October 2019
If you plan on purchasing a California business, you should be aware of California’s Bulk Sales Law. The law is designed to protect a business’ creditors and prevent a situation where a seller walks away with the sale proceeds, leaving creditors unpaid. Generally, a buyer would not be liable for a seller’s debts unless otherwise agreed, but some statutes impose successor liability on the buyer. The bulk sales law is one of them and failure to follow the law’s requirements can leave a buyer stuck with the seller’s debts.
Sales Subject to California’s Bulk Sales Law. The bulk sales law only applies to certain sellers, including those whose principal business is the sale of inventory from stock, including those who manufacture what they sell, or a restaurant owner. Thus, sale of a service business would not be subject to the bulk sales law. The sale must also be of more than half of the seller’s inventory and equipment and fall outside the seller’s ordinary course of business. If the transaction is subject to the bulk sales law, then the buyer (or an escrow agent) must prepare a notice that informs potential creditors of the impending sale and allows them to submit a claim for payment against the purchase price.
Sales Exempt from California’s Bulk Sales Law. The bulk sales law does not apply to a sale of assets having a net fair market value of less than $10,000 or more than $5,000,000. The law also does not apply to the sale of an interest in a business entity, such as stock in a corporation or a membership interest in a limited liability company.
Strategies for Addressing Liabilities in Exempt Transactions. Even if the value falls within the applicable amounts, many times the parties will structure the transaction in such a way that the bulk sales law is not triggered (i.e. a stock sale). However, a prudent buyer should still take steps to protect itself against unknown creditor claims. One method of doing that is agreeing to place a portion of the purchase price in a third-party escrow account for a specific period of time post-closing to secure payment of certain items, such as latent creditor claims.
Another method is to incorporate an “earn-out” component to the total purchase price. In an earn-out scenario, a portion of the purchase price is held in a third party escrow and released to the seller based on the business reaching certain post-closing performance milestones. If a creditor claim does arise during that time, the earn-out amount otherwise payable to the seller would be allocated to satisfying the claim and any payment to the seller would be adjusted accordingly.
DISCLAIMER: This Advisor is one of a series of business, real estate, employment, estate planning and tax bulletins prepared by the attorneys at Fauver, Large, Archbald & Spray, LLP. This Advisor is not exhaustive, nor is it legal advice. You should discuss your particular situation with us or with your own attorney. Our legal representation is only undertaken through a written engagement letter and not by the distribution or use of this Advisor.
