Preventing Successor Liability in Business Purchases

Hillel Goldman

When you look to purchase an existing business, there are many issues that must be examined. One of the most important issues that you must examine is whether there could be successor liability for your business and how to protect yourself from it. When you buy a business you want to attempt to prevent acquiring any unknown business liabilities of the target company. To do this you must work closely with your professional team. This article will examine certain actions you can take to try to avoid acquiring surprise business liabilities.

First and foremost, you must examine the target business thoroughly. The due diligence process is extremely important. Your letter of intent must say that your obligation to move forward in the deal will be subject to satisfactory due diligence. You need to have sufficient time to review the target company. You also need to be assured that you will receive complete cooperation and information from the target company.

In performing your due diligence you must seek certain information. In addition to examining the target company’s business, you must review its financial statements, tax returns, and outstanding tax liabilities. You must also examine its liabilities. You must find out if there are any judgments or any litigation pending or threatened against the company. Additionally, you must examine all contracts in place (both external and internal). An examination of environmental issues is also important. Finally, you must examine the company’s insurance coverage.

Once your due diligence is complete, the next step is to prepare the contract. It is important that the contract is complete. Inevitably, I’ve found whenever the parties push for a barebones contract (“we don’t need to address this because….”), these are the parties that end up with post-closing disputes and litigation.

There are certain critical provisions that need to be in the contract. First, you want to have a provision that specifically sets forth what liabilities you are actually assuming. Second, you must have adequate representations and warranties from the seller. If the seller is represented by a business lawyer this should not be a problem (some of the framing may be negotiated but the seller’s lawyer should not balk at these provisions). I once represented a client buying a business from a seller whose lawyer was strictly a litigator. The seller’s lawyer refused to allow standard seller representations and warranties in the contract (the lawyer claimed that it would be malpractice to allow them). Needless to say, that deal died very quickly.

Second, it is important that any liabilities that you are assuming are clearly set out in the contract. Third, an indemnification provision protecting you from those seller liabilities that you are not assuming needs to be included. Finally, you and your professionals need to do a line-by-line review of the contract schedules examining closely all exceptions to the representations and warranties.

In addition to contractual protections, there are other things that you can do to minimize your potential successor liability. First, you should purchase the seller’s assets through a new entity. This allows you to acquire only the assets of the business that you choose. Second, you should require the seller to maintain its entity’s existence and liability insurance for a period of time after the sale takes place. By doing this, a disgruntled creditor can still look to the seller for its damages instead of attempting to collect them from you. Finally, you must carefully review and strictly comply with all statutory requirements that could impose liability on you as the buyer of the business.

To avoid the surprises of successor liability, therefore, you must make sure that you put together an experienced professional team that can lead you through the important but arduous business purchase process.