The Benefits Of Asset Purchases For Buyers & California Bulk Sales Law: When and How Buyers Can Eliminate Successor Liability

This article is to assist prospective business buyers by increasing their overall understanding of the advantages of asset purchases as opposed to stock or LLC membership interest purchases, and to explain the basics of California Bulk Sales law and its importance.

I.  Why Buyers Should Pursue an Asset Purchase Instead of Stock/Membership Interest Purchase:

Someone looking to purchase an ongoing business, should first give serious consideration to the method and structure of the sale, and how they will acquire the business from the Seller. Buyers may wish to buy a Seller’s equipment, customer list, inventory, good will, or name and logo. However, to limit their personal liability, business owners often put their business inside a legal entity (for this article’s purposes, the “Seller Entity”). When this is the case, Buyers can acquire the Seller Entity itself, or purchase specific assets from the Seller Entity, through the Buyer’s own legal entity. Although both options have their pros and cons, for the reasons outlined below, Buyers should understand that asset purchases are nearly always their best option.

The great majority of legal entities are corporations or limited liability companies (“LLCs”). Since corporations and LLCs provide limited personal liability, business owners transfer to or acquire business assets through their entity, and as individuals, they simply own stock or membership interests in the entity.

As stated above, Buyers can obtain ownership of the entity itself by purchasing the stock or membership interests in the entity, and thereby obtain control of the entity’s assets. However, if a Buyer purchases the entity itself, the Buyer will also be acquiring all the Seller Entity’s liabilities, which can include potential tax liability. Further, the Buyer will also inherit the current tax basis of the business’s fixed assets, meaning the Buyer does not receive a step-up in basis on the acquired assets and cannot restate the depreciation on them.

Alternatively, Buyers can engage in an asset purchase, where they buy specific assets from the Seller Entity, take no ownership of the Seller Entity itself, and leave all unwanted assets with the Seller Entity. Structuring the sale as an asset purchase provides several benefits to the Buyer, including:

• Avoid the existing obligations that come with managing the Seller Entity.
• Avoid inheriting the potential unknown tax liabilities belonging to the Seller Entity.
• Avoid inheriting the current or trailing claims from employees, governmental entities, and vendors.
• Other kinds of possible ongoing disputes between the Seller Entity and third parties will remain with the Seller Entity.
• Avoid having to evaluate old inventory belonging to the Seller Entity.
• Avoid taking on employee benefits plans or options provided by the Seller Entity.
• Bookkeeping may be much easier for Buyer’s business moving forward.
• Appraising the value of a business is easier because most or all the Seller Entity’s nontangible assets will likely not be included in the purchase.

Although asset purchases are clearly more advantageous for Buyers, asset purchases can come with their own set of issues to consider. For instance, it can be expensive and tedious transferring the title of certain assets, contracts, licenses and permits to the Buyer. Also, third-party creditors can still claim successor liability if they have claims on the assets the Buyer purchased, and if the Buyer did not take the appropriate actions to avoid assuming the Seller’s liability.

II.   Whether Conducting an Asset Purchase or Stock/Membership Interest Purchase, Buyers Should Understand California Bulk Sales Law and When it Applies.

 If you are buying a California business or its assets, you need to know if the Bulk Sales Law applies to the sale.

California’s Bulk Sales Law exists to protect creditors by giving them advance notice of a bulk sale. A Bulk Sales Notice is a published notice to the world of the pending purchase, which helps prevent Sellers from selling a business or its assets to good-faith Buyers, and then walking away with the proceeds without having first paid their creditors. A Bulk Sales Notice also prevents Sellers from selling a business or its assets substantially under market value (perhaps to a family member or friend) and avoid paying creditors the full amount of the debt.

If the Bulk Sale procedure is properly followed, and if creditor claims are not made within the specified period, a Buyer will avoid any successor liability they may have otherwise had. Even if a creditor makes a claim after a Bulk Sales Notice is published, a Buyer can still eliminate their liability, so long as the Buyer agrees to only proceed with the sale upon payment to the Creditors out of escrow from the sales price.

Determining Whether a Bulk Sale is Occurring:

If you are buying a business or assets in California, it helps to understand what constitutes a “bulk sale”. In California, a bulk sale is:

1. A sale of more than half the Seller’s inventory or equipment, as measured by fair market value on the date of the sale agreement.
2. The sale is outside the ordinary course of the Sellers business.
3. The Seller’s principal business is the sale of inventory from stock, and
4. The Seller’s business is in California.

 Assuming the above criteria are met, California Bulk Sales Law categorizes a bulk sale by the net value of the assets to be sold. The three possible categories are:

• Small Cash Sale: If, on the day the purchase agreement was executed, the net value of the assets to be sold was greater than or equal to $10,000 but less than $2,000,000, the sale will qualify as a Small Cash Sale. For Small Cash Sales, there are slightly different requirements that will apply (see below).
• Standard Bulk Sale: If, on the day the purchase agreement was executed, the net value of the assets to be sold was greater than or equal to $2,000,000, but less than or equal to $5,000,000, the sale will qualify as a Standard Bulk Sale.
• Exempt: If, on the day the purchase agreement was executed, the net value of the assets to be sold was less than $10,000 or greater than $5,000,000, the sale will be completely exempt from California Bulk Sales Law.

Bulk Sale Procedure:

After a Buyer has determined that they will be executing a bulk sale, to eliminate their successor liability after the sale, they must then follow the procedure for a California Bulk Sale. A good starting point is obtaining a list from the Seller containing all of business names and addresses the Seller has used in the past three years. A Buyer must then provide a Bulk Sales Notice containing the following:

1. A statement with regard to the fact that a bulk sale will take place.
2. The Buyer’s and Seller’s names and business addresses.
3. The list of all other business names and addresses used by Seller within the last three years.
4. A description of the assets to be purchased, and where they are located.
5. The location where the bulk sale will take place.
6. The anticipated date when the bulk sale will take place.
7. A statement of whether the sale qualifies as a Small Cash Sale.

Small Cash Sale Additional Requirements: If the sale will be a Small Cash Sale, the Bulk Sales Notice must also contain:

1. The names and addresses of the persons whose claims must be filed.
2. The last date for when those persons can file a claim.

Note: The last day for when a claim can be filed is one business day before the date the Bulk Sales Notice states the bulk sale is to take place.

Once the Bulk Sales Notice has the required information listed above, it must be recorded and published properly at least 12 business days before the date of the bulk sale. The Buyer must:

1. Record the Bulk Sales Notice with the Recorder’s Office of every county where an asset involved in the sale is located, and the county where the Seller is located.
2. Publish the Bulk Sales Notice in newspapers of general circulation in every county where an asset involved in the sale is located, and in the county where the Seller is located.
3. Deliver, by registered or certified mail, the Bulk Sales Notice to the county Tax Collector in every county where an asset involved in the sale is located.

When Buyers Fail to Comply:

If a Buyer fails to provide proper notice under California Bulk Sales law, the sale will remain valid, however, the Buyer will become liable to creditors for damages equal to the difference between the total claim and the amount the creditor could have recovered had the Buyer properly complied with the Bulk Sale Notice requirements.

In summation, all prospective business buyers should carefully consider the advantages of asset purchases as opposed to stock or LLC membership interest purchases before entering the process of structuring and negotiating the sale, and understand how to determine if California Bulk Sales law will apply, so that they can eliminate any successor liability they may inherit.