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Buying a San Diego Business: How to Avoid Successor Liability
If you are thinking of buying a business in San Diego or elsewhere in California, it is important to know what liabilities and debts of the seller you are agreeing to pay and what liabilities and debts you are rejecting. The legal doctrine of “successor liability” covers certain circumstances where a seller’s liabilities to attach to a buyer post-closing. An excellent and skilled San Diego corporate lawyer can ensure that you avoid successor liability.
San Diego Corporate Law: What is Successor Liability?
As we discussed previously in reference to mergers and acquisitions, there are some circumstances in which a buyer of a business either wants to or is willing to accept responsibility for the seller’s debts and obligations. However, under those circumstances, the purchase price has without question been adjusted by the buyer to take those debts and obligations into account.
However, mostly, buyers seek to avoid accepting the debt, liabilities, and obligations of the seller of a business. This is often simply a matter of reducing acceptable risks. Given the nature of business, some obligations are unknown. Maybe it is a sexual harassment lawsuit that has not yet been filed or some other unknown and unexpected legal, tax, administrative, or regulatory problem.
As California courts have defined it, the doctrine of successor liability means that a buyer of a corporation does not assume the seller’s liabilities unless:
- There is an express or implied agreement of assumption
- The transaction amounts to a consolidation or merger of the two corporations
- The purchasing corporation is a mere continuation of the seller OR
- The transfer of assets to the purchaser is for the fraudulent purpose of escaping liability for the seller’s debts.
See Cleveland v. Johnson, 209 Cal.App.4th 1315 (Cal.App. 2nd Dist. 2012).
San Diego Corporate Law: Importance of Well-Structured Purchase
In general, if the purchase is structured as a “stock purchase,” then it is presumed that the buyer is agreeing to undertake responsibility for the seller’s debts and liabilities. By contrast, if the deal is structured as an “asset purchase,” then it is presumed that the buyer is NOT assuming the seller’s debts and liabilities. Thus, it is important to structure the purchase correctly to reflect the intentions of the parties.
San Diego Corporate Law: Importance of a Well-Drafted Purchase Agreement
In addition to structuring the deal properly, it is important to have a well-drafted purchase agreement. Among the important provisions, a statement should be made whereby the parties agree that the buyer is not assuming any debts, obligations, and/or liabilities of the seller.
In addition, the purchase agreement should have the seller indemnify the buyer for certain types of unknown obligations such as sexual harassment lawsuits and the like.
San Diego Corporate Law: Importance of Due Diligence and Seeking Waivers
Finally, to avoid successor liability, the buyer’s experienced corporate attorney will expect the seller to provide as many waivers as are needed. There are several well-known sources of potential successor liability including:
- Large creditors/suppliers
- Lenders
- Taxing authorities — for sales tax, use tax, and employee tax withholding requirements
- Bulk sales
- UCC financing and collateralization
- Judgment liens
Since these are well-known, the seller’s attorney is expected to provide waivers or documentation showing the absence of such liabilities, the payment of such liabilities from the sales proceeds, or waiver. As an example, if the buyer is purchasing substantially all of the assets of the seller, depending on the size of the transaction, the transaction might be subject to the bulk sales law. If the buyer fails to comply with the law, irrespective of anything written in the purchase agreement, then the buyer might be liable to the seller’s creditors if the seller does not pay them. The process is three steps – providing notice, recording the notice with the county recorder’s office, and waiting the appropriate length of time before closing the deal. If creditors make their claims known, then payment will have to be arranged/negotiated. Sometimes at the closing, there is a hold-back of monies from the seller’s proceeds to ensure that monies are available to pay creditor claims.
There are similar methods of obtaining waivers for taxes, UCC financing statements, etc. All should be obtained prior to closing.
As can be seen, avoiding successor liability can be treacherous. Skilled corporate counsel is essential.
Contact San Diego Corporate Law
For more information, contact experienced corporate attorney Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard has many years of experience handling all aspects of the sale or purchase of businesses in California. Mr. Leonard can provide advice and guidance on the complex issue of whether an asset sale/purchase is preferable to a stock sale/purchase and can custom-draft the sales/purchase contract to avoid successor liability. Contact Mr. Leonard by email or by calling (858) 483-9200.
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