Successor Liability

Posted on Sep 26, 2018

Successor liability is the acquisition of debts and liabilities of the former entity owner to the new entity owner. This is common when an existing or new business purchases the shares or LLC membership interest of a company, or when two companies merge to form one entity, therefore transferring the future debts and liabilities of the seller to the new or surviving company.

When purchasing an existing business, it is important to consider to what extent your business will be responsible for the seller’s debts and liabilities following the purchase. Making sure that you are informed and taking the necessary steps to alleviate your company’s risk is critical in the process of purchasing a business.

How to avoid successor liability:

1.) If the purchaser has an existing company, they may create a separate subsidiary company to purchase the target business. This will, therefore, place the liabilities of the acquired business in the separate subsidiary so that they are not the responsibility of the parent company. However, the subsidiary will now assume the liability.

2.) The buyer may include specific legal provisions in the purchase agreement to place the seller’s liabilities back onto the seller.

3.) The buyer may purchase only the assets of the target business.
While an asset sale is an ideal way to avoid successor liabilities there are a few exceptions as explained by the Supreme Court of California in Ray v. Glad Corp. (1977), 19 Cal.3d 22:

“[T]he rule states that the purchaser does not assume the seller’s liabilities unless:
(1) there is an express or implied agreement of assumption,
(2) the transaction amounts to a consolidation or merger of the two corporations,
(3) the purchasing corporation is a mere continuation of the seller, or
(4) the transfer of assets to the purchaser is for the fraudulent purpose of escaping liability for the seller’s debts.”

Successor Liability to Government Agencies:

Buyers may also be held accountable for the seller’s obligations and debts to governmental agencies.

Such liabilities may include:

*Franchise and income tax, interest, and penalties – payable to the Franchise Tax Board

*Contributions to California unemployment fund, interests, and penalties – payable to the Employment Development Department.

*Sales and use taxes – payable to the California Department of Tax & Fee Administration

In order to avoid this, the buyer may seek to obtain confirmation that the seller’s obligations to governmental agencies have been fulfilled, prior to the closing of the sale/merger.

In conclusion, it is highly recommended to consult an experienced professional in regards to assessing one’s risk for potential successor liabilities. Compass First is dedicated to identifying and mitigating such risks in a variety of situations to ensure a smooth business acquisition process for all parties involved.