Am I Buying More Than a Business?
Successor Liability Issues that May Remain After the Closing

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.

Employer Withholding

Federal law does not specifically provide for successor liability in collection of payroll taxes; however, states 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 no tax liability 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 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 company’s assets (personal and real property) 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, in itself, 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 purchaser in the asset purchase sale excludes the specific assets which are offending the environmental law!

Conclusion

Most entrepreneurs want to expand their business, and 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 the attorneys of Weiss & Associates, P.C. in performing your due diligence and carefully crafting your purchase agreement will help you minimize those liabilities that cannot be entirely avoided.

Weiss & Associates, P.C. represents individuals and companies of many different sizes in a myriad of businesses and industries. For many of our clients, we provide guidance on issues both related to their business and their personal matters. If we may be assistance to you, please contact the attorneys at Weiss & Associates, P.C.

 

© Weiss & Associates, P.C. 2008