Discover the legal implications of inheriting unpaid payroll taxes in M&A asset deals. Learn from a real case involving a buyer facing a $100 million liability. Insights on managing risks and mitigating potential tax liabilities.
June 30, 2020
Introduction:
When acquiring assets in a merger or acquisition (M&A) transaction, buyers need to be aware of the possibility of inheriting unpaid payroll taxes from the seller.
The Situation:
In a specific case, a buyer purchased the assets of a financially troubled company for $7.3 million upfront and an additional $2.5 million over the following 41 months. The seller was in financial distress due to uncovered federal and state payroll tax debts totaling $100 million. Despite knowing about these tax issues, the buyer proceeded with the acquisition.
Legal Dispute:
Five months after the deal was completed, the seller group filed for bankruptcy. Subsequently, the bankruptcy trustee initiated legal action against the buyer, seeking to recover funds the buyer had withheld and to nullify the sale as a fraudulent transfer. The buyer defended its position, claiming it had a right to offset its potential liability for the $100 million unpaid payroll taxes. However, the court rejected this argument because the IRS and state tax agencies had not yet taken action against the buyer.
Insights:
This situation was unique because the buyer was aware of the seller’s unpaid payroll taxes prior to completing the acquisition. The seller was a subsidiary of a public company, and even though the issues had been disclosed in regulatory filings, the buyer still proceeded. The seller’s financial troubles were publicly revealed and led to changes in its management.
The buyer’s risk of taking on federal payroll tax liability was relatively low at the time of closing, as the deal didn’t involve the transfer of buyer stock, and the asset purchase agreement did not impose federal payroll tax responsibilities on the buyer. State payroll tax risk depended on specific state laws.
Managing Risk:
One method to mitigate federal and state payroll tax risks for buyers could have been to acquire the business through a bankruptcy process under Bankruptcy Code Section 363. This approach allows buyers to purchase the business without inheriting the seller’s liabilities through a court-approved order. Such an acquisition could have potentially eliminated the payroll tax risk.
Furthermore, a Section 363 acquisition would have prevented the bankruptcy trustee or any creditors of the seller from challenging the acquisition as a fraudulent transfer and attempting to undo the deal.
This case highlights the complexities involved in M&A transactions, particularly when dealing with financially distressed sellers and potential tax liabilities. Buyers must carefully consider their options and potential risks before finalizing such deals.
Case Details:
This case is referred to as In Re Corporate Resource Services, Inc., Case No. 15-12329 (MG) (Jointly Administered) Adv. Pro. Case No. 16-01037 (MG), United States Bankruptcy Court, S.D. New York, (Signed March 1, 2017).
By John McCauley: I help manage the tax risks associated with buying or selling a business.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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