Hidden Liabilities in Asset Purchase Agreements
In the competitive tech sector, mergers and acquisitions are vital for developing a business. Unfortunately, debts and liabilities that have been hidden from the buyer may put them at financial risk. Buyers may try to prevent this by obtaining assets rather than the full company. This method may nevertheless result in a buyer taking on debts secured by the assets being acquired. When structuring a deal as an asset acquisition rather than a stock purchase, it’s critical to know whether debts or other liabilities exist that might become the asset buyer’s responsibilities.
Why Structure a Deal as an Asset Purchase Agreement
When one business buys or merges with another, the buyer not only gets the target company’s assets, but also its debts and liabilities if they haven’t been paid off before the deal. This includes debts that the buyer may not be aware of due to insufficient due diligence on their part. In this scenario, the courts may declare the buyer to have had “constructive awareness” of such debts and liabilities. Constructive knowledge occurs when a person is believed to have knowledge of a fact by law, regardless of whether or not they have actual knowledge of the fact, since that information may be attained through reasonable care.
To avoid the possibility of assuming unknown debts or liabilities, a buyer may choose to acquire only certain portions or assets of another company. The business that is selling its assets can continue to exist as a legal entity either as an operational business if it retains assets or as an empty shell until it is liquidated. The debts and liabilities of the selling company are retained by the seller and are not inherited by the buyer. Some debts and liabilities, on the other hand, may be directly related to the assets that are acquired, and the buyer of those assets may be liable for those debts and liabilities.
Assuming a Seller’s Debts and Liabilities Unknowingly
Using purchased assets as collateral to secure the seller’s debt obligations is a common strategy for a buyer to assume a seller’s debts or other liabilities in an asset acquisition transaction. If the seller gave a lender a security interest, and that security interest was “perfected,” the buyer of those assets has constructive knowledge of the debt, and so becomes responsible for it. When a security interest is filed with the corresponding government agency, it notifies everyone, including the asset buyer, that the asset is encumbered. If the buyer fails to pay the debt that the encumbered assets secure, the secured lender has the right to seize the goods and sell them to repay the loan.
Secured debt impacts real estate deals in addition to corporate takeovers, as real estate is frequently burdened by mortgages or deeds of trust. The responsibility to pay a debt secured by real estate does not go away when the property is sold. That debt must either be paid when the property is sold or it will remain with the property and become the buyer’s responsibility.
It is the responsibility of the buyer to do thorough due diligence to determine any debts or liabilities that may become their burden. Before the deal can be completed, these obligations must be settled between the buyer and seller, as well as the lender in some cases. It is critical to be represented by an experienced attorney when acquiring any asset in order to identify possible debts and other liabilities and establish whether the buyer or seller will be accountable for such responsibilities once the sale is closed.