Managing US Risk: Leaving your troubles behind. Understanding successor liability in US M&A

When a buyer purchases a business it wants to get what it paid for -- and nothing else. A buyer definitely does not want to be saddled with the liabilities of the old business unless it means to do so. This is the problem of successor liability; buyers want certainty in knowing what liabilities they are purchasing in M&A transactions. In the US, answering questions about successor liability can be tricky.

The general rule of successor liability in the US is that an asset purchaser it not liable for the seller’s liabilities. So, to minimize the risk of successor liability, a buyer interested in acquiring a business is often better off by doing so through an asset purchase rather than by buying all of a business’s stock. However, buyers should be aware of a number of exceptions to this rule.

While the law of successor liability varies by state, most states adhere to four traditional exceptions where the buyer may inherit the seller’s liabilities even when there is an asset (as opposed to stock) deal.

1.   Assumption of Liability: A buyer may be held liable for the seller’s liabilities when the buyer explicitly or implicitly assumes the seller’s liabilities in the terms of a purchase agreement.

-- Explicit: The purchase agreement explicitly provides for the transfer of liabilities to the buyer.

-- Implicit: Certain conduct implicitly suggests that the buyer intended to assume the seller’s liability. Can apply even where a purchase agreement explicitly disclaims the buyer’s liability.

2.   De facto Merger: A buyer may be held liable for the seller’s liabilities where the transaction is called and treated as an asset sale, but the transaction is deemed to be a de facto merger of the two businesses. States differ on the requirements for a de facto merger but in general consider the following factors in favor of a de facto merger:

3.  Mere Continuation: A buyer may be held liable for the seller’s liabilities when the buyer is deemed to be a “mere continuation” of the seller. States differ on their approach to mere continuation but in general consider the same factors in favor of a de facto merger to support a finding of mere continuation.

4.  Fraudulent Conveyance: A buyer may be held liable for the seller’s liabilities when the transaction in question is deemed to have been undertaken to defraud creditors either by:

-- hindering the rights of the creditors, or 

-- has the effect of rendering the seller insolvent. 

Fraudulent transfers may be:

-- actual: a transfer with the intent to defraud creditors; or

-- constructive: a fact-specific inquiry that reveals an indicia of fraud in the transaction, such as a close relationship among the parties to the transaction, a secret or hasty transaction and inadequate consideration.

Authors: Tim Harkness and Meher Talib