By Christopher T. Koenig, Bellavia Blatt & Crosset, P.C.
Assumed liabilities can seriously jeopardize or even break a transaction if not properly managed prior to signing an Asset Purchase Agreement (APA). At the very least, they can cause the seller to continue to be liable for financial obligations post-closing, and result in the buyer potentially losing some added value in the goodwill it is paying.
This article will highlight several real-world scenarios reflecting common problems and also offer tips that will help you avoid letting assumed liabilities obstruct a smooth closing.
Scenario One: The buyer and seller are nearing the end of negotiations and are on the eve of signing the APA. When discussions commenced several months prior, an exhibit labeled “Assumed Liabilities” was prepared based on information obtained from the seller, and the buyer indicated a willingness to accept everything on the list. Now the seller learns that his service manager signed a lease a week ago for a new diagnostic scanner. Suddenly, the APA exhibit has to be revised and there may be more negotiating to do, assuming the buyer wants the new tool.
The point here is that even a small, seemingly inconsequential shop tool can seriously affect a buy sell transaction. If, for example, the tool in question is on a three-year, $500.00 per month lease, and the vendor’s agreement does not allow for assignment of the contract, the seller has significant financial exposure.
Practice Tips: Avoiding the problems that assumed liabilities can create is about being proactive. Anyone contracting for goods or services needs to be aware that vendor contracts may contain language with long-term, unforeseen consequences. As such, it is prudent to allow counsel to review those agreements and negotiate changes.
It is also important to fully understand the meaning of the terms assignment and assumption. The former is often mentioned in vendor agreements, but generally in the context that assignment is permissible only when the vendor sells its own assets. The latter is rarely evident, however, and its absence means that the original party to the contract remains financially responsible if a permissible assignee defaults in the future.
Ultimately, it is worth contemplating that a vendor unwilling to allow a business to easily assign contractual responsibility and subsequently enable a well-qualified buyer to assume full contractual liability may not be the kind of vendor to patronize.
Scenario Two: A seller has found the perfect buyer and the parties are contemplating an all-cash transaction that should proceed quickly to closing. In preparing documents to include with the “Assumed Liabilities” exhibit, a review of the dealer management system (DMS) contract reveals that the seller is only midway through a sixty month, $8,000.00 per month agreement that specifically prohibits assignment. The word assumption is nowhere to be found. Notwithstanding that the seller may be able to negotiate a transfer with the vendor, the buyer is adamant about utilizing an alternative DMS provider. Suddenly, the seller has a $240,000.00 liability.
The key takeaway here is understanding that DMS contracts, perhaps unlike any other assumed liability, can be lethal to finalizing an APA and proceeding to a successful closing. While offering a dealer tremendous operational efficiency, they are imbedded with language that is often as foreign and hard to decipher as the very computer code they exist to sell. That language can inhibit a successful closing.
Practice Tips: Reviewing the DMS agreement should be first and foremost on the list when thinking about assumed liabilities. Quickly focus on looking for the magic words assignment and assumption. Search for some type of escape clause or buyout provision but don’t be too surprised if neither exists. Without resistance from counsel at the time of original contracting, DMS vendors are masterful at crafting and implementing language that preserves the full term of the contract. However, that does not mean concessions cannot be obtained at the time of a buy sell. The price to pay for early termination depends on the vendor. Start the discussion about transfer or termination as early as possible, and if you are getting nowhere seek assistance from a consultant specializing in DMS negotiations.
Conclusion: Assumed liabilities may contain hidden problems that should be addressed early and appropriately in the buy sell timeframe. Put a complete list together as soon as possible, review the associated contracts thoroughly, and make it a habit to periodically check to ensure that the list remains valid. Most importantly, don’t make the wrong assumption that the list is only a minor issue to be dealt with in preparing the APA. That mistake may allow the assumed liabilities to consume the buy sell transaction.
Christopher Koenig is an associate at Bellavia Blatt & Crossett, P.C., with offices in New York, New Jersey, and Connecticut. He can be reached at 516-873-3000 or CKoenig@DealerLaw.com