Transferability of Liability. Unless contractually negotiated to the contrary, upon the consummation of a stock sale, the target’s liabilities (including trades and accounts payable, lines of credit, secured and unsecured long-term term) credit are transferred to the acquirer by operation of state law. If the acquirer requires financing from a bank or other third-party lender, the lender will often require a first priority lien or security interest on all of the underlying acquired assets (including current and future accounts receivable in addition to real estate, equipment, and inventory). As such, the lender will require that the target company to pay-off its exiting liens either prior to closing or no later than the proceeds from the purchase price paid at closing, and that all existing liens on the assets be terminated. However, in an asset sale, only those liabilities that are designated in the Asset Purchase Agreement as assumed liabilities are assigned to the acquirer while the non-designated liabilities remain obligations of the target.

A compromise between the asset or stock purchase is possible by way of an “h(10) election” whereby the parties consummate a stock purchase with all of the aforementioned results being the same except, for tax purposes, the deal is deemed an asset deal and the acquirer obtains the desired basis step-up in the assets.

Third Party Consents. To the extent that the target’s existing contracts have a prohibition against assignment, a pre-closing consent to assignment must be obtained. No such consent requirement exists for a stock purchase or merger unless the relevant contracts contain specific prohibitions against assignment upon a change of control or composition of ownership. It is essential that as part of due diligence, the acquirer’s attorney carefully review all third-party customer and vendor agreements to identify the requirements for assignment, and also if the third party has termination rights upon assignment. From a business perspective, the acquirer should consider whether the target’s key customers will stop doing business with the acquirer. Cooperation between the control persons of the target and acquirer in the form of post-transition assistance through a consultant agreement would include introduction to key customers, clients, and vendors to enable those relationships to continue.