When negotiating a transaction, one of the most important questions to answer is: Who is ultimately responsible for what happens after the deal closes? This often leads to a discussion about successor liability—a key issue in many transactions. Successor liability means that the buyer may become responsible for certain debts or obligations originally owed by the seller or otherwise attributable to the assets, depending on the nature of the purchase. No one wants to take on unexpected liabilities, but understanding this concept is essential in any well-structured deal. Whether you’re buying or selling, knowing how successor liability works can help you avoid costly surprises.
Successor Liability in Asset and Stock Sales
Understanding how successor liability applies depends on the type of transaction involved. In asset sales, liability is typically divided based on time: the seller retains responsibility for any liabilities incurred up to the transaction’s effective date, which is the day the assets officially transfer to the buyer. From and after that date, the buyer is responsible for any new liabilities. Stock sales, however, are more complex. When buying stock, the buyer generally acquires the entire company (or at least a proportionate part thereof), including all existing debts and obligations, as well as any future liabilities of the company. While these are the basic rules, successor liability can be limited or expanded through specific terms in the transaction agreements. That’s why it’s important to review all documents involved in the deal carefully.
Mitigating Successor Liability through Due Diligence
Like all other aspects of a transaction, successor liability can be limited or expanded as the parties see fit through careful drafting and negotiation. For a buyer to mitigate their successor liability and tailor the scope of their assumed obligations to their needs, due diligence is a must. Contractual provisions, such as liability caps, indemnification carveouts, representations and warranties, and schedules detailing excluded assets, claims, and pre-existing liabilities, can be used to carve out specific items, thereby creating subsets of liabilities that a buyer can specifically set aside. These liabilities remain with the seller after the effective date and closing. Thorough searches of court filings, lien claims, UCC claims, government and regulatory filings, and the balance sheets related to the assets can reveal potential liability issues the buyer may want to carve out of their assumed post-closing liabilities. Whether you are selling or buying an asset or stock, a careful review of diligence materials, transaction documents, and data room documents is an essential step in mitigating or expanding the liabilities passed on to the buyer after the transaction closes.
Specific Risks of Successor Liability
To provide further color on the importance of fully defining and understanding successor liability, consider the following issues that may arise if successor liability is not carefully considered or mitigated through due diligence: title defects, environmental defects, regulatory defects, unpaid claims for labor on the assets or work site, preferential stock treatment and undiscovered classes of stock, rights of first refusal or first offer on membership interests, lien claims, employment claims, personal injury claims, third party indemnity claims, unpaid taxes… the list is nearly endless. To avoid incurring these unexpected and cumbersome liabilities, it is imperative that both buyers and sellers keep successor liability at the forefront of negotiations when contemplating a transaction and give it the time and thought it requires to ensure the transaction remains a smart move long after the transaction has closed and the parties have walked away from the signing table.
Transactions are a long, complicated, and expensive process. With so many plates to juggle in the negotiation and consummation of a transaction, having a legal team with the expertise and attention to detail to handle successor liability is just as important as negotiating an appropriate purchase price. To ensure you are getting a good deal now and in the future, and for all your other transaction needs, reach out to the team at R. Reese and Associates and find out how we can get you the best deal for your future today.
Saayem is a Junior Associate at R. Reese & Associates and part of the Commercial Contracts, Land and Title, and Transactions Teams. To learn more about Saayem, visit his attorney page.
Disclaimer: The information and material on this website is general information about our practice and firm. This information does not offer specific legal advice and the use of this information does not create an attorney-client relationship with RR&A or any of its attorneys. The information on this website should not be used for legal advice, and persons should not act upon the information on this website without engaging professional legal counsel.
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