Liabilities That May Lurk in Poorly Drawn Asset Purchase Contracts

In business mergers and acquisitions, particularly in the context of asset purchases, the general legal rule is that the buyer does not assume the seller’s existing liabilities. This principle is fundamental to asset sales, distinguishing them from mergers or stock purchases, where the buyer typically steps into the shoes of the seller, including all liabilities. 

However, there are several significant exceptions to this rule, and overlooking them can result in unexpected and sometimes substantial obligations for the buyer. These are the major ways that liabilities can follow the assets:

1. Express assumption of liabilities — Asset purchase agreements often include schedules specifying liabilities the buyer will assume, including contractual obligations, warranties or employee-related liabilities. If the agreement does not contain a clear disclaimer, courts may interpret ambiguous language against the buyer and impose liabilities.

• Successor liability — In certain circumstances, courts may hold the assets purchaser under an implied responsibility for the seller’s debts. This can occur in cases where the buyer is a “mere continuation” of the seller, where the transaction was entered into fraudulently to escape debts or where the transaction amounts to a de facto merger or consolidation. If the buyer maintains the same management, employees, facility and business operations, a court may find the buyer is in fact continuing the seller’s business.

• Product liability — In some jurisdictions, if the buyer continues to manufacture the seller’s products without significant change, the buyer may become liable for injuries caused by those products post-sale. Courts reason that liability should follow the ongoing enterprise to ensure that injured parties have a potential source of recovery.

• Employment-related liabilities — If the buyer hires the seller’s employees and continues the business, statutory liabilities may follow the assets. These liabilities can arise under the Worker Adjustment and Retraining Notification (WARN) Act, the Employee Retirement Income Security Act (ERISA) and the Fair Labor Standards Act (FLSA).

• Environmental liabilities — The federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) and state laws can impose cleanup costs and fines on current property owners, even if they didn’t contribute to the contamination. 

To avoid unintended liability after an asset purchase, buyers should speak with an experienced mergers and acquisitions attorney who can take effective protective measures. An attorney will conduct thorough due diligence, investigating the seller’s contracts, environmental practices, employment obligations and any pending or potential claims. Second, an attorney can carefully draft the asset purchase agreement to clearly exclude the assumption of all unwanted liabilities. Third, an attorney can negotiate for indemnification provisions, whereby the seller promises to defend and compensate the buyer if certain liabilities arise post-closing. Finally, there can be escrow arrangements or purchase price holdbacks to provide additional security for the buyer in case undisclosed liabilities surface.

The Law Offices of Donald W. Hudspeth, P.C. in Phoenix represents companies of all sizes in business purchases and sales throughout Arizona. Call us at 866-696-2033 or contact us online to schedule a consultation.