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February 2, 2011

Firm News for February 2011: Best Practices: Bulk Sales Compliance

By: Katie G. O’Brien

A “bulk sale” is generally defined as the sale, not in the ordinary course of a seller’s business, of more than half the assets of the business. Bulk sales laws are intended to prevent business owners from committing fraud or evading creditors by transferring all or a substantial portion of the assets of the business to another entity or individual without first paying off creditors.

Bulk sales laws vary from state to state, but many states have adopted some type of bulk sales statute to protect creditors and ensure that a purchaser is not liable for a seller’s debt. The statutes often require the seller and/or purchaser to give notice of the sale to creditors or to the applicable state agency. Frequently, states will require that the parties escrow a portion of the purchase price until the state has verified the amount of taxes, interest and penalties due to the state or has confirmed that no taxes are due. Some states, such as New Jersey, issue a letter informing the purchaser exactly how much of Seller’s proceeds to hold in escrow if the parties choose to close the sale before the state has determined the amount of seller’s unpaid tax obligations. Other states do not provide quite as much guidance and simply direct a purchaser to withhold “a sufficient amount” of the purchase price to avoid liability for seller’s obligations. There is no formula to determine how much is a sufficient amount to escrow. When in doubt, it is always safest to escrow the full amount of the seller’s net proceeds until the liability can be accurately determined.

Some states have repealed a portion or all of their bulk sales laws, and have instead passed successor liability statutes.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 the appropriate state agency(ies) (for example, the state department of revenue and/or the state department of unemployment insurance) in advance of the closing date and that purchasers withhold a sufficient amount of the purchase price to cover any unpaid unemployment insurance contributions and taxes, interest and penalties until the state agency issues a certificate indicating the amount of taxes, interest and penalties due or a certificate stating that no taxes are due. In some states, a purchaser can avoid liability for a seller’s unpaid obligations by simply giving notice of the sale to the appropriate state department(s) within the time frames required by the applicable statutes. In other states, a purchaser may have continuing liability for the seller’s unpaid taxes or unemployment insurance contributions even if proper notice has been given. In those states, it is important to escrow a portion of the seller’s proceeds of sale until the parties receive verification from the state that no taxes or contributions are due.

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 of the state where the assets are located. Because many statutes require that notice of the sale be given a specific number of days in advance of closing, these state statutes should be researched as early in the closing process as possible in order to avoid a delay of closing. If a purchaser fails to comply with these laws, the purchaser may be held liable for seller’s unpaid debts and obligations related to the assets transferred, which, depending on the amount of debt purchaser inherits, could negatively impact a borrower’s business as well as impairing the lender’s lien position.

For more information on bulk sales compliance and other documentation and closing issues, contact Katie at (215) 542-7070 or kobrien@starfieldsmith.com.