Explore the risks of acquiring the assets of a business and potential liability for seller debts in M&A deals. Learn from a real case involving a luxury motor coach company and gain insights into protecting buyers from unexpected liabilities.
M&A Stories
May 14, 2019
Introduction:
One of the key concerns when acquiring a business is the potential liability for the seller’s debts not covered in the purchase agreement, especially when the seller faces financial trouble or liquidation shortly after the deal. In this blog, we discuss a case involving a Phoenix-based luxury motor coach company and a Torrance, California-based seller. Despite a significant cash purchase of $14.4 million, the buyer found itself entangled in a legal battle over the seller’s unpaid claims.
The Deal:
In this case, the seller was defending claims from several commercial landlords totaling $50,000 at the time of the sale. The buyer acquired most of the seller’s assets, covering secured and some unsecured debts. However, the seller still faced ongoing litigation from its landlords and continued its operations for another 1 ½ years post-sale. The buyer assumed certain trade debts but did not inherit the seller’s branding or upper management.
The Lawsuit:
The seller’s commercial lessors, unable to collect from the seller, sued the buyer in a Nevada state court, citing the de facto merger exception to successor liability. Normally, a buyer is only liable for the assumed liabilities explicitly outlined in the asset purchase agreement. However, the creditors argued that the buyer’s actions mirrored a merger, even without an actual merger.
The Nevada Supreme Court Ruling: The Nevada Supreme Court identified four factors for a transaction to qualify as a de facto merger. Three out of four factors must be present for a de facto merger:
1. Continuation of the seller’s enterprise by the buyer.
2. Ownership of the buyer by the seller or its shareholders.
3. Cessation of ordinary business operations by the seller.
4. Assumption of the seller’s trade liabilities and post-closing contractual obligations by the buyer.
The court ruled that this transaction failed three of these factors:
1. The buyer did not continue the seller’s business, as it didn’t use the seller’s branding or hire its upper management.
2. There was no continuity of shareholders between the buyer and the seller.
3. The seller did not cease ordinary business operations, holding onto assets, leases, and fighting legal claims for several months before liquidation.
Conclusion:
There is no de facto merger risk for all cash deals in most states. This case highlights that even an all-cash transaction may not necessarily shield the buyer from such claims in some states, such as Nevada. Careful consideration of the factors involved, and well-drafted purchase agreements are crucial to protect buyers from unexpected liabilities.
Case Reference:
MOH Management, LLC v. Michelangelo Leasing, Inc., No. 73920, Supreme Court of Nevada, (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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