Are Asset Sales Risk Free?
Businesses looking to expand are often faced with the decision of whether to purchase the assets or stock of another company. Conventional wisdom is that asset sales are generally preferable for buyers; whereas, stock sales are generally preferable for sellers. While this advice is generally correct, taken alone it ignores the factors lawyers and other professional advisors consider in recommending an asset based transaction or stock transaction. Such advice also tends to create a false sense of security in buyers that asset based transactions are risk free—which is not necessarily the case.
The primary benefit for the buyer in an asset transaction is that, when done correctly, the buyer can limit (but not necessarily eliminate) its exposure to certain liabilities. In contrast, in a stock transaction the buyer generally assumes all assets and liabilities of the business. However, even in asset sales, there are exceptions to the general rule—the two most common being successor liability and encumbered assets.
Under the successor liability doctrine, if the buyer essentially becomes the de facto seller after the asset transaction, an aggrieved party of the seller might have a claim against the buyer for the seller’s debt. Liability would be more likely where the buyer retains the seller’s employees, continues operating at the seller’s prior place of business, adopts the seller’s business name, and so on—all common practices in asset sales. While successor liability claims are ultimately difficult to prove, getting pulled into a lawsuit over successor liability issues can still be very costly to defend.
In addition to successor liability issues, if the buyer fails to perform sufficient due diligence, it may practically be exposing itself to significant liability if the acquired assets have liens or encumbrances. Even worse, the assets may have been stolen or pirated (especially in the software industry). Due diligence can help mitigate these risks and can also identify possible creditors of the seller (combating potential successor liability issues).
Thus, while asset sales are clearly preferred from the buyer’s perspective, simply entering an asset transaction should not create a false sense of security in buyers. Nor should buyers forego adequate due diligence in asset based transactions or fail to properly document the transaction legally.