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Business matters
- January 2006 -
Asset Purchasers BEWARE:
When A Buyer Assumes Liabilities
In An Asset Acquisition
By Bruce F. Rudoy, Esq.
Buyers buy assets and sellers
sell stock. This is a common starting point in structuring a business
transaction. A seller of a business often favors a sale of stock because
the buyer simply takes over ownership of the company and title to all
its assets and liabilities remain the same. Buyers often prefer to buy
only selected assets of the business -- typically equipment, real
estate, contracts and goodwill, rather than assuming the liabilities as
well.
Nevertheless, asset buyers may unknowingly inherit liabilities of the
seller’s business even if that is not intended. Because most business
deals are not as simple as buying assets or selling stock, a negotiated
business transaction will often provide comprehensive representations
and warranties of the seller, assumed and excluded liabilities by the
buyer, indemnifications by seller, and an escrow withheld from the
purchase price to fund any liabilities that don’t fall into one of these
categories or that arise after the closing.
Some common examples of assumed liabilities for an asset purchaser
include amounts becoming due after the closing under leases or other
similar agreements, obligations to fill purchase orders accepted prior
to closing but not completed, or trade payables under a certain
benchmark amount agreed upon between the parties. Even though the
parties look to specifically identify those liabilities that an asset
buyer will assume, without careful examination, an asset purchaser may
still be left with obligations of the seller even if the purchaser did
not expressly agree to assume those liabilities.
Examples of those obligations which could pass to a purchaser without an
express assumption are:
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Environmental Liabilities.
Certain state or federal statutes require a purchaser to clean up
contaminated property even though the contamination was caused by a
prior owner or operator. It is critical for a buyer to obtain an
environmental study of real estate to be purchased.
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Sales Taxes. If the
business is engaged in retail sales, most state laws require that the
purchaser check that the seller has reported and paid all sales taxes
due on its operations. If not, the purchaser will be required to pay
any deficiency. To protect against un-known sales tax deficiencies, a
sufficient escrow fund held for a reasonable amount of time can
provide a remedy for post-closing disputes.
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Breached Contracts. If an
assumed contract has been breached by the seller prior to closing, the
purchaser may be required to remedy the breach. If the contract is
important to the transaction, the breach would have a material adverse
effect on the buyer.
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Liens. Mortgages, land use
restrictions and defects to clear title on real property and security
interests on other assets will continue in effect on those assets in
the hands of the purchaser (even though the purchaser will not be
liable for the underlying indebtedness, i.e. business loans of the
seller).
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Product Liability. Some
courts have imposed liability upon a business purchaser for defective
products sold by the prior business operator, particularly where the
purchaser continues to produce the same products from the same
manufacturing facility and using the same trademarks.
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Business Continuation. If a
purchaser is a continuation of the selling entity, the purchaser is
likely to inherit the seller’s liabilities. This situation may be
indicated where the shareholders are virtually the same before and
after the closing and less than fair value was paid to the seller.
A purchaser of a business can
reduce these risks by assembling a transaction team at the beginning of
the process to define what is being purchased and sold and the price and
terms of the transaction. A purchaser can also be careful to engage in
the following steps to reduce these post-closings risks.
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Due Diligence. A fair
review of the seller’s records and assets should focus on how well the
seller has kept up with its liabilities and the likelihood of
contingent liabilities which may require additional investigation.
Lien searches can identify specific assets which are subject to liens
which the seller can have paid off and released at or prior to
closing. Litigation searches may lead to discovery of patterns of
product liability or other business risks that a buyer can control
after closing. Employee benefit plans are often overlooked element of
the business. Employee benefit plans should be carefully examined to
insure that the buyer will not inherit cumbersome plans or violations
of the rules under those plans.
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Indemnification. The seller
will typically agree to defend, indemnify and hold the purchaser
harmless from liabilities of the business which the purchaser does not
expressly agree to assume. This mechanism may remove the onerous step
of forcing the purchaser to litigate against the seller post-closing.
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Escrow. Since the value of
indemnification is no greater than the post-closing financial standing
of the seller, the parties should determine what portion of the
purchase price should be deposited in escrow to apply against
liabilities not assumed by the purchaser and for unforeseen
liabilities. If the purchaser is to pay a portion of the purchase
price after closing, escrow can be used for this purpose as well.
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Estoppel
Letters/Assignments of Contract. A buyer can request that the seller
obtain an estoppel letter from contractors of the business. This gives
the buyer comfort that those contracts are in full force and effect,
have not been breached and that the contracting party agrees to allow
the buyer to continue to perform or receive benefits of those
contracts.
Even though an asset
purchaser is ostensibly less exposed to the seller’s liabilities, a full
investigation of the seller is prudent. An asset lawyer should approach
the transaction just as if the purchaser were buying stock of the
business.
Bruce F. Rudoy is a shareholder in the firm’s Business and Finance
Department and a member of the Mergers & Acquisitions Practice Group. If
you would like to discuss the best methods to structure a merger or
acquisition, please contact Bruce at 412-594-5608 or via e-mail at
brudoy@tuckerlaw.com.
^Top
A Primer On Business Governance:
Corporations and LLCs
By Bruce F. Rudoy, Esq.
The management and ownership
of a corporation is divided into three categories - officers, directors
and shareholders. These categories are often used in a limited liability
company setting as well when structured as a corporation, albeit under
different monikers – officers, managers and members. LLC’s governance
can take many forms (i.e. – an LLC can be structured like a corporation,
limited partnership, general
partnership or sole proprietorship) whereas a corporation’s governance
is more traditional and less flexible.
Here is a brief description of each role in a corporate structured
entity, whether a corporation or an LLC:
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Shareholders/Members.
Shareholders/members own the company. They act through shareholder/
member meetings and they are responsible for making extraordinary
decisions such as whether to sell the company or buy another company.
Shareholders/ members elect members to the board of directors/managers
and leave the management of the company to the board.
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Directors/Managers.
Directors/managers represent the shareholders/members and the
management of the company. They are primarily responsible for the
strategic vision of the company and act through board meetings.
Directors/managers have duties of loyalty and due care to the company
and the shareholders/ members. They hire and oversee the officers of
the company.
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Officers. Officers run the
day-to-day operations of the company. They report to the board of
directors/ managers and receive authority from the board. Officers
have duties of loyalty and due care to both the company and the
shareholders/members.
The bylaws of the company (or
operating agreement if the company is an LLC) can establish the
guidelines for when an officer is authorized to make certain decisions
or must receive approval from the board of directors, when and how a
meeting is called and run, voting issues, how to carry a company action
or obtain approval of that action, how to establish management
committees and many other issues. When an LLC is structured like a
partnership, the roles of the parties may change.
Bruce F. Rudoy is a shareholder in the firm’s Business and Finance
Department and a member of the Mergers & Acquisitions Practice Group. If
you would like to discuss governance issues for your business, please
contact Bruce at 412-594-5608 or via e-mail at
brudoy@tuckerlaw.com.
^Top
10 Things Not To Do When
Entering Into A Buy-Sell Agreement
By William T. Harvey,
Esq.
The shareholders of a closely
held corporation will, in many instances, enter into a buy-sell
agreement in order to restrict the transfer of the corporation’s shares,
and provide for a way for a shareholder to sell his or her shares upon
leaving the business. Before signing a buy-sell agreement, shareholders
should consider the following list of 10 things not to do:
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Don’t set the buyout price
for the shares at book value unless you intend to penalize the selling
shareholder.
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Don’t sign a form document
that you got off the Internet or that does not take into account the
unique features of your business and its shareholders.
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If you are a minority
shareholder, don’t sign a buy-sell agreement prepared by the attorney
of the majority shareholder without first taking it to your own
attorney to review.
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Don’t enter into an
agreement that is meticulously drafted for your business as it exists
today but has no flexibility for future changes.
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Don’t provide for a
valuation mechanism that will cost more to implement than the value of
the shares.
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Don’t enter into a buy-sell
agreement without taking into account its impact on your overall
estate plan.
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Don’t look to a buy-sell
agreement for protections as a minority shareholder. If you are a
minority shareholder make sure the articles and/or by-laws of the
corporation provide such protections.
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Don’t set a buyout price
for the shares based on a certificate of value signed by all
shareholders unless you provide for an alternative valuation method if
the certificate of value is outdated.
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Don’t set a buyout price by
making it equal to the amount of life insurance you are willing to
purchase for each shareholder, then use that same price for lifetime
transfers. The life insurance won’t be available, and there may be no
similar funding source for the purchase of the shares.
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Don’t forget to take into
account required tax payments when estimating the cash flow that would
be available for purchasing shares.
William T. Harvey is a
shareholder in the firm’s Business and Finance Department and a member
of the Mergers & Acquisitions Practice Group. For more information on
this topic, please contact Bill at 412-594-5550 or via e-mail at
wharvey@tuckerlaw.com.
^Top
Protecting Your Trade Secret
By Steven B.
Silverman, Esq.
WHAT
EXACTLY IS A TRADE SECRET?
To meet the legal definition of a trade secret, the information or
material: 1) must provide its owner with actual or potential economic
benefits; 2) cannot be generally known outside the business; 3) cannot
be readily ascertained from those outside the business (such as by
reviewing a trade journal or through reverse engineering); 4) and most
importantly, its secrecy must be secured through reasonable means.
Trade secrets can be business or marketing plans, chemical or pricing
formulas, software, design or manufacturing techniques, and the most
heavily litigated one - - customer lists. Probably one of the most
famous trade secrets is the formula for Coca Cola. But cases are replete
with more mundane ones that are just as important to their owners, such
as a hairdresser’s client list or even a fudge recipe.
HOW CAN YOU KEEP A TRADE SECRET SECURE?
First, you have to be able to identify the trade secret. Many companies
fail to recognize that an important aspect of their business is in fact
a trade secret. Or worse, they assume that something is a trade secret
when it is not because they haven’t adequately protected it. Either way,
they’re unlikely to prevent the disclosure of that secret when they try
to enforce their rights. This is why businesses should review these
issues with their attorney to identify exactly what should be considered
a trade secret.
Pennsylvania requires businesses to take “reasonable” steps to secure
the secrecy of their trade secrets. What is reasonable depends on the
circumstances, but certain generalizations apply. For instance, only
those who have a need to know should have access to the secret. If the
secret is on a computer, at a minimum, it should be password protected.
If as part of a business’ sales efforts a secret is disclosed to help
land a sale, the prospect should first be required to sign a
non-disclosure agreement.
Most importantly, a business must continuously educate its employees on
the need to maintain the secret’s confidentiality, both within and
outside the company. Ideally, this should be done throughout an
employee’s tenure. Upon hiring, the employee should sign a separate
confidentiality agreement, or at least sign a confidentiality policy in
an employee handbook. Upon departure, an employee should be reminded at
an exit interview to maintain confidentiality post-employment, and maybe
even sign another written acknowledgment of that policy.
WHAT CONSTITUTES MISAPPROPRIATION OF A TRADE
SECRET?
The definition of “misappropriation” has become slightly broader with
the recent passage of Pennsylvania’s Uniform Trade Secrets Act. A
misappropriation, essentially a theft, of a trade secret occurs when
someone comes into possession of a trade secret knowing or having reason
to know that the secret was acquired by improper means. This means that
you don’t have to be the actual thief to be considered a
misappropriator. Consider the new employer who hires a competitor’s
employee and is given the competitor’s trade secret. Under the Act, even
though that employer did not take the secret himself, he can be liable
for misappropriation.
The Act also imposes a no-fault component. For example, one day you open
your mail and find that someone has anonymously sent you your
competitor’s unique pricing formula. You never asked for the formula;
you did nothing to obtain it; and you have not even utilized it (yet).
Under the Act, your mere possession of your competitor’s formula makes
you liable for misappropriation as long as you reasonably knew or should
have known that the formula was your competitor’s trade secret.
The Act also includes within the definition of a trade secret
“misapp-ropriator” anyone who discloses a secret to anyone else without
the owner’s consent.
HOW DOES PENNSYLVANIA’S NEW UNIFORM TRADE
SECRETS ACT HELP BUSINESSES MAINTAIN TRADE SECRETS?
In addition to expanding the definition of “misappropriation” the Act
broadens the rights of the trade secret owners in several ways. First,
unlike the previous two-year statute of limitation under the prior law,
the Act now gives the secret’s owner three years to bring suit.
Secondly, unlike under prior law, the Act allows for the recovery of
attorneys’ fees if the misappropriation was “willful and malicious.”
Essentially, that phrase is defined as an intentional or reckless act
showing that it’s likely that the wrongdoer was conscious of his
actions. This means that the person who did the actual taking of the
secret will almost always be liable for the owner’s attorneys’ fees,
while the ultimate recipient of the stolen secret may not.
Finally, the Act allows the trade secret owner to recover “exemplary
damages” in addition to recovering actual losses like lost profits.
Where the misappropriation is willful and malicious, the owner can
recover these types of damages of up to double the owner’s actual
losses. The Act offers these damages as an alternative to punitive
damages under the prior law (which were rarely awarded).
WHAT SHOULD YOU DO IF YOUR TRADE SECRET HAS
BEEN STOLEN?
The first remedy the trade secret owner should seek is an injunction.
The owner should ask the Court to require the thief and those to whom he
or she has disseminated the secret to return it (and all its copies and
permutations) to its rightful owner. The injunction should also preclude
all those who had access to the stolen secret from utilizing it in any
way.
Unlike most civil cases which can last for years, an injunction
proceeding typically lasts only several weeks. However, much of the same
type of legal work done in a typical case is condensed into days instead
of months. For this reason, trade secret cases can be very time and
lawyer fee intensive. But the alternative to pursuing an injunction can
be devastating if the trade secret is allowed to remain in a
competitor’s hands.
Steven B. Silverman is a shareholder in the firm’s Litigation
Department and Co-Chair of the firm’s Intellectual Property/Technology
Practice Group. For more information on this topic, please contact Steve
at 412-594-5609 or via e-mail at
ssilverman@tuckerlaw.com.
^Top
Data Disposal Regulations Effective:
Start Your Shredders
Almost every week we hear a
new report about some security breach where a business disclosed
personal data of its customers or employees. Sometimes these breaches
occur during routine disposal of data or documents—such as merely taking
out the trash. In an age where identity theft is a pernicious and
growing problem, these security breaches are cause for serious concern.
The Federal Trade Commission (FTC) has issued new regulations under the
Fair Credit Reporting Act (FCRA) and the Fair and Accurate Credit
Transactions Act (FACTA) aimed at reducing the risk of identity theft
that may occur during the disposal of sensitive data contained in
consumer reports.
To Whom Do the Regulations Apply?
Users of consumer reports will be subject to the new FTC data disposal
regulations. “Users” include employers who obtain consumer reports on
prospective or current employees. Consumer reports are very broadly
defined. They include background checks that employers obtain from third
parties who, as part of their business, provide reports about a person’s
credit worthiness, character, reputation, personal characteristics, or
mode of living, which are then used to determine eligibility for
employment.
The sensitive information includes social security numbers, driver’s
license numbers, phone numbers, addresses and e-mail addresses. Although
the FTC regulation applies only to sensitive information from consumer
reports, it will be virtually impossible for employers to track the
source of each piece of personal information to determine where it came
from and whether it must be destroyed in compliance with these
regulations. Thus, we advise employers to treat all such sensitive
information as if it came from a consumer report and comply with the
FTC’s regulations.
What Do the Regulations Require?
“Any person who maintains or other-wise possesses consumer information
for a business purpose must properly dispose of such information by
taking reasonable measures to protect against unauthorized access to or
use of the information in connection with its disposal.” The regulations
recognize that employers may either dispose of such data themselves or
hire a third party contractor to do the job. Whichever method you
choose, you must ensure that after disposal, the data is no longer
practicably readable or reconstructible.
If you choose to dispose of the regulated data yourself, you must
implement policies and procedures that include shredding, pulverizing,
or burning such data and data storage media. Your policies and
procedures should include situations where you sell, donate or transfer
equipment upon which such information has been electronically stored. In
addition, you must monitor compliance with these policies and
procedures. If you choose to contract with a third party, you must
notify the service provider that your trash includes protected consumer
information, and include the provider’s agreement to follow these FACTA
regulations within the contract for services.
Penalties for Noncompliance
Employers who violate the new FTC regulations are liable for statutory
dam- ages of up to $1,000 for each employee whose data was improperly
disclosed during disposal, civil fines of up to $2,500 per employee, and
actual damages to employees whose identities are stolen as a result of
the disclosure. Expect a class action lawsuit when large numbers of
employment records are involved.
Considering the vast amount of personal and confidential information
maintained in human resources departments, having effective policies and
procedures regarding data security and disposal just makes good business
sense.
For more information on this topic, please contact Homer L. Walton,
Co-Chair of the firm’s Labor and Employment Practice Group, at
412.594.5657 or
hwalton@tuckerlaw.com.
^Top
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