One would think that when purchasing a business through an asset sale, a seller's legacy liabilities stay with the seller and don't attach to the buyer. In most instances that's true. The purchaser of a business asset is not going to be on the hook for existing liabilities connected to the assets. But there are significant exceptions to that general rule. If the uninformed business purchaser is not careful, he or she can potentially be subject to unwanted legal consequences through a concept known as legacy liability. Also commonly referred to as successor liability, legacy liability can easily be foisted on the unwary or ill-advised business purchaser.
Business acquisition 101
The average person is unaware that acquiring a business is not as simple as Elon Musk cutting a large check to Twitter in a moment of rich-guy spontaneity. Business purchases involve a lot of paperwork, and with good reason.
Business acquisitions come in two general flavors – asset purchases and stock purchases.
A stock purchase is where the purchaser buys an ownership interest in the business itself. Such a transaction necessarily includes indirect acquisition of an ownership of the assets held by the business at the time of the purchase. Because a stock purchase entails buying into an ownership share of the actual business, it usually entails the transfer of preexisting liabilities held by the business, which are obviously things a seller is happy to transfer. Notably, the acquisition of legacy liability by a stock purchaser is a natural part of the process and is something the purchaser knows going into the deal.
In contrast to a stock purchase agreement, an asset-purchase agreement does not consist of buying into the business. Rather, it is simply the purchase of the assets held by a business such as machinery, intellectual property or customer lists. Unlike a stock purchase, in an asset purchase the seller retains ownership interest in the business after the transaction is complete, along with any legacy liabilities.
The law's take on asset purchasers and legacy liability
Under Illinois law, there are four ways a business purchaser can be subject to legacy liability in an asset purchase. A simple way for a business purchaser to avoid this problem would be to ask four basic questions prior to entering into an asset purchase agreement:
1. Does the asset-purchase agreement expressly or impliedly state an assumption of liability?
2. Could the transaction reasonably be considered a de facto business consolidation or merger?
3. Is the asset-purchase agreement structured so that you are merely a new hat for the seller?
4. Is the seller presently involved in litigation, being contacted by creditors or does it appear to be in financial turmoil?
This is straightforward, since you simply need to read the actual language of the purchase agreement to see if there is anything about inheritance of the seller's legal liabilities. Illinois courts interpret contracts by examining the "plain and ordinary meaning" of the language used in the document. This means that if there is language in an asset-purchase agreement that explicitly states (or very strongly implies) a transfer of liability, you should expect to be on the hook if you signed the document. Sometimes buyers agree to take on certain liabilities – accounts payable or certain employee obligations are common examples.
That being said, not many people outside of lawyers can sift through lengthy contracts without falling asleep from boredom. By design, it is often easy to overlook detrimental language, even if it is plainly stated in the agreement. Although it is customary for business acquisitions such as asset purchases to involve lawyers on both ends, any purchaser who thinks themselves capable of proceeding without counsel in their corner would be ill-advised. At the very least, purchasers should have an experienced attorney read over the asset-purchase agreement to see if there is any whiff of legacy liability, especially if the seller has a lawyer on their side.
A de facto merger occurs when the business buyer and seller style the deal as an asset purchase, but the substance of the transaction resembles a merger or a consolidation of the two entities. Even though this question is more of a deterrent applicable to those looking to commit fraud rather than looking to purchase assets, it should be on every business purchaser's radar.
The bottom line is that just because a business sale is called an asset-purchase agreement or is structured to appear as one, it does not itself make the transaction an asset-purchase agreement. Such a transaction can be unwound, and, worse yet, under those circumstances an unsuspecting buyer could possibly find themselves at the mercy of legacy liability.
Does the asset-purchase agreement state something to the effect of the seller's same employees will continue to use the same assets, with the same management, to produce the same product at their preexisting location? If so, you might be in trouble.
This exception to the general rule that a buyer is not responsible for the liabilities of a seller is the one that poses the greatest risk. Courts look at whether the transaction is a continuation or reincarnation of the seller. And part of that analysis looks at the ownership and management of the purchaser compared to the ownership and management of the seller. If there is great similarity, it's likely that a court will allow successor liability. Also, if any language in an asset-purchase agreement enables the seller to retain access to the assets it is purportedly selling to you, there is no shame in walking away. Again, experienced counsel should be able to advise you on these types of traps.
Whereas I suggested that a business-asset purchaser looking to avoid legacy liability should walk away in the previous scenario, this would be where running would be the better option. And that's all the more true if there's even a hint that the transaction is designed to defraud creditors. No further explanation is necessary here other than my advice for buyers to avoid the temptation of any discounted prices offered by a seller, no matter how alluring they may be.
These four issues are why, in part, asset-purchase agreements can be so lengthy. But that language is there to protect you. Do it right and seek out experienced legal counsel to assist you.
