Selling More Than Just Your Business – A Primer on Successor Liability

The following article is from one of IAG’s partnering groups, AxialMarket.

When you sell your company, it’s possible, even likely, that some liability originating from the period of your ownership will befall the new owner who buys your company.

This creates for a sticky issue when you are negotiating the terms of the purchase and sale agreement in an M&A transaction. Neither party wants to assume any liability post-transaction, and the buyer will do everything they can to protect themselves against any assumed liabilities, which include, but are not limited to product, contractual, tax, and environmental liability issues. To avoid post-transaction litigation, it’s important to identify all knowable liabilities and clarify specifics around who is assuming what when drafting the purchase agreement.

In general, when the sale is structured as an asset sale, the buyer does not assume liability, whereas if it is structured as a stock sale, they do assume at least some amount of liability.

Regardless of how the sale is structured, the development of Successor Liability Laws has defined the situations when a buyer is always responsible for the liability of the previous owner, under any and all circumstances.

The Successor Liability Exceptions are:

  • Continuation: If the sale of the company is a continuation of the original company, the buyer can assume liabilities. Depending on which state litigation occurs, what defines a continuation can be interpreted very broadly or narrowly. Characteristics of a continuation include ownership of assets, continuation of the company officers and their roles, and inadequate consideration paid for assets.
  • De facto Merger: Technically speaking, a merger differs from a continuation, but in terms of successor liability, they share similar characteristics. In addition to the factors mentioned under continuation, the courts can also look to see whether operations or the physical location are the same, whether the new owner maintains the company name, and whether or not public perception has changed.
  • Assumed Liability: In this instance, the buyer chooses to contractually assume specified liabilities from the seller.
  • Fraudulent Transfer: If a seller sells the assets of its business with the intent to defraud creditors, they continue to assume liability for the company.

When selling your company, you should consult an attorney to fully understand what measures you should take to negotiate liability. Negotiations over the assumption of liabilities is usually a give and take but also can surface some real dealbreakers, so during the negotiation stage of the M&A transaction, keep the following in mind:

  • In the purchase agreement, clearly define to what extent the buyer should assume liability under different circumstances.
  • Make sure you indicate a resolution for liabilities not stipulated in the purchase agreement.
  • Understand your liability if you plan on continuing with the new company, either in a consulting, executive or board position.
  • Be sure to take into consideration how the company is paid for (cash, stock, debt), as it can impact who assumes responsibility for certain liabilities.

By assuming any post-transaction liability, you reduce the risk for the acquirer, which can impact the purchase price. An experienced buyer will often uncover much of the liability risk during due diligence, which will help avoid post-transaction complications. Moreover, a good M&A Advisor will help you navigate and negotiate your rights as a seller.

By Jamie Romero