Successor liability is a legal doctrine that establishes the liability of a successor who takes over a previous owner’s property and/or loan. A lender may be able to recover damages from a buyer (the “successor”) who purchase a seller’s property.
Pre-existing Liens & Liability
A typical rule of thumb is that a successor of a business or property should not be held liable for the debts of the antecedent of either although this is subject to change depending on the scenario. If an individual is purchasing a business, they must be aware of any tax liens or UCC filings that may be present as they will take priority over any purchase agreement that is in place.
When previous liens exist on an asset, they can strip the buyer or the new owner of the asset itself. An individual can even find themselves being held responsible for different debts, obligations and acts that were carried out by the previous owners that may be worth more than the assets the individual acquired in the first place.
In states like New Mexico, California, and Illinois the purchaser of the assets is not held responsible for the liabilities of the seller except when:
The purchaser has agreed to take on the debts or liabilities
When the transaction is essentially a merger or consolidation
When the purchasing corporation is an extension of the selling corporation
A fraudulent transaction in order to escape the liabilities for any debts
If a purchase agreement between the seller and the buyer doesn’t explicitly state that the buyer is not taking on any acts, or debts, etc. that are associated with their purchase, it is possible that they may be subject to litigation. It is important to note that a Purchase Agreement should specifically state which responsibilities they will or will not be assuming upon completion of the transaction.
De Facto Merger
There are four factors that can be associated with the De Facto Merger Exception, which are the following:
Is there continuation of enterprise?
Has the seller halted normal business operations?
Has the purchaser continued the seller’s actions or obligations?
It is important to understand that three out of these four factors must be the case in order for the exception to take effect.
Mere Continuation Exception
A mere continuation exceptions can be triggered if only a single company stands after the transfer of assets as well as an identity of stocks, stockholders, and directors that exist between the two companies included in the deal. This usually happens when the owner of the company that is selling still with holds a large stake of the ownership in the company that is buying.
The Fraudulent Transaction Exception
The buyer of an asset can be deemed liable for obligations and debts if it is found to be made as a way to dodge debts. For example, if ownership is given to the sellers owners as consideration for assets gained, they can attempt to transfer over the ownership as a way to dodge any obligations that may be due. To combat this strategy, stock in the buyers company can be transferred to the seller as this will keep the selling company debt-free.
How A Purchaser Can Become Liable
It can be easier to become liable for past actions of an asset as there are a few ways that can render a buyer a victim.
Triggering an Exception to Successor Liability. If the circumstances include some of the exceptions that were previously listed, the debts of the selling company can fall on the purchaser.
Outstanding Liens. Ucc and tax liens on particular assets that the purchaser believes that they have acquired, will hold priority over the purchaser but only if the lieans have been filed before the buyer has made the purchase.
How To Avoid Seller’s Debts & Liabilities
Conduct a Lien Search
Conduct a Title Search for Titled Assets
Check in with the Local Tax Authority
Craft a Carefully Worded Asset Purchase Agreement
Escrow Funds for Outstanding Liability