So you want to own your own business- Part 6

The Dealer Holds the Pot
​
Other decisions that should be made fairly early in the negotiations include whether bulk sale laws are applicable, and whether an escrow agent will be used. Often these two considerations are commingled, and some confusion may result.

In general in California, bulk sale compliance is required for businesses whose principal business is the sale of inventory from stock, including manufacturers; restaurants; and certain auctions, or series of sales. One way to think about this is to consider whether it is possible that someone else is owed money that was used for the purchase of the goods, or inventory, being sold by the business. The bulk sale laws protect such creditors by requiring notice of the impending sale of either a majority of the assets or the entity itself.

Contrary to common understanding, there is no statutory requirement for an escrow with an asset sale, even if the transaction falls under the bulk sale transaction. 

​ California Commercial Code §6106.2 states that if a bulk sale and the value of the assets being sold is more than $10,000 and less than $2,000,000 and is payable in cash or a promise to pay cash in the future (excludes sales where the buyer pays with stock), then either the buyer or an escrow agent must provide public and recorded notice so that any creditors can submit a claim to either escrow or the buyer for payment out of the sale proceeds.  Failure to obtain relevant tax clearances leaves the buyer open to possible liability for the seller’s unpaid taxes.

Even though not actually required, an escrow agent can help protect the buyer much as an escrow agent does in a real estate transaction, if utilized properly. Unfortunately, sometimes a buyer assumes that the escrow agent is their agent, and will watch out for their interests. The escrow agent's role is that of a neutral third party, and while they are an excellent resource, they are not part of the buyer's team.

Sometimes a buyer wants to cut costs by not having, and paying for, escrow services. The perception, not entirely unearned, is that the escrow process will delay closing and introduce undesirable complexity into the process. However, when a buyer decides to forego escrow, they should be aware of what they are giving up, and should consider certain steps in lieu of the protections afforded by having a professional escrow officer. A business escrow agent typically publishes the notice to creditors in a paper of record, and records the notice in the county records; performs lien searches; obtains appropriate tax clearances; and may also obtain verification of the existence/authority of the seller’s legal entity from the Secretary of State and/or assistance with the transfer of a fictitious business name or licenses. They will also act as a third party fiduciary in holding and disbursing funds, and collecting signatures on documents. Using an escrow to handle funds is especially helpful when there is any sort of holdback or earnout, or in the event that it is necessary to close before all tax clearances are received.

What to do if you are not using bulk sale or escrow:
The buyer in an asset purchase who is not using bulk sale (or for a transaction to which bulk sale does not apply), and/or not using an escrow, should at a minimum take these actions in order to avoid successor liability for the seller’s obligations:

• Make it clear in the purchase agreement what liabilities are being assumed and unequivocally state that no others are being assumed
• Investigate possible claims:
  • review historical financial records, such as the balance sheet, bank records of payments to third parties,
  • Lien and public records searches
    • UCC search
    • For titled vehicles, determine if there are any liens on title
• Require specific representations and warranties from seller regarding any existing obligations or claims, among other things
• Obtain clearances from taxing agencies (https://apps.americanbar.org/buslaw/blt/2008-11-12/carpenter.shtml), such as:
  • Board of Equalization (sales and use tax)
  • Economic Development Department (withholding and employment related taxes) See, for example, California Unemployment Insurance Code § 1701. et seq)
  • Franchise Tax Board (good standing letter)
  • City/County where the business is located
• Require seller indemnification with right of direct and immediate setoff of any seller note when applicable

The decisions surrounding bulk sale compliance and the use of escrow are bigger than the cost involved, or any delay in closing that might result.