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Buying a Business? How to Protect Yourself From Seller’s Unpaid Obligations Default
When buying an ongoing San Diego business, in general, buyers want to avoid being responsible for any of the Seller’s pre-sale obligations. This is among the many reasons that, if you are in the process of buying a business, you need to retain an experienced San Diego corporate attorney to help you through the process. Part of the “due diligence” of a business purchase is to uncover and catalog all of the current, pending, and near-future obligations that are owed by the Seller — those obligations that were incurred while the seller was operating the business. Those obligations should be paid before or at the closing from the proceeds of the sale. Typically, ongoing obligations like rent or utilities are prorated as of the closing date.
However, there is always the danger that some obligation is overlooked or that the seller fails to pay an obligation that the seller agreed to pay. What is a buyer to do? Here are a few strategies for protecting a buyer.
Avoid Any Sort of “Sellers’ Promise” to Pay
It is generally a bad idea to accept a seller’s promise to pay for various obligations post-closing. If the seller has agreed to pay, then those payments should be sent out as part of the closing. Otherwise, there is a danger that the seller will not make the payments; maybe the seller fully intended to pay, but something unforeseen happens. In any event, it is best to avoid “seller’s promises.”
Create an Escrow
One of the most common methods of protecting a buyer is to create a payment escrow from the sales proceeds. Often this is set as a percentage of the purchase price and is set to terminate after a reasonable amount of time after the closing — say six months. The money in the escrow is used to pay anything that the seller does not pay and also for any overlooked obligations. An escrow can also be used where the amount of an obligation is uncertain at the time of the closing. For example, often a tax certificate or invoice is needed from the State of California for income or sales or other taxes. However, maybe there is a delay in the receipt of the certification/invoice. As such, the parties can agree on a reasonable estimate and escrow two times that amount for payment when the documentation is received.
Obtain a Guaranty From a Third Party
Another option that is less common is to have a third-party provide a guaranty for payment of any seller’s obligation that goes unpaid. This can be the owners of the business being sold or an affiliated company (if any). This reduces the risk to the buyer since, if litigation must be filed, then the buyer can bring suit against the seller and the guarantor.
Explore Possible Insurance Options
In a similar vein, insurance products are sometimes commercially available that can alleviate risk. An example here is title insurance is real property is involved in the business purchase.
Always Obtain Indemnifications and Hold Harmless From the Seller
In addition to the foregoing, it is important that the sales contract contain indemnity and hold harmless language and make it clear that the buyer is not assuming any of the seller’s obligations. This language will allow the buyer to sue the seller if the seller does not pay an obligation incurred when seller was operating the business.
Call San Diego Corporate Law Today
For more information, call attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides legal services related to business law, private securities offerings/sales, the sale/purchase of a business and for mergers and acquisitions. Mr. Leonard can also assist with setting up a new corporate entity, annual corporate maintenance, and can help review and draft business contracts. Mr. Leonard can be reached at (858) 483-9200 or via email. Like us on Facebook.
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