Worst case – buying a business with a large unknown liability

Introduction

One of the biggest risks in buying a business, car or house is the unknown problems that pop up after the purchase. This case illustrates the problem.

The deal

Buyer purchased all the stock of a company from sellers.

Sellers promised in the stock purchase agreement that the company had not guaranteed the debt of any other company.

The unknown liability

Prior to the closing, this company had guaranteed the debt of another company.

Buyer did not know about this guaranty before buyer purchased the company.

The lawsuit

After the closing the other company defaulted on the debt. The creditor sued its debtor, the company buyer purchased, as guarantor of the debt, and the buyer. An Alabama federal court said that creditor had a legitimate claim against buyer to reach funds buyer had received from the purchased company, the guarantor of the debt.

The buyer may lose those funds to the creditor. Buyer can hopefully recover its loss from the sellers of the company it bought. with a claim against sellers for their broken promise that there were no company guarantees.

This case is referred to Hiring Automation, LLC v. Simple Onboard, LLC, Case No. 4:18-CV-773-KOB, United States District Court, N.D. Alabama, Middle Division, (January 30, 2019).

Comment

When you buy the stock of the company you buy not only the dog but its fleas. Meaning: you buy not only the assets of the company but all its liabilities, even those unknown to you at the closing.

What can you do about this risk?

1. Kick the tires (due diligence). However, in this case the court said that at least one of the sellers knew about the guaranty and hid it from the buyer.

2. Get seller to promise in the written agreement to cover your losses if an unknown loss crops up after closing.

3. Or, buy the assets of the company and not assume any unknown liabilities. This generally works, with some exceptions.

By John McCauley: I help businesses minimize risk when buying or selling a company.

Email: jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

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