The Ghost of Transactions Past: How Successor Liability Can Haunt the Present and Future of Your Business

Running the numbers, modeling markets and demand, and planning growth and profitability are common exercises for any acquisition. But in the excited rush around making the next big purchase, businesses sometimes neglect the trail of sticky and costly problems that can tag along with a deal, frequently expressed in the form of successor liability. Understanding how liabilities can follow an asset through the door–or exit with an asset at closing–is therefore important to any transaction. 

Although Non-Liability Is The General Rule . . .

At least as far back 1890, the U.S. Supreme Court held that a good faith purchaser of an asset for value took that asset free and clear of the general liabilities of the seller. Fogg v. Blair, 133 U.S. 534, 538 (1890). The Supreme Court thought this rule sufficiently self-evident that “it is surprising any other can be supposed.” Id. For this reason, the preferred form of transaction has typically been an asset sale rather than a purchase of the seller corporation itself. But even an asset sale needs care, as the exceptions to the general rule can make a critical difference to both seller and buyer.

. . . Beware the Exceptions.

As asset sales grew to be the preferred transaction form, courts were increasingly concerned about claimants who were left with little recourse–especially when an asset sale constituted the seller’s major exit and dissolution event. Accordingly, over the last 100 years, the courts have chipped away at the non-liability rule, adding a number of exceptions providing for successor liability, even for an asset sale. Originally quite narrow, these exceptions have grown and evolved, to the point that predicting whether a buyer will have potential successor liability can be difficult to ascertain. These exceptions include:

  • Assumption of Liability Exception – Simply stated: what does the asset purchase agreement say about the buyer’s assumption of liabilities? If the buyer expressly disclaims an assumption of liability, that will usually defeat subsequent efforts to hold the buyer liable for something that happened before the asset sale. It won’t necessarily stop a claimant from suing the buyer, but as between seller and buyer, the contract will help determine who pays the bill if the claimant is successful. Clarity and certainty in drafting is therefore important. It isn’t, however, always possible to track every item and category of liability. In cases where an agreement is silent, who gets stuck with which liability will depend on what the court gleans from the contract language, the facts and the parties’ respective intentions, and what the law of the jurisdiction favors.  
  • Mere Continuation Exception – Although buyer and seller pretend to operate under different names, is the buyer really nothing more than a continuation of the seller’s business? In determining the answer, the courts will look for an identity of ownership, assets, and objects between the seller and the buyer. The Georgia courts have imposed successor liability under this exception when the seller and buyer have had the same stockholders, employees, vendors and customers, were involved in providing the same goods and services, and were otherwise largely indistinguishable except for the name.
  • De Facto Merger Exception – Is the buyer essentially doing the same business, at the same place, using the same people, with the same assets as the seller? If the answer is yes, the courts have been more inclined to impose the de facto merger exception–especially when the seller has dissolved following the sale, and the old shareholders were paid out in buyer’s stock. The migration of ownership, assets, people, and operations to the new company can therefore become a major challenge if not done correctly.
  • Fraudulent Avoidance Exception – Is the transaction a fraudulent attempt to avoid liability? A court is more likely to say “yes,” especially if, outside the bankruptcy context, it appears the underlying transaction has been structured to avoid debts and other obligations of the seller, or when the asset in question has been sold for less than what is reasonable and fair. 

Some Useful Suggestions

So, what ought a buyer or seller do to properly capture and apportion successor liability?

  • Understand the transaction – It’s not enough that a deal is merely called an asset purchase. Think through what the parties are doing, and how deal terms describe the nature and size of the transaction. As a very rough rule of thumb: the more the set of assets and operations being purchased look like a critical part of what the seller does, or all of what the seller does, the more successor liability will be an issue after closing.
  • Understand the asset – Some assets come with more liability, from regulatory and legal risk to governmental oversight and filing requirements. Pinpointing the sources of potential liability will enable the seller and buyer to better designate the party best suited to handling and addressing specific liabilities post-sale.
  • Have the right team – Having the right people, with the right knowledge and information, perform due diligence on an asset is essential. Identify these people early in the buying and selling process.
  • Understand the contract – Is the agreement legible? Can you read it? Do you understand it? The more an agreement is weighed down with ‘legalese,’ long run on sentences, and poor organization, the less likely the buyer and seller–and their attorneys–will understand what in fact is being agreed. Demanding documents in straightforward English is your right as the client. 
  • Have the right lawyer – The right law firm can make a big difference in how your transaction is documented and understood. Consider whether the lawyer you choose is a good fit to your business and provides the type of value-added advice that improves the quality of your transaction and helps you better understand your choices and preferences throughout negotiations.

Understanding Your Liability and Its Future

No matter what type of business you run, it is important you understand how liability can follow your business. Whether you are purchasing an asset or selling an asset, potential liabilities should be carefully weighed and considered as part of the larger transaction.

The attorneys at Baker Jenner LLLP have helped clients ranging from startups to middle market movers and shakers and Fortune 500 companies in a wide variety of M&A transactions. Whether your business needs assistance in a deal, or advice and representation in litigation concerning a liability, contact Baker Jenner to schedule a consultation today. 

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Baker Jenner LLLP

Baker Jenner LLLP is a business solutions law firm. We partner with clients to achieve their goals while managing transactional, regulatory, and legal risks.

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