Explore the risks associated with acquiring companies and the potential consequences when assets are used as collateral in M&A deals. Learn from real-life cases and key takeaways.
M&A Stories
May 15, 2019
Introduction:
When considering the acquisition of a company, it’s crucial to be aware of potential risks, especially regarding the company’s assets used as collateral for financing. In this blog, we’ll explore one such risk and its consequences.
The Risk:
Many companies pledge their assets as collateral for loans, and as a buyer, you should be aware of this practice. While the purchase agreement often includes assurances from the seller that their assets are free from liens, these assurances may not always provide full protection.
The Caveat:
Seller representations and warranties are valuable, but they only grant the buyer the right to pursue legal action for damages if it’s discovered that the assets are indeed collateral for a properly perfected secured loan with a UCC financing statement.
The Consequence:
If the assets are subject to a secured loan, the buyer takes ownership with the security interest attached. In the event of the seller’s loan default, the buyer might be left with assets subject to the lender’s claim, potentially resulting in financial losses.
A Real-Life Case:
Consider the case of a Phoenix-based Nevada corporation that manufactured video lottery machines. The company borrowed money, using these machines as collateral and the lender properly filed a UCC financing statement. A buyer acquired the assets, trusting the seller’s representation that the machines were lien-free.
Legal Battle:
However, when the seller defaulted on the loan, the lender sought damages. The buyer, having already leased some of the machines, found itself in a legal battle. The court ruled in favor of the lender, as they had valid liens on the machines due to proper documentation and UCC filing.
Key Takeaway:
This case highlights a crucial lesson for buyers: Conduct thorough due diligence. Part of this process involves running a UCC search on the target business to identify any assets encumbered by liens. This diligence extends to other potential liens, such as those related to taxes.
In summary, in the realm of M&A, knowing the status of a target company’s assets regarding secured loans is vital. Relying solely on seller assurances may leave you vulnerable to unexpected financial consequences, as seen in the referenced case.
Case Reference:
Potts v. Maryland Games, LLC, Civil Action No. CBD-18-3250, United States District Court, D. Maryland. Southern Division, (Filed March 29, 2019)
By John McCauley: I help businesses minimize risk when buying or selling a company.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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