling business), and make as many other changes to the management of the business as it can justify – changes both to the people doing the managing and the methods in which they manage.
Fraud is another context in which courts have traditionally held that deals conducted for the purpose of avoiding liability will not let buyers and sellers off the hook. If the deal isn’t done for a reasonable purchase price or there is demonstrated evidence that the intent of the transaction was to defraud creditors, courts are very likely to impose liability on whatever party is able to pay, including the buyer, regardless of how the transaction is structured on paper.
There’s more to this area of the law but it’s technical (read: boring). Seriously, I’ve said enough to give you an idea of the significance of this issue. It’s a state-by-state and court-by-court question in any case. So, when you’re structuring your deal, if you decide to do it as an asset purchase and the buyer is trying to take at least something less than all of the liabilities, be sure to have a thorough chat with your lawyers about successor liability.
We’ll continue looking at asset deal structures in the Part 2
Author: Brett Cenkus
Brett Cenkus is a business attorney with 18+ years experience based in Austin, Texas. He has worked with a variety of businesses and has clients throughout Texas as well as many technology clients throughout the United States. Brett is a Harvard Law graduate with a sharply seasoned mind and an entrepreneurial heart. As a founder of 6 companies himself, he is especially passionate about helping startups succeed. In 2016 Brett was named the winner in the Individual category for RecognizeGood’s Ethics in Business & Community Award. He offers businesses solutions that are in sync with their culture, goals and values. You can learn more about Brett by visiting the About page on this website.