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You’re an entrepreneur, and you’ve just found a company you want to buy in order to expand your own business. In setting up the purchase, you’ve decided you want to do an asset purchase. After all, you’ve heard that one of the benefits of an asset purchase is that, unlike in a stock purchase or merger, you can pick and choose which assets you want to buy and which liabilities you want to assume . . . right?

As in so many thorny legal issues, the answer is . . . it depends. Although it is generally true that in an asset purchase transaction you can pick and choose which liabilities you want to assume (almost like wheeling a shopping cart around a department store), there are a few types of liabilities that may follow you, regardless of how you structure your deal.

The Court Doctrines of Successor Liability

There is a well-settled principle in law that a corporation that purchases the assets of another corporation is not liable for the debts or liabilities of the selling corporation. Notwithstanding this principle, courts in both Illinois and Missouri recognize four exceptions to this rule: (1) when the buyer expressly or impliedly agrees to assume the liability; (2) when the transfer of the assets is entered into to defraud creditors; (3) when the buyer is a mere continuation of the selling corporation; and (4) when the transaction amounts to a de facto consolidation or merger.

Express or Implied Assumption. This is the most obvious and easily avoided route to successor liability. In short, liability for debts or claims will attach to a successor if the successor expressly or impliedly assumes the debt or liabilities. Most commonly, this will happen if the asset purchase agreement (expressly or by ambiguity), or the buyer’s actions imply that the buyer will be assuming these obligations. The asset purchase agreement should set forth the specific liabilities the buyer is assuming and expressly disclaim all other liabilities. Likewise, the buyer should avoid taking any action outside of the agreement or after closing that suggests that it intends to pay for such obligations.

Fraudulent Transfer. If your company is underwater, can you sell its assets to your brother for a pittance, have him hire you at a great salary and then throw your arms up in the air when your company’s creditors come knocking? Of course not—that would be a fraudulent transfer or conveyance. Essentially, if a seller sells the assets of its business with the intent to hinder, delay, or defraud creditors or if a seller sells its assets without receiving reasonable compensation in return, the transaction may be deemed a fraudulent transfer, and creditors may seek certain remedies, including setting the conveyance aside. So long as you are purchasing the business assets in an arm’s-length transaction for a reasonable price, you should be able to avoid the attachment of successor liability under this exception.

Mere Continuation. Courts may attach successor liability if the purchasing corporation is a “mere continuation” of the selling corporation. Some states have applied this test broadly, including situations where only the business operations are continued. However, both Missouri and Illinois have applied a narrower test: without a continuity of management, corporate organization, and, in particular, ownership, no continuity will be found. Other factors the courts may look at include the similarity of the operations, workforce, retention of the name of the seller, and whether the buyer holds itself out as a continuation of the seller. This is the easiest exception to fall into. Often, buyers want to continue a business and minimize disruption. However, if there is a significant difference in ownership and management structure (as would be the case in most arm’s length transactions), you should be able to avoid getting snagged by this exception.

De facto Consolidation or Merger. Although technically distinct, this exception bears significant similarity to the mere continuation exception. Statutory, or formal, mergers under Illinois and Missouri law require the surviving corporation to assume the liabilities of the merging corporation. However, if a transaction has the general appearance of a merger but does not formally qualify as a merger under state law, successor liability will still attach. The tests in Illinois and Missouri are formulated with slight differences. However, the basic gist is the same: the purchasing corporation must generally assume the liabilities of the seller, and the selling corporation (as well as the separate identity of the shareholders) must cease to exist. A common circumstance of a de facto merger might involve a transaction where the selling corporation’s shareholders receive shares of the purchasing corporation in exchange for the selling company’s assets or where, as in the mere continuation circumstance, there is otherwise a continuity of shareholders, management, assets, workforce, and operations. So long as a buyer keeps the transaction at arm’s length and the parties remain “strangers after the sale,” a buyer should be able to avoid the successor liability imposed under this exception.

Statutory Successor Liability

In addition to these four court-made exceptions of successor liability, buyers also need to be aware of several statutes which specifically impose successor liability for certain of the seller’s tax liabilities.

Employer Withholding

Federal law does not specifically provide for successor liability in collection and remittance of payroll taxes; however, state laws are a different matter. In Missouri, the seller of a business is required to request from the Missouri Department of Revenue a statement of all employer withholding due and owing, and failure to do so may result in a penalty assessed against the seller. Unfortunately, that penalty doesn’t get the buyer off the hook. If no certificate is issued showing that all Missouri employment taxes are current and paid on behalf of the seller, the buyer will be liable for the full amount of all unpaid taxes, interest and penalties due from the seller.

Illinois law provides a substantially similar procedure whereby the buyer of the company is required to notify the Illinois Department of Revenue of the impending sale, and the department, in turn, will issue a “Bulk Sale Stop Order” directing the buyer to withhold a certain estimated sum from the purchase price and failure to do so will result in the buyer becoming liable for the tax liability.

What these laws mean in a nutshell is that if you fail to comply with their requirements, you won’t just buy equipment, leases and goodwill — you will have unwittingly just bought the seller’s withholding tax liability as well! Thorough due diligence and legal planning can make sure you avoid these liabilities before they attach to you and your business.

Sales and Use Tax

In Missouri, very similar to employer withholding liability, the seller of a company is required to apply for a certificate from the Missouri Department of Revenue showing no liability for sales or use tax. If the seller fails to do so, or if any amounts of sales or use tax remain unpaid at closing, the buyer must withhold sufficient amounts from the purchase price to pay off all amounts, or else the buyer becomes liable.

Illinois law provides essentially the same procedure and results as in the employer withholding context whereby the buyer of the company is required to notify the Illinois Department of Revenue of the impending sale, and failure to do so may result in the buyer becoming liable for the sales tax liability. This doesn’t mean, of course, that the buyer is off the hook. (Hopefully, your purchase contract provided that the seller warrants that there is no existing tax liability.) It only means that you can bring a lawsuit to force the seller to pay. The problem, however, is not only that bringing such a lawsuit will take time and expense, but also that if the seller hasn’t paid their tax liability, they may not have the money to indemnify you regardless of what they’ve promised under the sale contract.

Income Tax

There are no particular laws which attach a seller’s Missouri or federal income tax liability to a successor; however, the government in both cases may attach a lien against a selling company’s assets (personal and real property) prior to closing for unpaid taxes. Although this is not unlike a mortgage, UCC filing or other lien, if you do not perform your proper due diligence prior to purchase, you may find that the assets you just purchased are subject to the seller’s debts and potential foreclosure!

By contrast, Illinois law appears, at least, to provide true successor liability for the seller’s state income tax debt unless the buyer performs the proper notification procedures required by the Illinois Department of Revenue.

Trade Creditors

Article 6 of the Uniform Commercial Code, where it is still in effect, imposes liability upon the buyer for all of the seller’s debts to its trade creditors unless certain notice requirements are met. These notice requirements are a significant burden, but failure to comply with them can have catastrophic consequences, and you may end up paying all of the seller’s bills. Missouri and Illinois have both repealed Article 6, so this law is not a problem in these states. However, as a practical matter, if the seller fails to pay its biggest vendors, those same vendors may use whatever leverage they have to force you to pay the debts of the seller (and if they are the only vendors available for the product, that leverage can be significant, and you may find yourself forced to choose between paying the seller’s bills or scrambling to find a substitute vendor!)

Other Liabilities

Although tax issues are the most common successor liability issues to consider (partly because they are the most easily remedied), the list above is by no means exhaustive of all successor liability you may encounter. Most commonly, successors-in-interest may be held liable in a variety of employment contexts, including Title VII, unfair labor practices, the Age Discrimination in Employment Act (ADEA), and the Uniformed Services Employment and Reemployment Rights Act (USERRA). Courts have found successor liability in environmental contexts such as under the Comprehensive Environmental Response, Compensation and Liability Act, (CERCLA), even when the buyer in the asset purchase sale excludes the specific assets which are offending the environmental law!

Conclusion

Most entrepreneurs wanting to start or expand their business find asset purchases are one of the most effective ways of doing so. As with any course of action in business, there are always risks involved in an acquisition. Although it is impossible to completely cover every contingency that may arise, working closely with your attorney in performing your due diligence and carefully crafting your purchase agreement will help you minimize those liabilities that cannot be entirely avoided.