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Common Questions About Sales and Acquisitions of a Business:
This is a hard question to answer, as it really depends on the terms of the deal. At a minimum, you need a Purchase Agreement and Bill of Sale. There are generally two types of purchase agreements: Asset Purchase Agreements and Share or Membership Purchase Agreement, depending on whether just the assets are being purchased, or whether ownership in the actual corporate entity is being purchased. There are pros and cons to both types of transactions.
If the price of the business will be paid over time, another document needed is a promissory note. If there are assets in the business to be used as a security interest, you may also need a UCC-1 filing to perfect that security interest. If there are titled assets, you may need separate and individual bills of sale or title transfer documents. Finally, if there are assumable contracts (i.e. the lease, mortgages, lines of credit, etc.), then you will need separate documents for those, as well. There are other documents that may be needed, depending on the circumstances of the sale, type of business, etc.
When the shares or membership interest in a company is purchased, all assets and liabilities transfer with that purchase — ownership in the company is being purchased, not the individual assets. This is beneficial when the company itself has significant credit or assets or unassumable contracts.
An asset purchase, in contrast, is used when a purchaser only desires all or some portion of the assets, and not the company’s liabilities. This is the most popular form of business transaction, although most people don’t realize that not doing this right can lead to what’s called “successor liability,” where the successor in interest in substantially all the assets are still liable for some cause of action, liability or debt of the previous company.
The general rule is that a successor entity is not liable for the acts (or debts) of its predecessor, unless the elements of certain exceptions have been met. In most states, including New Mexico, Nevada and Illinois, there are four customary exceptions to the general rule: (1) Where the purchaser expressly or impliedly agrees to assume such debts or liability, (2) Where the transaction is really a consolidation or merger, (3) When the purchasing corporation is merely a continuation of the selling corporation, and (4) Where the transaction was fraudulently made in order to escape liability or debts.
The “de facto merger exception” is what usually snags most purchasers in an asset sale. This exception states the purchaser can be held to liabilities or debts as though they formed a merger, even if they didn’t meet (or follow) the statutory requirements. There is a four-factor test: (1) Whether there is a continuation of the enterprise, (2) Whether there is a continuity of shareholders, (3) Whether the selling company ceased its ordinary business operations, and (4) Whether the purchasing company assumed the seller’s obligations. All factors are weight equally, and a de facto merger will not exist when only two of the four factors exist.
Usually, an asset sale triggers two or more of the four-factor test. When that happens, it’s critical the purchase agreement contain proper representations and warranties, and that the purchaser protect him or herself with indemnity clauses.
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