June 30, 2020
One M&A tax risk in an asset acquisition is seller’s unpaid payroll taxes.
The buyer in this case purchased the assets of a financially distressed business for approximately $7.3 million dollars payable at closing and $2.5 million payable over the next 41 months. The seller was in financial distress as the result of the discovery of unpaid federal and state payroll tax liabilities of $100 million. Nevertheless, the buyer closed the deal despite its knowledge of the payroll tax liabilities.
The seller group filed for bankruptcy 5 months after the closing. The bankruptcy trustee then sued the buyer in the bankruptcy proceeding to recover amounts the buyer refused to pay the seller and to avoid the sale as a constructive fraudulent transfer.
The buyer challenged the suit arguing in part a right of set off for the potential $100 million in liability for unpaid payroll taxes. The court dismissed the buyer’s claim because the IRS and state tax agencies had not yet gone after the buyer.
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).
This was an unusual case because the buyer knew about the seller’s unpaid payroll tax liabilities before closing. The seller was owned by a public company. The auditors had not initially picked up the problem and when it broke publicly, it resulted in a change in seller’s top management.
These problems were all disclosed in SEC filings and were known by the buyer. The seller was financially distressed, and the buyer had a history of buying distressed businesses.
At closing, the buyer’s risk of having to pay seller’s unpaid federal payroll task was low because no buyer stock was involved in the deal and the buyer did not assume the federal payroll tax liability in the asset purchase agreement. State payroll tax risk depended upon the applicable state laws involved.
Nevertheless, one tool to manage buyer’s federal and state payroll tax risk would be for the buyer to have purchased the business out of bankruptcy under Bankruptcy Code Section 363. Section 363 permits the buyer to buy the business free of seller’s liabilities pursuant to a bankruptcy court order. This would probably have eliminated the risk.
A 363 acquisition would also have prevented the trustee or any seller creditor from trying to avoid or unwind the acquisition by claiming the deal was a constructive fraudulent transfer.
By John McCauley: I help manage the tax risks associated with buying or selling a business.
Telephone: 714 273-6291
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