Understanding Successor Liability

Posted on October 7, 2014

By: Richard C. Hatem

In acquiring some or all of the assets of another entity, companies must be careful to avoid being exposed to liability as a successor to the predecessor entity. Structuring the transaction as an asset purchase had been an effective method of protecting a buyer from a seller’s liabilities. However, buying a business in this fashion is no longer a sure way of acquiring the assets free of all liabilities. The courts have now identified several exceptions which could lead to unintended liability.

When courts are tasked with determining the extent of successor liability, they will generally examine a multitude of factors. Each situation is different and the analysis is primarily fact-based. Some of the factors which will be examined include: (1) Is the new company a mere continuation of the previous entity. Courts will look to see if key officers or directors of the predecessor are involved in the new entity, and if the same name, location, or facilities are being used; 2) Did the seller dissolve or cease doing business as a result of or immediately after the sale; 3) were substantially all of the assets of the predecessor acquired, leaving only a corporate shell; and (4) is the successor company benefiting from the goodwill or reputation of the predecessor.

Finally, if the buyer entity continues the production of the predecessor’s line of products it may be subject to the product line exception. In this instance, the buyer may assume strict liability for the same product line previously manufactured, if the right of action against the predecessor company is no longer available as a result of the purchase.

Strategies To Avoid Liability

There are many strategies available to prospective buyers as they attempt to avoid successor liability. For example, buyers may request that sellers maintain their corporate existence post-closing and retain insurance policies covering pre-closing liabilities.

Additionally, the asset purchase agreement should expressly state that the buyer is not assuming any of seller’s debts or liabilities. The Agreement should specifically identify known liabilities or ongoing litigation for which the seller is retaining sole liability. Finally, the agreement should contain an indemnification provision calling for the seller to defend and hold the buyer harmless in the event any post-closing liability arises.

The circumstances of each asset purchase are unique. Consulting experienced counsel during the structuring of any purchase can have a significant impact on lowering a buyer’s potential exposure to the debts and liabilities of the seller.

Richard C. Hatem is an Associate with Kring & Chung, LLP‘s Irvine, CA office. He can be reached at (949)-261-7700 or rhatemat-sign kringandchung DOT com.