Purchase of All Assets

Terms:

Intellectual Property:
Property is divided into “Real” property (land) and “Personal” property – i.e., everything but land. However, as a sub or tangential class of personal property, intellectual property often stands as a category of its own. Intellectual property includes a variety of legal devices, such as patents, trademarks, business secrets, etc. which are not physically touchable, but are nonetheless assets of a firm. Such properties are often very valuable to the firm as they represent either the ideas that make the firm work, or the image that the firm portrays to the world. Given this value, the law has devised means of protecting this property, despite its ethereal nature.

Goodwill:
An element of any merger transaction is the “transfer” or sharing and pricing of “goodwill”. At its essence, goodwill actually comes to the law through an accounting concept. Essentially, the idea is that a company, over the course of its operations, accumulates value that is associated with its name and reputation in the community in general. While not a physical asset, such goodwill represents real value to the corporation. As such, when a company chooses to enter a transaction, it is not only selling its assets and obligations, it is also selling its goodwill. Thus, any such accumulated good reputation (or conversely, bad public perception) is priced into a transaction.

Liquidating Dividend:
When a company has reached a point of dissolution, and in the event that there are still assets left after all creditors have been paid, the company will then pay a dividend, known as a liquidation dividend, to the shareholders. The dividend represents the terminal value after the sale of all assets, and represents the close of relations between the company and its shareholders.

Overview to Asset Purchases

In addition to the several vehicles for creating business combinations that we have already discussed, there is one final type of transaction that, while not technically a business combination, has the benefit of creating the same results without some of the worrisome liabilities.

This final transaction, the "purchase of all assets," or a purchase of substantially all assets, follows the form of its name. Essentially, an asset purchase occurs when a company, outside the regular course of its business, sells all or substantially all of its assets to another firm. When we refer to a purchase of all or substantially all assets, we mean just that. In the course of the transaction, the selling company will have sold the acquirer everything – including its stock, all or most of its operating plant, property, and equipment, any intellectual property it may own, its balance sheet, its goodwill, etc. – everything that made the company what it was. In the end, the acquiring company will now have all of the business operations of the selling firm, and the firm that did the selling will then make a cash distribution to its shareholders and dissolve the firm.

Asset Purchase Procedure

At once, asset purchases are some of the easiest and most complicated transactions in the field of business combinations. On the one hand is the fact that an asset purchase requires no governmental intervention. The board of the selling company simply authorizes the sale and provides the shareholders with the details of the plan for them to vote on. Subsequently, the shareholders of the selling firm – and the selling firm alone – vote on the transaction. See Baron v. Pressed Metals of America, Inc., 35 Del. Ch. 325 (Del. Ct of Chancery 1955). This shareholder approval, required to be by a majority or 2/3 vote, is required because of the fundamental nature of the change. See Robinson v. Pittsburgh Oil Refining Corp., 14 Del. Ch. 193 (Del. Ct of Chancery 1924). You will note that nowhere in the steps above is there a requirement for a filing with the state. See 8 Del. C. § 271.

On the other hand, the sheer complexity of designating what assets will be sold and at what price creates a great deal of need for negotiation and consultation. Unless a single price to be paid for the selling company’s assets can be agreed to (which would be typical only in the case of a company either bankrupt or on the brink of bankruptcy), a complex bargain needs to be struck. The selling company will need to identify and price its assets and the acquiring company will be faced with the conundrum of determining what assets it intends to purchase and it must bargain over the price to be paid.

Ultimately, the choice of engaging in an asset purchase is made by the selling company when it has run out of alternative options, or in the case of a small close company, when the company has reached the end of its predetermined purpose. In either event, finding an acceptable suitor to purchase the company’s assets may be a complicated endeavor in itself.

EXAMPLE: Troubled, Inc. has fallen on extremely hard times and is on the brink of bankruptcy. However, the company’s board recognizes that the company still has several assets that could be valuable in the right hands. As such, it decides to seek a buyer for those assets, rather than to turn the firm over to bankruptcy receivership. In their search, they identify a buyer who sees a place for Troubled’s assets in its own operations. Given the poor economic health of Troubled, the companies quickly agree to a price – with some thought given to the specific value of individual assets – and conclude an asset purchase agreement whereby Troubled transfers all its remaining assets to the acquirer for a specified sum of cash.

Liability and Asset Purchases

Perhaps the single biggest reasons why companies engage in asset purchases rather than other combination transactions are the limits on liability that the transaction creates. Specifically, and unlike the other business combinations, the asset purchase model does not transfer the liabilities of the selling company to the purchaser. See 8 Del. C. § 282. The logic is that the acquiring company is simply purchasing the target’s assets – not its entire business and corresponding obligations. While this may seem a thin line, it is incredibly important.

As we observed above, a typical scenario for an asset purchase is a situation when the target company is in some sort of trouble. That trouble may be financial, i.e., bankruptcy, but it also may be for liability that the company faces in civil tort proceedings. While the target company may be in severe financial or civil straights, it may nevertheless have valuable assets, in the forms of physical assets or operational assets that it may sell for cash. Given such a situation, an acquiring buyer would naturally be concerned about “buying a lawsuit.” However, with the advent of the asset purchase transaction, the acquiring company may complete the transaction without the worry of a backlash in the form of added liability.

EXAMPLE: Forthright, Inc. has a reputation in the business community as being an honest and environmentally friendly waste disposal firm. Terrible Trash, Inc., does not have such a reputation. In fact, Terrible is facing an enormous lawsuit for violation of state and federal waste disposal laws. What Terrible does have is a series of valuable contracts and machinery that Forthright feels it can put to good use. Forthright makes Terrible an offer whereby it will construct an asset purchase, paying Terrible for its contracts and machinery without assuming any of Terrible’s tort liability. Because Terrible is desperate for cash to handle its legal bills and to begin cleanup of the polluted site, it accepts Forthright’s offer and transfers the equipment for cash. Nevertheless, Terrible maintains the liability for the lawsuit and such liability does not affect Forthright. Note that even if Terrible dissolved, a court may order it to stay in existence for the purpose of paying off the lawsuit. See 8 Del. C. § 278.

However, there are some limits on the liability shield. If the asset purchase was undertaken by the selling company simply to avoid the liabilities it has accumulated, then the transaction may well be disallowed by the courts, or, alternatively, the acquiring company may be held itself liable, despite the transaction’s form as an asset purchase. Similarly, the liability shield may also be lost if the sale was merely a continuation of the old business. In other words, if the transaction was done simply to avoid some liability issue and not for a valid business purpose, the acquiring company may be liable to pay the debt or damages from the lawsuit. See In re Rego Co., 623 A.2d 92 (Del. Ct of Chancery 1992).

EXAMPLE: Slim has been building up extensive debt on his company’s account and then using the money for his own personal enjoyment. Ultimately, creditors begin to make claims on the company and Slim is in trouble. He decides to establish a new company Two Co., and transfer all of his original company’s assets to that firm in the form of an asset sale. When the creditors begin to make claims against the old company’s equipment, Slim tells them it has been sold and is no longer available. Infuriated, the creditors file a suit. Subsequently, a court invalidates the transaction transferring the assets to Two Co. as a fraudulent transfer, and requires that the assets be sold to other buyers to provide cash to satisfy the obligations.

Dissolution on Sale

In Chapter Seven of the course, we will spend some time discussing the various forms of Bankruptcy – a legal process that may mean the end of the firm. However, bankruptcy is not the only legal procedure that ends the course of the firm. The firm itself, or more precisely its shareholders, may themselves decide to terminate the firm and distribute its assets, in the form of a “liquidating dividend” to shareholders.

Dissolution and liquidating dividends are relevant to the asset sale transaction in that an asset sale is often followed by dissolution of the corporation, as voted on by the shareholders, followed by a distribution of the proceeds received in the sale to the shareholders.

EXAMPLE: Gone Fishin’ Inc. recently completed an asset sale of its hand-held fishing game to Toy Joy Inc. With the cash it received in the transaction, Fishin’ paid off all creditors, and with the remaining cash, paid a liquidating dividend to shareholders and then legally dissolved the firm.