One risk in buying the assets of a business is being sued by a seller creditor for a seller liability that the buyer did not assume in the asset purchase agreement. This risk is much higher when buying all the business assets of a seller that liquidates immediately after the closing.
This happened to a buyer, a Phoenix based luxury motor coach company that provided ground transportation in several states. In this case, the seller was a Torrance, California based corporation that provided transportation services in Arizona, California, and Nevada.
At the closing, the seller was defending claims by several of its commercial landlords for $50K in damages. In financial trouble, the seller had put itself up for sale. It sold most of its assets to the buyer for $14.4 million in cash.
This amount covered the seller’s secured creditors and some of its unsecured creditors. But the seller was still defending itself on the landlord $50K claims.
The closing left the seller with numerous assets and land leases. The seller also continued to fight the commercial lessors lawsuit for another 6 months. Its owners did not liquidate the seller (a corporation) until 1 ½ years after the closing.
The buyer assumed some trade debts but did not use the seller’s logo or hire any of the seller’s upper management.
The seller’s commercial lessors were unable to collect against the seller and sued the buyer in a Nevada state court. Ordinarily, a buyer of the assets of a business is only liable for liabilities of the business that the buyer expressly assumes in the asset purchase agreement.
The buyer did not assume any liability seller owed to the commercial lessors under the asset purchase agreement. Nevertheless, the creditors sued the buyer in a Nevada state court, under the de facto merger exception of Nevada’s successor liability rule. The Nevada trial court ruled that the buyer was not liable to the seller’s creditors because the transaction was not a de facto merger.
The creditors appealed to the Nevada Supreme Court and lost.
The Nevada high court said that the de facto merger exception to the successor liability rule applies when the buyer has essentially merged with Seller, even though there was no actual merger. The transaction to be a de facto merger must have 3 out of the following 4 factors.
The four factors are: (1) whether there was a continuation of the seller’s enterprise by the buyer after the closing, (2) whether the seller or its shareholders owned part of the buyer after the closing, (3) whether the seller ceased ordinary business operations after the closing, and (4) whether the buyer assumed the seller’s trade liabilities and post-closing contractual obligations.
The court found that the transaction flunked 3 of the 4 de facto factors. First, the buyer did not continue the seller’s business because the buyer did not use the seller’s logo or hire any of the seller’s upper management. Second, there was no continuity of shareholders because the transaction was an all cash deal and neither the seller nor its owners owned any of buyer after the closing. And three, the seller did not cease ordinary business operations after the closing, since the seller retained numerous assets and land leases; continued defending the commercial lessees damage claims in courts for 6 months; and did not liquidate until 1 ½ years after the closing.
This case is referred to MOH Management, LLC v. Michelangelo Leasing, Inc., No. 73920, Supreme Court of Nevada, (Filed March 29, 2019)
The de facto merger risk can be a problem in many asset deals. Even in a cash deal, the buyer often continues the same business with the same people; assumes the seller’s trade payables and contract post-closing obligations; and the seller goes out of legal existence immediately after the closing.
Some states seem to say that you can’t have a de facto merger in an all cash deal (meaning no buyer stock as part of the purchase price): examples are California, Marks v. Minnesota Mining & Mfg. Co., 187 Cal.App.3d 1429, 1436, 232 Cal. Rptr. 594 (1986); Ohio and New Mexico, see my blogs http://www.mk-law.com/wpblog/cash-buyer-of-paper-mill-assets-not-liable-for-sellers-cercla-liability/ and http://www.mk-law.com/wpblog/new-mexico-court-rejects-application-of-de-facto-merger-doctrine-to-buyer-of-assets-of-the-maker-of-hot-tar-holding-tanks/
However, apparently in Nevada buyer’s stock as part of the purchase price may not be enough to save the buyer from the transaction from being treated as a de facto merger.
By John McCauley: I help businesses minimize risk when buying or selling a company.
Telephone: 714 273-6291
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