What you need to know about the bulk sale law in buy-sell transaction

Larry Shewfelt

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.

No self respecting athlete would enter a contest without some prior familiarity of the rules of the game to be played. In fact, he would know that to be effective, he must go beyond the rules and learn the subtle nuances of the game in order to gain a competitive edge so often necessary to massage the outcome of the contest and attain results more in line with his desires

When conducting the purchase and sale of an automobile dealership, much in the same manner as virtually any other business, the California Commercial Code Division 6 relating to “Bulk Sales” comes into play as the basic ground rules governing the transaction. The Bulk Sale law places the responsibility squarely upon the Buyer’s shoulders to comply with the provisions of the statutes, unless the transaction is handled through an escrow in which event the Escrow Holder becomes responsible to comply with certain provisions of the Act [Section 6106.2(b)]. Generally speaking, failure to comply subjects the Buyer to liability to any creditor of the Seller in an amount equal to what the creditor would have realized had he been given the opportunity to file a claim pursuant to a proper notice.

With the exception of specified exemptions, the Bulk Sales Statutes call for recording the notice of the pending sale in the county where the assets are located and publishing the notice 12 business days prior to the date of sale. In addition, a copy of the notice must be delivered to the county tax collector 12 business days prior to the date of sale. When the notice is recorded between March 1 and the last Friday in May, the required delivery to the tax collector must also include a copy of the seller’s business property statement (form 571 – L). When the principal business office of the seller is in a different judicial district than the location of the assets being conveyed, the notice must be published, and if not in the same county recorded, in that jurisdiction as well. The Bulk Sale Statutes identify specific information which must be included in the notice and in particular require a statement “whether or not the transaction is subject to Section 6106.2″, which is discussed later in this article.

Recent legislative revisions to the Bulk Sale Statutes in 1991 incorporated, among other things not addressed in this article, several significant changes which are briefly summarized as follows:

(1) creation of a minimum and a maximum threshold for transactions under which the Bulk Sale statute would apply. Any transaction under $10,000 or in excess of $5,000,000 is exempt from Bulk Sale treatment (i.e., no publication or recording of the Bulk Sale Notice is required;)

(2) a raising of the amount of the “consideration” (from $ 1,000,000 to $2,000,000) under which the obligation of the Buyer or Escrow Holder arises to apply such consideration to the payment of timely filed claims [6106.2(b)] AND under which a specific “Cash Short Closing” procedure may apply (6106.4);

(3) creation of a class of transactions between $2,000,000 and $5,000,000 under which one must publish and record the Bulk Sale Notice, with the stark exception that there is no provision allowing creditors to file claims and no duty of the Buyer and/or Escrow Holder to apply the consideration to the payment of timely filed claims and

(4) an increase in the amount to be held in escrow for a claim disputed by the Seller.

These revisions demand more attention for they have been the discussion of many an educational forum within the escrow industry and arc clearly subject to legal interpretation among escrow holders, the attorneys representing Purchasers and Seller on a transactional basis, and the principals themselves. So to sharpen our competitive edge, let’s take a closer examination of the issues and questions raised under each of the above changes.

(1) Section 6103(c)(12) actually provides for all exemption from Bulk Sale application for any sale of assets having a value (i) net of liens and security interests, of under $10,000, or (ii) of more than $5,000,000.

(a) A potential conflict in the code arises in opting for the exemption by reason that the value “net of liens and security interests” in less than $10,000 in that had the transaction been handled in compliance with the Commercial Code provisions and a “cash short closing” situation arose, unsecured creditors could attack a secured creditor’s priority claim by attempting to show that the claim exceeded “the consideration fairly attributable to the value of the properties securing the claim” [6106.4 (b)(2)]. The question arises, “Why would this provision even be in the statute if the intent of the statute was to except transactions which left a transactional “equity” in the Seller of less than $ 10,000?”

(b) Even where the transaction does not result in a “cash short closing”, an unsecured creditor may bring an action questioning the legitimacy of the failure to comply with the Bulk Sale provisions or that the transaction was “concealed” in light of the fact that the above described conflict exists for other provisions of the statute.

(c) Notwithstanding the exemption of a transaction from Bulk Sale application, a Buyer must still consider the exposure to liability that may arise from various statutes outside of the scope of the Bulk Sale statutes:

(i) Successor Liability to the State Board of Equalization, Employment Development Department and Franchise Tax Board under the provisions of various tax statutes;

(ii) Liens of record at the Secretary of State affecting the personal property being conveyed;

(iii) Liens of record at the County Recorder’s office affecting the Real Property or Leasehold Estate;

(iv) Federal Tax Liens filed against an individual Seller within the past ten years in the County of residence of such individual Seller.

(v) Obtaining the consent of the Landlord to the Seller’s assignment of a Lease and/or Buyer’s execution of a new Lease

(vi) Synchronizing the exchange of money for title, transfer of the Lease, termination of existing liens …

(2) As in the Bulk Sale statutes prior to 1991, the Buyer (or Escrow Holder if the transaction is handled through an escrow) is required to apply the consideration to the payment of timely filed claims. The change in 1991 applies to any transaction of $2,000,000 or less where it previously applied only to transactions with a consideration up to $ 1,000,000.

(a) Our first concern with this provision as with item #3 below is the manner in which the consideration is being computed The most significant question posits whether the value of the New Vehicle Inventory should be considered in the computation of the purchase price/consideration when the inventory is floored by a lender and there is no equity. Within the Escrow industry and among the majority of legal counsel with whom I have spoken, the consensus is that it should not. Arguably, taking the New Vehicle Inventory valuation at face value for purposes of the application of the Bulk Sale statute can skew or grossly misrepresent the financial health of all upside down dealership when the flooring amount equals or exceeds the consideration for new vehicles calculated in accordance with the formula contained in tile Buy-Sell Agreement.

(i) Furthermore, in the vast majority of sales of dealerships, the purchase price for the New Vehicles does not pass through the escrow, but is rather evidenced by the payoff by the Buyer’s flooring lender to the Seller’s flooring lender. This practice potentially defeats one of the criteria for the Bulk Sale, i e. that the Buyer (or Escrow Holder) “apply the cash consideration … to pay those debts of the Seller for which claims … and are received in writing on or prior to the date specified as the last date to file claims with the buyer or escrow agent designated in the notice to receive claims. ” [6106.2(b)].

(b) It is only within this universe of transactions reflecting a consideration of $2,000,000 or less that the “Cash Short Closing” procedures apply. It is these transactions which attract the most exhaustive attention, consternation and liability. The Commercial Code provisions are really most complete, within reason, and provide a fairly logical framework not too dissimilar to a bankruptcy filing at substantially less cost and stigma attached to it. I would venture to surmise that the unsecured creditor has a better chance of collecting a greater percentage of its claim through this type transaction than through a bankruptcy.

(i) In a cash short closing scenario, if at the time the transaction would otherwise have closed, the cash deposited, or agreed to be deposited, is NOT SUFFICIENT to pay all claims in full, there must be a delay in the PASSING OF LEGAL TITLE AND DISTRIBUTION OF THE CONSIDERATION for an additional period of 25 to 30 days from the date of mailing of a subsequent notification to all creditors having timely filed a claim. This subsequent notification will advise those creditors the names of all creditors having filed a claim, the amounts of each claim timely filed, the amount proposed to be paid to each claimant, and the date on or before which payment is expected to be made, which shall be not less than 25 days nor more than 30 days from the date of mailing of the notification.

(3) In the Bulk Sale provisions prior to 1991, any transaction in excess of $1,000,000 required publication of a Notice to Creditors, but no provision for the filing of creditors claims nor requirement of the Buyer or Escrow Holder to apply the consideration to the payment of such claims arose. With the revisions to the statutes in 1991, the threshold was increased to encompass transactions over $2,000,000 but less than $5,000,000 as the exemption from the requirement even to publish a Notice went into effect for transactions in excess of $5,000,000.

It is important to note that none of these provisions release a Seller from responsibility to pay its creditors, it is only the Buyer and the assets it is purchasing that are being protected from attack by unsecured creditors of the Seller.

(4) The remaining feature of the revisions to the Bulk Sale statutes addressed in this article is the provision allowing the Seller to deny the claim of any “unsecured creditor” but increasing the amount to be withheld from Seller’s proceeds from the amount of the claim to an amount equal to (1) 125 percent of the first $7,500 of the claim, and (2) an amount equal to that portion of the claim in excess of the first $7,500… Such amount is withheld in the escrow for a period of 25 days from the date of mailing of a notice to the creditors of the disputed claim.

Remember that an Escrow Holder is a service agent, a disinterested third party to whom a Buyer or Seller, or their respective attorneys and accountants may look for information relating to the transfer process. This article addresses a small part of the process with which they must be familiar in order to assist in the completion of the purchase and sale of an enterprise or business assets. Attorneys are well aware of the importance of the Escrow Holder in this process and are quick to seek the education and expertise of an agent who handles such transactions on a daily basis. A relationship with a competent Escrow Holder is one to nurture and appreciate, and you too will reap the awards and be ahead of the game. Bon chance!

This article was written in 1998.

Mr. Shewfelt is principal and escrow officer at Wilshire Escrow Company. He can be reached at 213-935-3530. The website address for Wilshire Escrow is: http://www.wilshire-escrow.com/