Many companies put their assets up as collateral for financing. A buyer of a company needs to know this before buying the business.
This risk is minimized in part by the seller representing and warranting in the purchase agreement that the assets are free and clear of all liens other than those disclosed in the purchase agreement.
But that seller representation and warranty only gives the buyer a right to sue the seller after the closing for damages for breach of the representation and warranty if it turns out that the assets are collateral for a secured loan that is properly perfected by the filing of a UCC financing statement.
In such a case, the buyer takes those assets subject to the security and can lose this collateral if the seller defaults on the secured loan. At that point the buyer may have a claim against a seller with no assets.
The seller in this case was a Phoenix based Nevada corporation that made video lottery machines. It borrowed money from a lender and its video lottery machines were collateral for the loan. The lender properly perfected its security interest by filing a UCC financing statement with the State of Nevada. The financing statement lists the seller as debtor, the lender, as secured party, and the assets of the seller as collateral.
Later a buyer purchased the seller’s assets, including the video lottery machines. The seller represented and warranted to the buyer that the video lottery machines sold to the buyer were not subject to any liens. The buyer did not do a UCC search with the State of Nevada to see if seller (a Nevada corporation) had any UCC financing statement filings against its assets.
After the closing, the seller defaulted on the loan and the lender sued the seller for $1.5 million in damages. The buyer had taken possession of the video lottery machines and had leased some of them to restaurants in Maryland.
The lender sued the buyer in a Maryland federal district court asking the revenue that the buyer earned from the video lottery games used in the restaurants be placed in a trust account pending the outcome of lender’s suit against the seller.
The buyer argued that it did not know about lender’s collateral interest in the machines; and that the buyer had relied on the seller’s purchase agreement representation and warranty that the machines were not subject to any liens.
The court said too bad. The lender had valid liens in the video lottery machines since it had properly documented its secured interest through a note, security agreement, and perfected filing of a UCC financing statement in the State of Nevada. Therefore, the earnings from the machines were ordered to be placed in a trust account pending the outcome of lender’s suit against the seller. They will be used to pay down the seller’s loan if the lender wins the suit.
This case is referred to Potts v. Maryland Games, LLC, Civil Action No. CBD-18-3250, United States District Court, D. Maryland. Southern Division, (Filed March 29, 2019)
The lesson here is clear. In doing due diligence, run a UCC search on the business you are buying to see if any of the assets are subject to UCC liens. This would be part of the lien due diligence you may need to do; for there may be other lien searches such as liens for taxes.
By John McCauley: I help businesses minimize risk when buying or selling a company.
Telephone: 714 273-6291
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