Imagine your company decides to purchase a business. The business is up for sale at a great price and seems a worthy investment for future revenue. You purchase the business, oversee a merger, and quickly begin to start generating revenue from your new enterprise. Everything seems great, right?
Two years later, however, things don’t seem so great. A product that was sold by the company before you acquired it is found to have a serious defect and you are faced with a lawsuit for an error that wasn’t even made by your current infrastructure, yet you are still responsible. If it was a pharmaceutical company, perhaps a pill that was sold is found to have negative side effects long term that were not known previously. If it’s a vehicle or piece of electronic equipment that was sold, perhaps the product is found to be defective after a period of time and may result in fires being started or injury during use of the product.
These are just a couple of examples of defects that can be discovered years after initial development. Many times, the original owners of the company are no longer in control of it and it becomes the problem of whoever acquired the company. This situation is known as successor liability, and there are many ways to prevent it from happening to you through a business acquisition.
Avoiding Successor Liability in a Stock Purchase
Successor liability may exist in a situation where a company purchases a controlling interest in a company through their stock, a partnership interest in a partnership, or the membership interests of a limited liability company. In all these situations, the buyer steps into the shoes of the seller and may share many of the same liabilities as the entity.
While a seller is obligated to disclose any known existing liabilities, oftentimes contingent liabilities exist. Contingent liabilities are those of which the seller is unaware. Contingent liabilities may or may not turn into actual liabilities. An example of a contingent liability would be an individual injuring themselves on company property prior to an acquisition that the company may be unaware of. The individual may never file a lawsuit, but if they do, the contingent liability becomes an actual liability.
A buyer can avoid these liabilities by structuring the purchase as an asset purchase. In this type of purchase, the business assets are acquired, but not the business liabilities.
Avoiding Successor Liability Through Not Complying With Bulk Sale Laws
California holds a set of bulk sale laws intended to protect trade creditors by imposing liability on the buyer. Whenever making a large purchase, such as over 50% of a company’s assets, it is in the buying party’s best interest to provide appropriate notice of the bulk sale to the county tax collector. Again, this protects the buying party from unknowingly buying into liabilities the seller is trying to free themselves of.
Avoiding Successor Liability Through Public Policy Exception for Manufacturing Businesses
Also known as the “Product Line Successor” rule, this exception can override the protection provided by structuring a business acquisition as an asset acquisition. As mentioned previously, an asset purchase structure will generally protect a person from a seller’s contingent liabilities, however this exception applies under certain limited circumstances for manufacturing businesses as created by the California Supreme Court.
This exception occurs under the following circumstances:
- The plaintiff is no longer able to seek remedies against the original manufacturer due to the acquisition.
- The successor has the ability to assume the original manufacturer’s risk-spreading role.
- It is found to be a fair responsibility of the successor company to acquire due to it being a burden attached to the original manufacturer’s goodwill that is being enjoyed by the successor in continuous operation of the business in question.
Avoiding Successor Liability in Certain Tax Situations
In some situations, acquiring a business even as an asset purchase may leave the buyer responsible for the seller’s tax liabilities and related penalties. These taxes, while not necessarily as detrimental as a lawsuit or otherwise against the original company, may still be financially cumbersome. Working with a business escrow service and hiring a reputable business attorney are great options to protect yourself from an added obligation you may not even know exists.
Other Considerations
A lot of the other considerations to make are simply common sense. You should always do adequate research if you intend to acquire a business. While it’s not particularly difficult to discover if a company is in the middle of some financial crisis making them consider a sale, you’d be surprised how many businesses try to escape some kind of liability by selling their business while being fully aware of the crisis. Even more surprising is how many buyers take an interest in a business without considering if they may be in the middle of some type of financial crisis that makes the business worth paying to get rid of rather than worth paying to buy.
Some obvious flags are businesses being sold for ridiculously low asking prices and secrecy about some of the financial records or company history prior to the sale. As a buyer, you have the right to know as much as possible about the business you are considering purchasing. Any secrecy should be met with suspicion.
Hiring a California Business Attorney
Avoiding successor liability can be done easily by working with a reputable attorney every step of the way when considering acquiring another business. A professional business attorney can advise you about potential risks and help you prepare the necessary paperwork appropriately so you do not find yourself caught “holding the bag” due to some other company’s negligence that is now your own.
WB Law Group is a professional law firm dedicated to assisting you with your business needs. For questions, or to schedule a consultation, contact us today at (559) 431-4888.