Linda wanted to sell a small company which was secondary to her main company. It had never generated the profits she or her late husband had expected. She wanted to concentrate on her core business. And she wanted cash.
Linda talked to her accountant, and found a broker, who found a buyer for the company’s equipment. The buyer wanted the equipment to expand the product line of his existing business. They agreed on a price and signed a letter of intent. Then the seller called an attorney who advised the sale of equipment was not the best route for her – a stock sale would have been preferable.
A stock purchase is the purchase of the shares of stock of the corporation. This form is generally preferred by sellers. In a stock purchase, the buyer can receive all the company’s contracts, licenses and permits –without consent of the third party (Liquor licenses are an exception in most states). A company owner may prefer a sale of shares due to a tax advantage: the gain on the sale of shares may be taxed at a lower rate than ordinary income and in fact, a portion could be tax free. Buyers dislike it because it exposes the buyer to all of seller’s liabilities—both known and unknown, from trade payables to potential environmental concerns. A buyer can seek some comfort by doing aggressive due diligence, obtaining warranties and indemnification from the seller, and keeping a portion of the purchase price in escrow in the event of breach of warranties. However, the best drafted warranties won’t be worth a hill of beans if the seller no longer exists. Escrow, and resulting litigation, can be expensive and time-consuming.
An asset purchase is just that: purchase of some or all of a company’s assets. Examples of assets include facilities, vehicles, equipment, tooling, inventory, customer lists, and intellectual property. While sometimes the purchase of the assets may resemble the purchase of an entire company, it is not. After a purchase of assets, no matter how encompassing, the corporate entity remains. It may only be a shell, in which case it may be appropriate to follow state law procedures for dissolving the corporation rather than letting it “die” by neglect of corporate tax and filing requirements.
Both stock and asset sales bring with them the potential for successor liability being imposed on the buyer in the future. A buyer should have a qualified attorney review the potential for successor liability in order to structure any sale to avoid it. Successor liability is a matter of state law.
Under the product-line theory of successor liability in California and Washington, a purchaser of substantially all the assets of a firm assumes, with some limitations, the obligation for product liability claims arising from the selling firm's presale activities. Liability is transferred irrespective of any clauses to the contrary in the asset purchase agreement."
Ohio has adopted the general rule of successor liability, which provides that the purchaser of a corporation's assets is not liable for the debts and obligations, including liability for tortuous conduct, of the seller corporation. There are four exceptions to this general rule, three of which impose liability without regard to contract. A successor corporation may be held liable when:
(1) the buyer expressly or impliedly agrees to assume such liability;
(2) the transaction amounts to a de facto consolidation or merger;
(3) the buyer corporation is merely a continuation of the seller corporation; OR
(4) the transaction is entered into fraudulently for the purpose of escaping liability.
Back to Linda and her company. The sale of equipment was moving forward. Buyer prepared a draft purchase agreement on his own—reusing an agreement from a previous and very different deal which also involved containing an escrow agreement for part of the purchase price. While an escrow agreement to hold back part of the purchase price as a safeguard may be preferable from a Buyer’s standpoint, Linda objected —on the advice of her lawyer—because it was inappropriate and too costly. Buyer agreed to remove it.
Some additional issues arose in drafting the documents. The Buyer also needed to assume payments on certain leased equipment, stay in Seller’s facilities for several months, wanted to hire two of Seller’s employees and sought a 10 year non compete from Linda. All of these required documentation and negotiation. How and why this was done and the ultimate result will be discussed in future articles.
Monica Williams is principal in Monica B. Williams Co. LPA, a firm focusing on business transactions for privately held companies. She works with business owners who want to avoid the legal potholes involved in buying/selling a business. Her experience ranges from a $100,000 sale of a steel service company's assets to a $44M acquisition of a tool manufacturer. She advises on legal aspects of company restructurings, mergers and acquisitions and works with tax and accounting professionals to structure transactions to protect and benefit clients.