A significant step in the acquisition process is determining the structure of the deal. The two most common deal structures are: (1) the purchase of the ownership interests of the target (e.g., a stock deal), and (2) the purchase of substantially all of the target’s assets (i.e., an asset deal). An often cited reason for structuring an acquisition as a purchase of substantially all of the target’s assets is that the acquirer can choose which, if any, liabilities of the target that the acquirer will assume. In contrast, a stock deal results in the acquirer purchasing the entire company, which includes all liabilities of the target. In an asset deal, the implication is that the target’s liabilities that are not expressly assumed by the acquirer remain liabilities of the target, and the acquirer will not have exposure for them. As a general rule, this is correct. However, there are exceptions to the general rule which impose “successor liability” on the acquirer. This article describes several of the more common exceptions.

Product Liability: Various exceptions arise in the area of product liability claims, when a plaintiff asserts that the acquirer should be liable for the damage or injury caused by a product that was manufactured by the target prior to being acquired by the acquirer. Many states recognize four traditional exceptions to the general rule against successor liability in product liability cases: (1) express or implied assumption of liability by the acquirer; (2) de facto merger of the target and the acquirer; (3) mere continuation of the target’s business by the acquirer; and (4) fraudulent transfer. The applicability of any of these exceptions is determined by a fact driven analysis of the transaction and the pre- and post-closing activities of the target and the acquirer.

State Taxation: Another exception arises in the area of state taxation. Many states have enacted statutes that impose successor liability on the acquirer for the target’s unpaid state tax liabilities (e.g. withholding and sales taxes), unless the acquirer has received a “tax clearance certificate” from the state taxing authority. Depending on the state, the target or the acquirer may request a tax clearance certificate from the state taxing authority. Processing times can be as short as a few days or as long as several months so acquirers and their tax and legal advisors should consider this issue as early on in the process as possible to avoid having to delay the closing. The receipt of a tax clearance certificate showing no unpaid state taxes eliminates the potential for the acquirer to have successor liability for the target’s state taxes. If the certificate reveals that the target has unpaid state taxes, then the acquirer is usually required to escrow a sufficient portion of the purchase price to satisfy the unpaid tax liability.

Environmental: State and federal environmental laws also impose successor liability on an acquirer for the environmental liabilities of the target, such as liabilities for the cleanup of a toxic spill. Again, there are steps that the acquirer can take to reduce or eliminate exposure for the target’s environmental liabilities. The most common step is to commission a environmental site assessment (i.e., a “Phase I”) which, if conducted in compliance with specified standards, will afford the acquirer a defense to successor liability.

Benefit Plans: Multiemployer plans have the potential to lead to successor liability for the acquirer. There are reported cases where the acquirer was held liable for the target’s unpaid contributions to a multiemployer plan plus, in some cases, interest, penalties, and attorneys fees. There is no safe harbor for the acquirer for these liabilities, so the acquirer should conduct thorough due diligence with respect to targets with multiemployer plans.

It is common practice for an acquirer to attempt to protect itself from unwanted successor liabilities by including representations, warranties, and indemnification provisions in the purchase agreement so that the target is required to make the acquirer “whole” for successor liabilities. The problem, however, is that successor liability issues often arise because the target is no longer in existence or financially able to satisfy the liability, so the third party claimant is looking to the acquirer for redress. In these instances, the acquirer’s right to indemnification from the target is usually worthless unless a portion of the purchase price has been escrowed or the target’s owners have guaranteed the target’s indemnification obligations, and the owners have sufficient assets to satisfy the claims. Despite these pitfalls, an asset transaction still provides an acquirer more protection from the liabilities of a target than a stock deal, but acquirers will need to attempt to identify and resolve any potential successor liability issues during due diligence. If you wish to discuss successor liability and ways to mitigate exposure, please feel free to contact one of the attorneys in our M&A/Securities Practice Group.

by Taylor C. Dieckman and Eric B. Oxley

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