The handling of successor liability is an important consideration in any buy-sell agreement for the purchase of a dealership assets. Invariably, in the buy-sell, the buyer’s attorney will include contract language requiring the seller to convey dealership assets free and clear of the seller’s obligations, except those expressly assumed under that contract. To attempt to avoid succeeding to the seller’s obligations, some buyers will opt to purchase the dealership’s assets under a buy-sell agreement, as opposed to buying the dealership corporation’s stock in a stock purchase agreement. However, unless properly addressed in the parties’ agreements, this protection can be weakened after the closing under various theories of successor liability or by operation of applicable law. The result is the buyer can be liable for the seller’s obligations, such as those to seller’s vendors, employees, and other third parties. Buyers should ensure that the terms of the parties’ agreements adequately address successor liability so that the seller entity and its owners remain responsible for seller’s liabilities, including giving contractual indemnities to the buyer entity and its owners for these obligations.
A general definition of successor liability contemplates that the buyer assumes the liabilities of the seller. These liabilities can include the seller’s vendor or executory contracts (e.g., DMS provider), tax liabilities, including sales, income or employment taxes, liabilities to third party creditors, environmental obligations, or liabilities for employment obligations. These are just a few examples of the kinds of successor liability a buyer may face. It is important for the parties and their attorneys to understand what gives rise to successor liability. The buyer will seek to avoid it and the seller may attempt to pass it along to the buyer.
In some areas, successor liability can arise by operation of statutory or case law. In fact, some courts have found buyers liable under federal law for the seller’s obligations to its employees. Although, generally, state law may preclude successor liability, under federal law, the same may not be true when liability derives from a federal employment or labor statute. For example, courts have held the buyer responsible as a successor to the seller for claims by the seller’s employees for failure to pay overtime under the federal Fair Labor Standards Act. The parties’ buy-sell agreement should contain provisions, among others, in which the seller represents and affirms compliance with all federal and state labor and employment laws. Of course, there should also be provisions entitling the buyer to relief in the event these assurances by the seller are false. Such a provision might include for example indemnities by the selling entity and its principals and owners. The effectiveness of these protections can hinge on whether the indemnifying parties have the capacity (financial and otherwise) to deliver on their obligations to indemnify and defend. There are other protections against successor liability the parties can negotiate and the lawyers can craft into the buy-sell agreements.
Another area in which successor liability for the seller’s unsecured creditor’s claims can arise includes the circumstances where the buyer does not comply, or waives compliance, with applicable state bulk sales laws. By failing to comply or waiving compliance the buyer may forfeit the protection granted by these laws.
Additionally, successor liability of the buyer might arise as to the seller’s secured creditors’ claims if creditors’ liens are not properly removed before closing of the buy-sell. In that instance, the assets are conveyed to the buyer subject to those liens and encumbrances. As part of the parties’ buy-sell agreements, provisions should be included requiring the assets to be conveyed free and clear of such liens and encumbrances, and buyers must, as a matter of due diligence, perform proper UCC searches to determine whether any lien notices have been filed. Properly secured creditors could seize assets purchased by the buyer to satisfy seller’s debts secured by the liens. Such liens must be paid and properly removed before closing to ensure the assets are conveyed to the buyer free and clear of encumbrances.
Buyers can also be obligated as a matter of successor liability for the seller’s tax liabilities. This could include sales taxes, use taxes, income and employment taxes, or franchise taxes. Tax clearance certificates or releases stating the buyer has no liability for seller’s tax liabilities should be required under the parties’ buy-sell agreements and obtained before the closing. Sometimes, an escrow of funds will also be necessary to afford buyer further protection against seller’s tax liabilities.
Successor liability considers the buyer responsible for the seller’s obligations. Cautious buyers will ensure adequate contractual provisions are included in the buy-sell agreements and necessary due diligence and other steps are performed prior to closing to protect themselves against this liability.