Protected by ironclad agreement? Think again!

Penny L Reeves and Former partner Halbert Rasmussen

NOTE: The following article is from the collection of articles in our Automobile Dealership Buy/Sell Newsletters. The newsletter deals with the complex area of buying and selling automobile dealerships. Some of the material may not be up to date because of changes in the law from the date shown at the end of the article. This article is not to be taken as legal, accounting, tax, or other advice. You should consult your own professionals for such advice and for any updating of the information provided.

“Why should I care about old agreements and claims against the seller? I am buying the assets, not the stock. And anyway, you lawyers can draft language to protect me.” We have heard these statements time and again in our representation of buyers in auto dealership transactions. Buyers often assume that so long as an escrow is set up and a bulk sale notice is published, they cannot be held liable for claims against the seller, unless expressly assumed by the buyer in agreement. Not true. The following very incomplete list gives some brief and sobering examples of potential liabilities which a buyer may face:

-environmental liabilities under state and federal law, even if the liabilities clearly related to prior dealership operations discontinued years prior to closing;

-violation of COBRA, ERISA or other employee benefits laws;

-sexual harassment claims by a former employee of seller for acts allegedly taking place prior to the close of the buy/sell.

Buy/sell agreements employ many tools that try to protect each party from both known and unknown liabilities, including representations, warranties, conditions, covenants, indemnities, reserve accounts, and escrows.

But no matter what the agreement provides, sometimes the very structure of the transaction and other factors can saddle the buyer with unexpected liabilities of the seller which were not bargained for. This is referred to as “successor liability.” Most dealers know about specific successor liability, such as unpaid sales taxes, but many are unaware of general successor liability, where all of the seller’s debts are imposed upon the buyer–just as if the buyer bought stock instead of assets.

General successor liability may be imposed on a buyer when it is found that the buy/sell transaction amounted to a “de facto” consolidation or merger of buyer and seller, or when the purchasing corporation is determined to be a “mere continuation” of the selling corporation.

The general successor liability doctrines were created by court opinions issued over the years, and not by statutory law. Therefore, there is no easy test to determine whether they apply. Some of the important factors that can result in the imposition of successor liability include:

-a continuation of the seller’s management, personnel, physical location, assets and/or operations;

-a continuation of shareholders (i.e., if buyer pays all or a part of the purchase price with its stock);

-ceasing of operations by the seller after closing, especially if it liquidates and dissolves as soon as practicably possible after the buy/sell closes;

-assumption by the buyer of some or all of the obligations of the seller necessary for the uninterrupted continuation of business operations;

-common stockholders, officers and directors;

-common business plans between buyer and seller;

-efforts by the buyer to be seen as the same entity as seller and attempts to exploit seller’s goodwill; and

-a duplication of staff, facilities, assets and commercial relationships.

A buyer must take steps at all stages of the buy-sell process and post-closing in order to minimize its exposure to successor liability claims from third parties. These steps include the following:

-structure the agreement as much as possible to emphasize buyer’s independence from seller. Avoid giving the buyer’s stock to the seller;

-to avoid being found to be a mere continuation of seller by exploiting seller’s goodwill or continuing seller’s corporate form, consider leaving goodwill out of the agreement and avoid having officers, directors, managers, and vendors of seller becoming part of buyer’s operations and routine;

-perform necessary due diligence prior to closing to verify the representations and warranties given by seller in the agreement. Include the following:

-UCC searches to determine commercial and judgment creditors of seller and any liens affecting the assets being sold;

-a search of local court records to verify that there are no pending lawsuits against seller;

-a Phase I report on the dealership property in order to minimize potential environmental liabilities; an audit of seller’s records for potential COBRA problems.

-require adequate reserve accounts from seller’s proceeds to cover tax and other liabilities pending receipt of official clearances; and

-lay down facts post-closing that will help buyer if third parties sue buyer based on successor liability. Be careful to be able to substantiate buyer’s new ownership in connection with the following: dealership business practices relating to the sale of new and used vehicles and parts and dealership leasing practices; the obtaining of dealership business licenses and dealer agreements; employee policies; and the dealership name and advertising.

Although there is no foolproof way for a buyer to completely shield itself from the imposition of successor liability for the acts of its seller, a buyer can take reasonable steps throughout the buy/sell process and after closing to protect itself from unwarranted claims of successor liability, including personal indemnity from the owners of seller, holding the buyer harmless from such claims.

This article was written in 1993.