Watch Out for Successor Liability When You Purchase a Business in Washington– Posted by Jason E. Wax
If you’re preparing to purchase a business in Washington, it’s important that you understand how to structure the deal in order to avoid successor liability. Successor liability is the idea that, in some cases, a company purchasing all or part of another company can become liable for the debts of the purchased company. Successor liability can apply regardless of whether the companies involved are LLCs or corporations. As a general rule, if you purchase the stock of another company, you acquire both the assets and the liabilities of that company; when you purchase only the assets of that company, the liabilities stay with the seller. For that reason, parties often prefer to structure acquisition deals as asset purchases instead of stock purchases.
The law in Washington is that “a corporation purchasing the assets of another corporation does not become liable for the debts and liabilities of the selling corporation.” Cambridge Townhomes, LLC v. Pac. Star Roofing, Inc. 166 Wash.2d 475 (2009). There are four general exceptions to this rule: (1) if there is an express or implied agreement for the purchaser to assume liability; (2) if the purchase is a de facto merger or consolidation; (3) if the purchaser is a mere continuation of the seller; or (4) if the transfer of assets is for the fraudulent purpose of escaping liability.
Express and implied assumption of liabilities are easily avoided by careful drafting and cautious communication. A typical asset purchase agreement will contain an express disclaimer of liability for the seller’s debt, as well as an indemnity clause requiring the seller to indemnify the buyer for all pre-sale liabilities. The implied assumption of liabilities most often occurs if the successor company makes representations to the seller’s creditors and those creditors interpret those representations as implying that the successor company intends to pay the seller’s debts. It is best to avoid all communication with the seller’s creditors.
The de facto merger and mere continuation exceptions are very similar to each other. Factors courts consider in determining whether a business has successor liability under the mere continuation exception include common identity between the ownership and management, and the sufficiency of consideration paid to the seller company for the assets being sold. Courts generally find de facto mergers in cases where the seller company continues as part of a new business and the seller’s shareholders or officers acquire shares (or other ownership interests) in the purchaser company in exchange for their stock in the seller company. The courts also look at continuity of management, personnel, business location, and operations. Stated another way, the more the successor company has in common with the seller company, the greater the risk that a creditor will assert successor liability claims based on the mere continuation and de facto merger exceptions.
The fraudulent transfer exception arises most often in cases where the consideration paid to the seller is grossly inadequate or even non-existent. Often, these transfers occur while the seller company is insolvent, on the eve of litigation, or just before entry of an adverse judgment. One simple method of protecting against fraudulent liability in these situations is to obtain an unbiased appraisal of the fair market value of the assets you wish to purchase. If the consideration paid to the seller is roughly equivalent, a creditor is going to have a difficult convincing a court that they were harmed by the transfer.
It is important to keep in mind that successor liability inquiries are very fact-specific. If you are considering purchasing a business in Washington, or if you have concerns about liability related to a previous transaction, the business and litigation attorneys at Lasher Holzapfel Sperry & Ebberson can help you to understand and manage your exposure.