For a growing company, an asset purchase agreement can be a strategic opportunity. Unlike mergers or stock acquisitions, an asset purchase lets the buyer choose specific assets from the target company, allowing them to bypass unwanted liabilities. However, this approach isn’t always liability-free. Courts have established multiple exceptions to the non-liability doctrine, and buyers may still end up responsible for certain obligations depending on how they operate the acquired assets post-sale.
In practice, asset purchases are often pursued quickly, as buyers aim to capture new market share, minimize business disruption, leverage tax advantages and control deal-related expenses. Unfortunately, a fast-tracked deal can overlook liabilities that might surface later, eroding one of the main benefits of an asset acquisition.
Example of an Asset Purchase with Hidden Liabilities
Consider a scenario where an e-commerce company acquires a competitor’s technology assets to bolster its platform. After closing the deal, the buyer learns that one of the acquired software features was actually licensed from a third party. The third party is unwilling to extend the same licensing terms, and the buyer must now decide whether to pay unexpected fees, engage in litigation, or remove the feature altogether. This example highlights the importance of thorough due diligence and clearly defining liabilities in the asset purchase agreement.
Key Exceptions to Asset Purchase Non-Liability
Federal and state courts recognize several exceptions to non-liability in asset purchases. Here are some of the most common:
- Express or Implied Assumption of Liabilities: When buyers agree to assume specific liabilities in the asset purchase agreement, they become responsible for those obligations. Courts can also imply liability based on the buyer’s actions, especially if the buyer continues operations as the seller did, including retaining employees, honoring contracts, or using the same branding.
- De Facto Merger Doctrine: If the transaction resembles a merger, courts may hold the buyer liable for the seller’s obligations. Courts consider factors like continuity of employees, management, and operations; whether the seller’s company ceases to exist; and whether liabilities were assumed to continue operations.
- Mere Continuation: Similar to the de facto merger doctrine, this exception focuses on whether the corporate entity is the same post-sale. A transaction may be deemed a “mere continuation” if the buyer’s ownership and management are similar to the seller’s or if the seller’s entity is effectively absorbed.
- Fraudulent Transfer: Courts may view a transaction as fraudulent if it appears designed to evade liabilities, often scrutinizing the price paid for assets to determine if it reflects fair value. This is particularly relevant in sales involving distressed companies.
State-Specific Exceptions and Successor Liability
State laws vary significantly on successor liability. For example:
- In Texas, buyers generally aren’t liable for the seller’s obligations unless they explicitly assume them.
- Delaware is reluctant to invoke the de facto merger doctrine except in rare cases.
- New York often enforces de facto merger exceptions, especially when transactions resemble mergers.
Industry-Specific Considerations in Asset Purchases
Asset purchases can pose unique risks depending on the industry. For instance:
- Healthcare asset purchases may involve liabilities around patient data and billing practices.
- Financial services must address risks related to anti-money laundering compliance.
- Technology companies often face intellectual property (IP) and data privacy liabilities that require specific protections in the agreement.
Key Steps to Minimize Liability Risk in Asset Purchases
To protect against hidden liabilities, buyers should focus on these crucial steps:
- Due Diligence: Comprehensive due diligence is essential to uncover any existing liabilities. Buyers should review the target’s financials, pending litigation, contractual obligations, IP licenses, and regulatory compliance. This step ensures that the asset purchase agreement accurately reflects potential risks.
- Identify Potential Pitfalls: Industry-specific issues, such as regulatory compliance in healthcare or IP licensing in tech, require specialized attention. Experienced legal counsel can identify these unique risks and help structure terms to mitigate them.
- Tailored Drafting: The agreement itself should include specific provisions detailing which liabilities the buyer is assuming and which remain with the seller. Clauses related to representations and warranties, along with a strong indemnification provision, hold the seller accountable for undisclosed liabilities. Representations may include assurances of IP ownership, accurate client contract documentation, and disclosure of any hidden debts.
Consult With a Lawyer
An asset purchase agreement can provide a buyer with targeted advantages over a merger or stock purchase, but buyers need to take deliberate steps to mitigate liability risks. With a skilled legal team and business consulting along with a strategic approach, an asset purchase can be structured to protect the buyer’s interests, enabling a smoother integration and reduced potential for unexpected future liabilities.
