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If you are considering the purchase of a small business, you should be concerned about whether you will be exposed to any of the seller’s liabilities.  Successor liability (i.e., a buyer being held liable for a seller’s obligations) can arise in certain situations, and buyers should take appropriate steps to mitigate this risk. 

Successor Liability Scenario #1: Stock Purchase instead of an Asset Purchase

If a buyer purchases a business by acquiring the common stock of a corporation, the partnership interests in a partnership, or the membership interests in a limited liability company, the buyer steps into the shoes of the seller as the owner of the entity.  The entity continues to own its business assets, and the entity continues to be responsible for its obligations and liabilities.

A seller of such an ownership interest is obligated to disclose the entity’s known liabilities to a buyer, but what about “contingent” liabilities of that entity.  Contingent liabilities are those liabilities that have been incurred by the entity prior to the ownership interest being acquired by the buyer, but the seller is unaware of them.  Contingent liabilities may or may not turn into actual obligations.  For example, a customer that slips and falls in a store before an acquisition might or might not file a lawsuit against the entity for their injuries.

A buyer can avoid these contingent liabilities by structuring the purchase transaction as an asset purchase rather than a stock purchase.  Generally, in an asset purchase, the buyer acquires the business assets, but not the business liabilities.

There are certainly circumstances where a stock purchase can be advantageous over an asset purchase.  However, successor liability is the key reason why most business attorneys will generally recommend that business acquisitions be structured as asset purchases.

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