Classification: Deal Driver
Section: Purchase and Sale
Negotiation Time: Moderate
Transaction Costs: Insignificant
Major Impact: Risk Management and Deal Value
Assumed and Excluded liabilities
What is This? The Assumed and Excluded Liabilities provisions, taken together, detail which of the Seller’s liabilities will be transferred to the Buyer and which ones will stay with the Seller.
The Middle Ground: Typically, the Assumed Liabilities include current accounts payable and the liabilities associated with Assigned Contracts. Tax liabilities of the Seller are typically excluded. Assumption of other liabilities will vary based on the particular deal, and if there are a number of them they can be listed in detail in the Disclosure Schedules.
Purpose: These provisions spell out which operational risks will reside with each party following the transaction. In achieving that goal, these provisions also force the parties to think through the potential risks of the transaction and how those risks should be allocated within the Agreement.
Buyer Preference: When Assumed Liabilities are broadly defined and Excluded Liabilities are strictly defined, the Buyer is more likely to inherit unknown or unexpected liabilities. While liabilities of any kind increase risk, liabilities that are not anticipated can be exponentially more dangerous. Therefore, the Buyer wants language indicating that it will assume the listed liabilities and no others, and to define the Assumed Liabilities as specifically as possible. It also wants the Excluded Liabilities to be framed as a non-exhaustive list, which means that the list includes any liabilities not explicitly assumed.
In regard to particular liability categories, the Buyer wants to exclude any liabilities arising before the Closing Date as well as any liabilities not arising in the ordinary course of business, including liabilities for which the Seller is at fault. Furthermore, a broad tax liability exclusion is in the Buyer’s best interest to protect it from successor tax liability. Additionally, liability for fees relating to the transaction (i.e. intermediary fees) that are payable by the Seller are typically excluded.
Seller Preference: In general, the Seller wants the Assumed Liabilities section to be a non-exhaustive list that includes any liabilities not specifically excluded in the Excluded Liabilities clause. It also wants to explicitly transfer all accounts payable that are not paid by the Closing Date, all liabilities associated with Assigned Contracts, and any other liabilities that accrue after Closing (e.g. employee compensation and benefits, taxes, etc.).
Differences in a Stock Sale Transaction Structure: In a stock sale, the liabilities of the target company automatically transfer to the Buyer. Therefore, the Agreement does not include the Assumed and Excluded Liabilities sections, and the bulk of the risk allocation is achieved through the Seller Representations and Warranties and Indemnification provisions.
We want The Middle Ground to be an ongoing dialogue for and resource to the lower middle market M&A community. The outline above is generally applicable, but there is always specific case law and nuance around certain industries that can be useful in helping buyers and sellers come together. If you are a lawyer or deal professional, we encourage you to add your perspective below.