Today I want to talk about buying a business with a newly formed acquisition subsidiary. In this case, an operating company we will call Parent wanted to buy the business assets of Seller. To do so Parent formed a newly formed company, which we will call Buyer. Buyer purchased the assets of Seller:
On April 21, 2015, … (Buyer) … and … (Seller) … entered into an Asset Purchase Agreement. … In exchange for acquiring substantially all of … (Seller) …’s assets, … (Buyer) … executed two promissory notes representing a $700,000 loan made from … (Seller) … to … (Buyer) … The notes required … (Buyer) … to pay … (Seller) … $100,000 on May 31, 2015 and $600,000 on June 30, 2015. Id. … (Buyer) … also agreed under a separate note to pay … (Seller) … an earnout amount of $125,000. …
Buyer never made any payments to Seller:
… (Buyer) … defaulted on the payments due on May 31 and June 30, and never paid any of the amounts owed to … (Seller) … under those notes. …
Seller sued Buyer, but it had no assets. Seller also sued Parent. Parent was not a party to the Asset Purchase Agreement and so asked the court to dismiss Buyer’s lawsuit against it. The Court refused to dismiss the lawsuit. It held that Parent can be liable for Buyer’s promissory notes given to Seller if Parent did not adequately capitalize Buyer:
Taking the allegations and the evidence in the light most favorable to … (Seller) …, … (Parent) … brokered an asset acquisition deal with … (Seller) …, then formed a wholly-owned subsidiary to execute the purchase agreement, without any intention of properly funding it, and ultimately reaped the benefits of … (Seller’s) … technology while its subsidiary continually delayed payment or legal consequences by representing to … (Seller) … that it would satisfy the debt and pay additional amounts if … (Seller) … agreed to not file a lawsuit. … (Seller) … has therefore met its burden to establish jurisdiction over … (Parent) … as the alter ego of … (Buyer) …
This United States District Court case is referred to as Scallop Imaging, LLC v. Blackhawk Imaging, LLC, Dist. Court, D. Massachusetts 2018 Civil Action No. 17-cv-10092-ADB, and can be found at: https://scholar.google.com/scholar?scidkt=15237134566953886767&as_sdt=2&hl=en
Comment. A company buying the assets of another business, often forms an acquisition subsidiary to buy the assets. The hope is to keep the acquired business’s creditors from reaching the assets of the parent company. This should work if the acquisition subsidiary is sufficiently capitalized. However, adequate capitalization is a question of fact and open to dispute. There is always a risk that the parent company may get sued for the liabilities of its acquisition subsidiary by a creditor that alleges that the subsidiary was not adequately capitalized.
By John McCauley: I help people start, grow, buy and sell their businesses.
Email: jmccauley@mk-law.com
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Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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