Successor liability: Avoiding the minefield of unexpected exposure

Buying a business is a risky proposition. The only way to contain and mitigate that risk is to conduct a thorough investigation into the acquisition target while being backed by retained advisors experienced in business transactions. In any acquisition there are dozens, if not hundreds, of risk factors. One such factor often not considered by first-time purchasers is that of successor liability – the extent to which the successor business, could be liable for certain debts and obligations of the seller’s business after closing.

Equity purchases

The structure of a business sale and purchase plays an oversized role in determining the scope of successor liability. Generally, in Oregon, Washington, and elsewhere, equity purchases (buying stock or membership units from the seller) guaranty your assumption of the subject business’s debts and liabilities. With an equity purchase you’re effectively purchasing the ownership of the business itself – and the debts and liabilities along with it.

There are scenarios where an equity purchase makes sense to a purchaser, such as when a good portion of the seller’s revenue is derived from government contracts. But most often, buyers will prefer to sidestep as much potential liability as possible. They do this by purchasing the assets of the business – rather than the business itself.

Asset purchases

When a buyer purchases the assets of a business, she will establish her own business with a newly minted tax identification number issued by the IRS. Being unburdened by issues that may be associated with the seller’s tax ID number usually eliminates most issues of successor liability. As with any general rule, there are exceptions. As outlined in Oregon case law, buyers in asset purchases may still be subject to successor liability for:

· Any debts or liabilities that are assumed by agreement (whether express or implied)

· Transactions that are, in effect, consolidations, mergers or continuations of the seller business rather than asset purchases

· Fraudulent transfers designed solely to get out of liabilities

In addition, certain wage claims, liens and unpaid taxes may survive asset purchases, becoming the liability of the buyer.

How to avoid successor liability

Because asset purchases do not necessarily extinguish all potential successor liabilities, savvy buyers should take additional steps to curb exposure. Due diligence is key. Examine the seller’s tax and financial records, payroll data, supplier agreements, operating history, and other business records to ensure there aren’t any gaps. Consider enlisting a CPA or forensic accountant to comb through records in detail. Conduct a thorough search for outstanding liens, including tax and UCC liens, and don’t proceed to closing without a thorough understanding of all risk factors.

Another key to avoiding unexpected liabilities is a solid purchase agreement specific to your transaction, with sufficient safeguards beyond standard indemnification language. This may entail establishing an escrow account, or structuring a holdback provision that allows you to withhold a portion of the purchase price for a set amount of time as security against potential claims.

How to buy a business the right way

Identify and engage with trusted, experienced advisors before undertaking any business purchase. Experienced professionals will help ensure your path to business ownership is effective, efficient, and focused. It will save you countless hours and foster peace of mind. Buying a business is one area where taking any shortcut is ill-advised. There is far too much at stake.