As addressed in detail in Part 1 of this article (available in the previous issue of this magazine), the rule of non-liability (the “Rule”), which holds that the purchaser of some or all the assets of a business is not responsible for the debts and liabilities of the seller, is subject to three distinct types of exceptions: contractual, statutory and common law. Where an exception applies, the purchaser can end up legally responsible for liabilities that are not of its making, and which, in some cases, are not something the purchaser intended to answer for.
Unfortunately for the prospective asset purchaser, knowing the exceptions exist is from the easy part. The hard part is knowing whether they apply to a particular acquisition.
Contractual exceptions cover debts and liabilities of the seller, which the purchaser expressly agrees to assume in the asset purchase agreement (the “APA”). Obviously, the purchaser will be aware of these exceptions simply by being familiar with the APA.
Statutory exceptions are a product of laws that impose successor liability upon the purchaser for taxes and sometimes other obligations the seller fails to satisfy. As such, the purchaser can familiarize itself with these laws, under what circumstances they apply, and what the potential consequences are through legal due diligence before the transaction is consummated.
Common Law Exceptions
In general terms, common law exceptions exist to address two scenarios:
- transactions intended in whole or in part to defraud the seller’s creditors;
- mergers and consolidations masquerading as asset sales. As discussed in Part 1 of this article, this second category accounts for the majority of cases in which a common law exception is invoked to prevent the application of the Rule — with most of those instances involving the so-called de facto merger exception.
Like the other common law exceptions to the Rule, the de facto merger exception is based on general principles that are typically the cumulative result of numerous judicial opinions. Consequently, the application of the de facto merger exception tends to be what lawyers call “fact-sensitive.” That is, the facts and circumstances of the particular situation dictate whether or not the exception applies. Obviously trying to make that determination in advance is something of a fool’s errand. Still, asset purchasers need to be able to assess with at least some accuracy the nature and extent of potential legal liability a deal poses as early in the process as possible.
So, when it comes to evaluating the likelihood that the de facto merger exception might strip away the Rule’s protection in a given transaction, what’s a purchaser to do?
The De Facto Merger Exception: Know the Triggers
While a prospective asset purchaser may never be able to predict with certainty whether the de facto merger exception applies to a particular asset acquisition, it is possible to determine the degree to which a transaction framed as the sale and purchase of assets is vulnerable to claims that it is actually a merger or consolidation dressed up like an asset deal.
It turns out that certain transaction characteristics are associated with the application of the de facto merger exception. The more of these characteristics a prospective deal has, the greater the likelihood a claim based on the de facto merger exception will succeed. Are “long-tail” claims likely? If the nature of the transaction makes it possible that claims against the seller could be raised well in future, it’s more likely that a court will apply the de facto merger exception to pass responsibility for those claims to the asset purchaser. Common examples of long-tail claims are those based on product liability or environmental contamination, either of which might not come to light until well after the sale is concluded. How long will the seller survive?
Transactions in which the seller liquidates and dissolves or otherwise ceases operations upon or shortly after the closing are more susceptible to claims based on the de facto merger exception. Is the seller receiving equity? If the seller and/or its principals are acquiring an ownership interest in the purchaser as part of the transaction, the de facto merger exception is more likely to apply. This is particularly true where those principals are involved in the management and operation of the business activities in which the acquired assets are used.
Will the seller’s business continue to operate in much the same manner? If the business in which the acquired assets are used continues after the closing using much of the same personnel in the same facility and manner as it did before the closing, the risk of a successful de facto merger claim increases. The likelihood of such liability is even greater where the purchaser holds itself out as a continuation of the seller and trades on the seller’s goodwill. Now What? Once a prospective asset purchaser has evaluated the contractual exceptions to the Rule, researched potential statutory exceptions and assessed the likelihood that the transaction could subject the purchaser to successor liability based on a common law exception, it’s time to take affirmative steps to mitigate the risk. Part 3 of this article will address that topic at length.
Sources: 1 Because it is the most prevalent common law exception, this section primarily addresses the de facto merger exception. 2 As noted in Part 1 of this article, a detailed treatment of this topic is provided in “Successor Liability in Asset Acquisition Transactions,” a January 12, 2019, Memorandum authored by Jon T. Hirschoff, John H. Lawrence Jr. and Daniel H. Peters and included in the M&A Lawyers’ Library, a service of the M&A Jurisprudence Subcommittee of the M&A Committee of the Business Law Section of the American Bar Association.
Mark L. Boos is a partner in the Indianapolis office of Dinsmore & Shohl LLP. He has been representing national, regional, and local midstream and downstream fuel distributors and convenience store operators for more than 20 years. He can be reached at 317.860.5304 or email@example.com.
NOTICE: This article is for informational purposes only and does not constitute legal advice. You should consult an attorney for advice addressing any particular set of facts or circumstances.