A buyer often prefers to purchase the assets of a company instead of its equity (such as stock of a corporation). One advantage of an asset purchase is that the buyer can avoid responsibility for the selling company’s liabilities; other than the liabilities the buyer expressly assumes in the asset purchase agreement.
That works well, but there are some seller liabilities that the buyer may get stuck with that the buyer did not assume. These seller liabilities are imposed on the buyer by a federal or state statute or a federal or state judicially created doctrine. In the trade these liabilities are called successor liabilities; meaning that the buyer as the successor to the seller is required to pay certain seller liabilities under certain circumstances.
In this case the seller was a law firm that in its prime had 10 offices in several states. It collected debts for creditors such as banks. However, by 2013 the firm’s business began to decline. By the beginning of 2015 the firm was down to one office.
At that point, the seller was on the verge of failure with an outstanding balance on its line of credit of $1.3 million, which was secured by all the seller’s assets, which were worth $26K.
At that time, the buyer, another debt collection law firm was interested in expanding into seller’s remaining location. The buyer agreed to purchase the seller’s assets for $15K. The purchase price was paid to the seller’s secured line of credit lender in exchange for the creditor’s release of its lien on the assets. The buyer then hired seller’s employees, and continued seller’s former operations under the buyer’s ownership.
The deal was documented by a simple asset purchase agreement. The buyer did not conduct much due diligence given the size of the deal. Also, the buyer did not assume any significant seller liabilities.
The deal closed on April 1, 2015. The seller received nothing from the buyer and had no assets; making it judgment proof.
The buyer did not know when it purchased seller’s assets that a former seller employee had accused the seller of sexual harassment and retaliation (that is firing her after she complained of sexual harassment). She filed complaints for sexual harassment and retaliation against the seller with a federal and state agency in June 2014.
The former seller employee sued the buyer after the closing in a New Hampshire federal district court claiming that the buyer was responsible for seller’s sexual harassment/retaliation liability under the successor liability doctrine, because the buyer continued the seller operations, and knew about the claim, or should have known about the claim had it conducted reasonable due diligence.
The buyer pushed back, saying that the buyer did not know about the federal and state claim; there were no red flags that would make buyer suspect that seller might have a sexual harassment/retaliation claims; and furthermore, it was not reasonable for the buyer to go looking for liabilities it neither knew existed or suspected given the fact that the buyer was only paying $15K for the assets.
The court agreed with the buyer and held that buyer did not have successor liability. It found that the buyer did not know about the claim. Furthermore, the court noted that a public record search by buyer would not have found the federal and state claims, as those claims are not available to the public; unlike court actions.
This case is referred to Kratz v. Richard J. Boudreau & Associates, LLC, Case No. 15-cv-232-SM, United States District Court, D. New Hampshire, (March 22, 2019)
Even if the buyer dug deeper and discovered the claim, the court said that successor liability would not apply in this case because it would be inequitable or unfair to the buyer. Why? Because successor liability is imposed upon the buyer to encourage the buyer to preserve some of the purchase price as a source for a payment for selected seller liabilities such as sexual harassment claims.
How do asset buyers secure part of the purchase price to satisfy these kinds of claims? A buyer could hold back part of the purchase price or put part of the purchase price in escrow. And if the seller won’t do that, and the seller has a healthy balance sheet, then the buyer could obtain an asset purchase agreement indemnification from the seller to reimburse the buyer if the buyer has to pay the claim.
But those techniques would not work in this case. There was no purchase price payable to the buyer that could be held back; and the seller’s indemnification would be worthless, since the seller was bankrupt.
By John McCauley: I help businesses minimize risk when buying or selling a company.
Telephone: 714 273-6291
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