Asset Purchase Agreements and Hidden Liabilities

AdobeStock_263358883-300x200Mergers and acquisitions are an important tool for expanding your business in the competitive field of technology. Unfortunately, hidden debts and liabilities can impose serious financial burdens on an unassuming buyer. Some buyers try to avoid this situation by purchasing assets rather than an entire company. This approach can still leave a buyer assuming debts that are secured by the assets being purchased.  When structuring a transaction as an asset purchase instead of a stock purchase, it is important to understand what debts or other liabilities exist that can become obligations of the asset buyer.

The Benefits of Structuring a Deal as an Asset Purchase Agreement

When one company acquires or merges with another company, the buyer is not only receiving the assets of the target company but also its debts and liabilities if they are not discharged prior to the sale.  The assumed debts and liabilities can even include ones that are unknown to the buyer.  If a buyer does not conduct proper due diligence prior to an acquisition, a buyer may assume liabilities that it is not aware of and courts can deem the buyer to have had “constructive knowledge” of those debts and liabilities.   Constructive knowledge is when one is presumed by law to have knowledge of a fact, regardless of whether or not one has actual knowledge of the fact, since that knowledge can be obtained by the exercise of reasonable care.

In an attempt to solve the problem of assuming unknown debts and liabilities, some buyers simply purchase the assets of another business.  In an asset sale, the business selling its assets can continue its existence as a legal entity either as an operational business if it retains anything, or it can continue as an empty shell until it is dissolved.  The selling business retains its debts and liabilities and does not pass them to the buyer.  However, some debts and liabilities could be attached directly to the assets being purchased, and a buyer of those assets could be responsible for those debts and liabilities.

How Buyers May Inadvertently Assume a Seller’s Debts and Other Liabilities

A common way a buyer assumes a seller’s debts or other liabilities in a transaction structured as an asset purchase is when the purchased assets are used collateral to secure the seller’s debt obligations.  If the seller of those assets granted a security interest to a lender, and if that security interest is “perfected,” then a buyer of those assets will be deemed to have constructive knowledge of the debt and the buyer will become responsible for that debt.  A security interest is “perfected” if it is filed in the appropriate governmental office, putting everyone on notice, including the asset buyer, that the asset is encumbered.  If the buyer purchases those encumbered assets and fails to pay the debt that those assets secure, then the secured lender can take back the assets and sell them to satisfy the debt.

In addition to corporate takeovers, real estate transactions are often impacted by secured debt as real estate is often encumbered by mortgages or deeds of trust.  The obligation to pay debt that is secured by real estate is of course not discharged simply because the real estate is sold.  That debt must either be paid upon sale of the property or the debt remains with the property and becomes the obligation of the buyer.

Whether purchasing real estate or the assets of a business, buyers must be vigilant with their due diligence to identify any debts and liabilities that could becomes obligations of the buyer.  Once these liabilities are identified, they must be resolved among the buyer and seller, and sometimes the lender, before the transaction is consummated.  Whenever purchasing any asset, it is important to be represented by an experienced attorney to identify potential debts and other liabilities and to determine whether buyer or seller will be responsible for those obligations after consummation of the sale.

The Right Silicon Valley Lawyers for All Purchase Agreements

Before purchasing any business assets, it is critical that you understand what debts and liabilities could become your responsibility after the sale.  Additionally, if you are a director or officer of the purchasing company, then you have fiduciary duties to look out for the best interests of the shareholders of the company.  If you do not conduct proper due diligence before an asset acquisition and your company inadvertently assumes the seller’s debts or other liabilities, you could be held liable for losses incurred by the company’s other shareholders.  Fortunately, these pitfalls can be avoided with the advice and counsel of the experienced Silicon Valley business lawyers at Structure Law Group who know how to protect you and your business at all stages of an asset purchase transaction. Call (408) 441-7500 or visit our website to schedule a consultation.

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