This is the fourth part in our look at buying or selling a struggling business. The first installment encouraged you to look beyond the immediate, with the second being about preliminary preparation for both buyers and sellers. Part three then took us deeper into the nuts and bolts of due diligence and the deal structure. In this part we will look at potential risks to the buyer and how to reduce those risks, with any sellers taking note. Although conventional logic would say that buyers have it easier in a market like today’s, it still takes attention and preparation for them to come out ahead.
Successor Liability
An asset purchase is attractive for the buyer of a troubled business. In an asset purchase, the buyer can generally take on only selected liabilities and debts, leaving most of the baggage with the seller, subject to exceptions such as successor liability and tax rules. The buyer can still become responsible for the seller’s past obligations, in spite of an agreement that tries to pin them on the seller.
”Successor liability” lurks, where a buyer becomes liable for the seller’s debts, no matter what the asset purchase agreement says. In California a buyer can be liable if they “impliedly” assumed obligations in the purchase agreement, or the deal looks like a “de facto” merger, or like the buyer’s business is a “mere continuation” of the seller’s, or if the transfer was a fraud aimed at helping the seller escape its debts. Independent counsel experienced in business acquisitions can review these risks for a particular transaction.
Fraudulent Transfer
In California a sale of assets can be a fraudulent transfer, aka “voidable transaction,” as to existing creditors or creditors who came into being after the transfer. Whether it is a fraudulent transfer or not depends on several elements, for instance (1) whether the seller received “reasonably equivalent value” in the transfer, and (2) whether the seller was insolvent at the time, or made insolvent by the sale. This could mean the entire sale is set aside. The buyers thought they got it cheap and then they do not get it at all.
California also targets “bulk sales” of a business or substantially all its assets with a notice provision. When the seller sells principally from inventory, e.g. manufacturers, restaurant owners, the buyer is responsible for serving notice on the seller’s creditors. Exemptions apply, like for sales over $5 million. The buyer is the one on the hook for complying, but buyers often make sellers contractually responsible for non-compliance.
Also California sales and use taxes can come back to haunt the buyer. Under California law, the buyer must hold back enough money to cover any unpaid sales or use tax of the seller until the seller shows paperwork from CDTFA that no liability exists. If the seller does not show the papers and the buyer fails to withhold, the buyer can be on the hook for the seller’s unpaid sales and use tax, even for sales before the closing, generally up to the purchase price. The buyer can request the certificate from CDTFA, but this may take 60 days or more, and may trigger an audit of the seller. Parties sometimes allocate liability for it by contract, while the seller stays liable until it notifies CDTFA about the sale.
Likewise, the buyer must set aside enough money to cover what the seller owes on unemployment. Either side may get a “Certificate of Release of Buyer” from the Employment Development Department (EDD) saying there is no such debt, but that takes time, so parties may agree by contract how to handle it. Having the certificate shields the buyer but does not release the seller, who generally must still file final returns with the EDD.
About Delancey Street
Delancey Street is a business debt settlement company that helps business owners nationwide. Our goal is simple: negotiate proposed debt settlements with funders, subject to their agreement. We are based in New York. We tell you how it is; because your business and future is on the line.
