Asset Purchase Agreement

Introduction

With the advent of the coronavirus, there is a wave of economic slowdown that has gripped the world economies thus causing a host of companies to lose businesses. A by product of the same would be frantic attempts to hold on businesses by companies who’ll be on the verge of shutting down. These attempts will give rise to transactions such as mergers, acquisitions and sale of assets.

Keeping these chains of events in mind, it is imperative to know the legal nitty-gritty of the instruments used to culminate the same. One such legal instrument is the Asset purchase agreement, the different facets of which will be dealt in the following article. 

General information

As the name suggests, an Asset purchase agreement is an agreement wherein the concerned parties i.e. between a buyer and a seller for the transfer of ownership of an asset.

The majority of the asset purchase agreement comprises the two parties defining and setting up provisions for each other to follow during the different stages of the process. It inter alia, sets down the standing and authority of the seller to engage in the sale of his/her asset, the buyers’ ability  and authority to purchase the asset, the price of purchase of the concerned asset, the assurance regarding the property not being in financial/legal trouble at the time of the transfer in addition to the potential environmental hazard caused by the same to the surroundings (becoming increasingly essential in the current times) , disclosures from the parties  involved  with respect to their actual value price,details of their companies etc.

The assets transferred in an asset purchase agreement include:

  1. Plant and machinery
  2. Stock
  3. Contracts
  4. Premises
  5. Know-how
  6. Goodwill

Contents

Such Agreements cover the following sections:

  • Interpretation: This Section provides the definitions for all the major words used in the general body of the agreement
  • Purchase and sale of stock: It involves enumeration of the purchase price, any alteration in purchase price, purchase price allocation for tax purposes between seller and buyer, assumption and exclusion of responsibilities and dispute resolution mechanisms
  • Representations and warranties of the seller and buyer: it provides all statements such as Organization and Qualification of Seller and the buyer, Financial Statements; Undisclosed Liabilities , Material Contracts by which any of the Purchased Assets are bound or affected etc that the seller and buyer  are contending to be accurate.
  • Stage wise covenants: It lays down the guidelines for the conduction of Business Prior to, during and post the closing of the transaction proceedings.
  • Matters related to employees: this deals with the terms on how employee benefits and any accrued bonuses should be handled post the concerned transaction
  • Indemnifications: It gives out the particulars of all compensations for harm or loss for any costs that may arise post transaction as a result of conditions that were present before the transaction.
  • Conditions to closing: It includes Conditions to Obligations common to all parties and specific only to the buyer and the seller.
  • Tax matters: This section specifies any special tax treatment entitles to the seller or buyer
  • Termination: It provides the conditions as to which the agreement may be terminated at any time prior to the closing.

Precautions

Even the best-drafted asset purchase agreement will be of no utilization and goes to waste when the arrangement is with an individual engaging in malpractices and misrepresentation of facts. Hence, basic due ingenuity is required to be performed before entering into such agreements. A few pointers to do so would be:

  • Review of books for the past five years.
  • Interviewing customers and partners.
  • Checking if any proceeding is against the seller.
  • Making things clear about secured and unsecured debt.

Advantages of engaging in an asset purchase agreement

The following provide the various advantages of an asset purchase transaction:

  1. Provides flexibility to the seller in terms of the sale price.
  2. The buyer has more choice and freedom to pick and choose the assets that he/she wants.
  3. With an asset transaction, goodwill, which is the amount paid for a company over and above the value of its tangible assets, can be amortized on a straight-line basis over 15 years for tax purposes. In a stock deal, with the acquirer buying shares of the target, goodwill cannot be deducted until the stock is later sold by the buyer.
  4. The buyer can state what, if any, liabilities it is going to take in the transaction. This limits the buyer’s exposure to liabilities that are large, unknown, or not stated by the seller.
  5. Because the exposure to unknown liabilities is limited, the buyer typically needs to expend less time and money, and fewer resources, on conducting due checks.
  6. Unlike the case with a stock purchase, minority shareholders do not ordinarily have to be taken into account in regard to an asset purchase, thus lifting off the pressure of persuading the minority shareholders.
  7. The buyer has the freedom to choose which employees they want to retain and which they do not without impacting their unemployment rates.

Disadvantages of engaging in an asset purchase agreement

Here are several disadvantages of an asset purchase as compared to a stock purchase:

  1. Contracts, especially with customers and suppliers may need to be renegotiated and/or renovated by the new owner to match the shift in ownership of assets.
  2. The tax cost to the seller is typically higher, so the seller may insist on receiving a higher purchase price.
  3. Assignable contract rights may be limited.
  4. Assets may need to be retiled.
  5. They can be construed to be de facto mergers[1]
  6. Employment agreements with key employees may need to be renegotiated.
  7. The seller needs to liquidate any assets not paid for pay yet any liabilities that have not been assumed, and take care of any leases that need to be terminated.

Conclusion

Assets purchase agreements remain a critical part of most business transactions.Asset purchase agreements ‘utilization is done when purchasers wish to deal with resources claimed by a bankrupt organization yet are not keen on securing the whole business activity because of the monetary condition of that organization. Instead of securing the whole business activity, speculators can basically single out which resources are alluring, and find a way to buy those specific resources, and not need to manage whatever other property that might be unimportant to them.

In the current chain of events, Contingent upon the circumstance encompassing the bankrupt organization and in the light of use of this process instead of purchasing the business and its advantages inside and out could cost less straightforward, while as yet giving plentiful prizes toward the back.

In pursuance of the same, there is already an increasing focus on targeting asset deals involving key technology or brands (reflected by patents or trademarks in particular) for the reasons suggested in this article. These bring unique challenges and considerations for those both acquiring and disposing of assets which we need to take up and settle.

Frequently asked questions (FAQs)

  1. What is the difference between an asset purchase agreement and a merger?

In an asset purchase agreement, the buyer purchases specific assets of the target that are listed within the transaction documents wherein generally, no liabilities are assumed unless specifically transferred under the transaction documents. In a merger, on the other hand, two different legal entities become one surviving entity thus resulting in all of the assets and liabilities of each being owned by the new surviving legal entity by operation of state law. The point of diversion between the asset purchase agreement and merger acquisition transaction is the freedom given to the seller of deciding as to which specific assets he wants to sell In case of the asset purchase agreement which is absent in case of a general merger -acquisition transaction.

  1. What is the role of ‘goodwill’ in asset purchase agreements?

The legal purpose of goodwill is to allocate value to the alliance resultant of the asset transaction between the businesses and is often identified as a distinct asset category in asset purchase transactions.[2]

  1. What is the significance of including the earn out provision in the asset purchase agreement?

An earn out acts as a means for the seller to get benefit out of the sold asset even post it’s sale. This clause would aid the seller in including a contractual provision stating that the seller of a business is to acquire added payment in the future if the business accomplishes certain financial goals, which are usually stated as a percentage of gross sales or earnings.


[1] A de facto merger means that although the transaction was structured as an asset acquisition in form, in substance it was no different than a merger or a share purchase. This is due to the fact that a) the principal owners of the target corporation became owners of the acquiring corporation, b) the target corporation was immediately dissolved after the close, and c) the funds were distributed to its shareholders without paying trade creditors of the target corporation.

[2] Purchase agreements: goodwill as a distinct asset,By Jenny Yoo on July 7, 2015,Posted in Corporate finance,Deal Law Wire, https://www.deallawwire.com/2015/07/07/purchase-agreements-goodwill-as-a-distinct-asset/

Leave a Reply

Your email address will not be published. Required fields are marked *