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January 4, 2017

Best Practices: Importance of Ensuring a Borrower Avoids Bulk Sales and Successor Tax Liability in the Sale of Business Assets

by Katherine D. Tohanczyn

Generally, the purchaser of a business is not liable for a seller’s unpaid taxes unless the purchaser agrees to assume them. However, most states have adopted laws that create a liability for a buyer who is purchasing more than half the assets of the business outside of the ordinary course of the selling entities’ business, commonly referred to as a “bulk sale.”

The type and scope of transactions that will trigger bulk sales laws differ by jurisdiction. For example, in some states, including Pennsylvania, bulk sales considerations will be triggered not only by personal property, equipment and inventory but also buildings and real estate. As such, even when loan proceeds are allocated solely for the purchase of real estate, a bulk sales clearance may need to be obtained by the purchaser.

The original purpose of bulk sales laws was to prevent people from committing fraud or evading debt by transferring all or a substantial portion of the assets of a business to another entity or individual without first paying any creditors. As a result, many traditional states place an affirmative obligation on purchasers of assets to provide the seller’s creditors with notice of a pending sale of the seller’s business, even though the seller is responsible for paying any outstanding debts to its creditors. In some cases, these laws also require a purchaser to withhold “a sufficient amount” of the purchase price so that the seller’s creditors can submit claims to be paid.

Some states have repealed a portion or all of their bulk sales laws and have instead passed successor liability statutes. These laws generally require that notice of the sale be given to a state agency (or sometimes agencies) prior to closing. In some states, giving notice within the statutory timeframe is sufficient for a purchaser to avoid liability for a seller’s unpaid obligations. In other states, a purchaser must also collect a certificate of no tax due from the appropriate agency prior to closing. The purpose of these newer statutes is to provide notice to the local taxing authority to ensure that the sales and use taxes and unemployment taxes have been properly paid by the seller through the closing date.

While, the consequences of failing to comply with bulk sales notice requirements vary by jurisdiction, most states impose significant tax penalties on a purchaser who does not escrow taxes for unpaid tax liability. Additionally, a purchaser’s failure to comply with the applicable bulk sales laws may also result in a purchaser being held accountable for claims against the seller from the seller’s creditor. If the purchaser is unable to pay back taxes or creditors, the state may place a lien on the personal property acquired by the purchaser.

SBA regulations and prudent lending standards require lenders to obtain the proper lien position on the assets being acquired in a business acquisition. To ensure that the state or other creditors do not have a senior lien on assets, lenders must make sure borrowers comply with the applicable bulk sales or successor liability laws.

Lenders should familiarize themselves with the laws of the jurisdiction in which the sale is occurring and in which any personal property is located to determine whether a bulk sales or successor liability law applies to the current transfer. If so, the lender should make sure the purchaser is aware of and complies with the requirements of the jurisdiction in question.

For more information on bulk sales compliance and other issues associated with business purchases, contact Katherine at ktohanczyn@starfieldsmith.com.