The so-called “rule of non-liability” (the “Rule”) is straightforward: The buyer of the assets of a business is not responsible for the debts and liabilities of the seller. This principle has long been one of the reasons buyers elect to purchase the assets of a seller rather than acquiring the seller itself in a merger, for example.
The protection afforded by the Rule is far from absolute, however. There are an increasing number of exceptions, any one of which can result in a buyer inheriting some or all of a seller’s liabilities, even in an asset deal. In short, just because you elect to purchase the real estate and inventory of a c-store operator or the supply contracts of a distributor, rather than the stock or membership interests of that operator or distributor itself, does not necessarily mean you’ll stay free and clear of seller liabilities.
One Rule, Many Exceptions
The exceptions to the Rule fall into three categories: contractual, statutory and common law.
A buyer is obviously free to take on seller debts and liabilities under the terms of the asset purchase agreement for a particular deal (the “APA”). Such liabilities typically constitute the “assumed liabilities” under the APA. Regardless of what the Rule says, if a buyer contracts to assume a certain liability, that liability passes to the buyer. This is what is referred to as a “contractual exception” to the Rule.
Statutory exceptions to the Rule are likewise relatively easy to understand. If there is a law on the books that makes the buyer responsible for certain liabilities and obligations of the seller, that law trumps the Rule. For example, some states still have so-called bulk sales statutes which can, under certain circumstances, make the buyer responsible for taxes imposed upon the transfer of most or all of the seller’s assets. Similarly, most states have laws which can result in the buyer being obligated to satisfy the seller’s unpaid sales and use, excise, state income, unemployment and/or other taxes. On the federal level, a seller’s liability for failing to comply with the requirements of the Worker Adjustment and Retraining Notification Act of 1988 (the “WARN Act”) in connection with workforce reductions, can, under certain circumstances, pass to the buyer.2 This can occur even though the affected workers were never on the buyer’s payroll.
Common Law Exceptions Mean Uncommon Complications
Common law exceptions to the Rule present a more challenging problem than do contractual or statutory exceptions.3 Unlike contractual and statutory exceptions, the existence and general effect of which can be determined going into a deal, common law exceptions are based on applying a collection of principles developed over time in numerous judicial opinions. Those principles tend to vary from state to state4 and, sometimes, even from case to case. Consequently, while it may be possible to roughly gauge the likelihood that a certain common law exception will apply to a given set of facts, making such predictions is as much an art as it is a science.
Moreover, common law exceptions to the Rule introduce an additional element of the unknown to the risk assessment equation. With contractual and statutory exceptions to the Rule, a buyer can ascertain in advance with some degree of certainty what liabilities it is assuming and to whom it may have to answer for those liabilities. Not so with most common law exceptions to the Rule — at least not without a greatly heightened level of due diligence going into the deal. To oversimplify a bit, if a common law exception to the Rule is found to apply, it’s as if seller and buyer are one and the same. Any creditor or other third party with a contractual, tort or other claim against the seller now has a claim against the buyer. In this regard, it is important for buyers to understand that the fact that the APA labels a given liability as one to be retained by seller is of little use if a common law exception to the Rule is found to apply. Creditors and other claimants looking to hold the buyer responsible for the seller’s liabilities are not parties to the APA, so how the APA allocates responsibility for those liabilities between the seller and the buyer are not binding on such creditors and other claimants.
Exceptions Swallowing the Rule?
While there are also various common law exceptions to the Rule that state courts have fashioned specifically to address products liability issues, three more traditional exceptions are probably most relevant in asset acquisitions generally.
First, there is a common law exception to the Rule for fraud. In simplest terms, the buyer cannot avail itself of the protection of the Rule if the sale was entered into in order to defraud the seller’s creditors. In such a case, the Rule will be inapplicable, and the buyer can find itself held liable for a seller’s obligations.
Second, under what has become known as the “mere continuation” exception, the Rule may also be circumvented if it is determined that the buyer is really a just a continuation of the selling entity. In other words, a corporate reorganization masquerading as an asset sale will not earn the buyer protection from the seller’s liabilities.
Along the same general lines as the mere continuation exception, the de facto merger exception overrides the protection afforded the buyer by the Rule when the transaction being characterized by the parties as an asset sale really amounts to a merger or consolidation of the seller and the buyer. By most accounts, this exception has become the most common avenue of attack on the Rule. According to the ABA Memorandum, for example, reported decisions referring to a de facto merger increased by more than 60 percent between 2008 and 2018, and by more than 180 percent between 1998 and 2018. Obviously, plaintiffs looking to hold a buyer responsible for a seller’s liabilities are turning to the de facto merger exception more often and with more success.
To recap, the rule of non-liability, which buyers have long relied on to protect themselves from successor liability, is eroding. In addition to being subject to contractual and statutory exceptions, it is now also being circumvented more often than ever before by the expanding use of common law exceptions— most notably the de facto merger exception.
So, What’s a Buyer to Do?
The second installment of this article will address the topic of how to accurately assess the degree and nature of risk a particular deal poses, and the third installment will suggest strategies for minimizing that risk.
Mark L. Boos is a partner in the Indianapolis office of Dinsmore & Shohl LLP. He has been representing national, regional, and local mid-stream and downstream fuel distributors and convenience store operators for more than 20 years. He can be reached at 317.860.5304 or mark.boos@dinsmore.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.