By Erin K. Tenner, Partner, Gray Duffy LLP
This article, the second in a series, discusses the basics of asset purchase agreements. (Read part 1 here.) An asset transfer is the most common means of transferring all of a privately owned business. Buyers prefer to buy assets because it limits exposure to the seller’s liabilities. But the limited exposure is not automatic. It is the result of a carefully-crafted agreement and properly-handled transaction from start to finish.
A buyer cannot buy part of a dealership by buying some of the assets – they will end up with only the assets. If a buyer can’t get part of the business by buying part of the assets, how can it get all of the business by buying substantially all of the assets?
First, a new entity is formed. The new entity will usually be an S corporation or a limited liability company – but it will depend on the circumstances of the buyer. It could be a C corporation or a partnership. The buyer buys the assets of the seller in place and in use, including the fixed assets, inventory, intellectual property, phone numbers, customer lists and records.
The Seller terminates employment of all its employees at the closing so the buyer can then hire some or all of them. The buyer can pick and choose the liabilities they want to assume. However, if the agreement is not drafted properly or if the transaction is handled incorrectly the buyer can become liable for all of the seller’s obligations as a successor in interest.
Successor liability means the buyer is treated as though s/he bought stock and is responsible for all of the seller’s liabilities. However, typically the buyer will have paid more to buy assets than they would have to buy stock because of the ability to limit liability. There is not space in this article to cover all the issues that need to be addressed to avoid successor liability, but here is a common one that exposes a buyer to successor liability: Parties often waive compliance with the state’s bulk sales laws either because the purchase price is high enough that nothing needs to be done to comply with the bulk sales laws or because some other exception applies.
The bulk sales laws protect a buyer from liability for the seller’s unsecured creditor claims if and only if the parties comply with the state’s bulk sales laws. If nothing needs to be done to comply, then doing nothing is still complying – unless the parties waive compliance. This is an agreement not to comply. A better approach than waiving compliance is to agree to comply. Otherwise, the buyer no longer has anything showing it complied with the bulk sales law to send to the attorney for a creditor who claims successor liability. Worse, they now have evidence that the buyer did not comply.
Avoiding successor liability is a big issue, but so is making sure you have an enforceable contract. Having a strong backbone, and an attorney with a strong backbone, is important if you want to end up with an enforceable contract. Dealers often see this as antithetical to getting a deal done, but just the opposite is true. Deals often fall apart because fear is driving the decisions rather than good communication, sound logic, proper planning and properly drafted agreements.
A frequent theme in asset purchase agreements these days is sellers or buyers who do not want to attach a current list of fixed assets because it is too much trouble (or maybe because they really do not want an enforceable contract). No judge is going to enforce a contract if they cannot tell from the terms of the contract what specifically the seller agreed to sell and the buyer agreed to buy. Any attorney worth their salt can tell a client this.
While inventory can be stated as inventory instead of being listed on an exhibit, because it is changing all the time and is easily identifiable, the same is not true for fixed assets. Fixed asset could include or exclude leasehold improvements. Just determining what is or is not a leasehold improvement is a subject on which reasonable minds could differ.
Asset purchase agreements typically define “fixed assets” as furniture, fixtures and equipment. Is a hoist a fixture or a leasehold improvement? Even if the contract excludes leasehold improvements, it does not address this issue because a hoist could be a fixture. This is an expensive item that a buyer may or may not have agreed to purchase if a list of fixed assets is not attached. There are many fixed assets like this in an auto dealership, so listing them is crucial.
Purchase price determination and allocation are two other issues that can save or cost a seller or buyer a lot of money depending on how a purchase agreement is drafted. Just including leasehold improvements can drastically increase the purchase price. Having counsel with expertise in dealership buy/sells draft your purchase agreement can save hundreds of thousands of dollars, and failure to do so can line the pockets of litigators.
For more on buy/sell basics watch check out our webinar series at www.grayduffylaw.com.
Erin Tenner is a partner at Gray Duffy LLP and can be reached at etenner@grayduffylaw.com or 1-818-907-4000.
