In the previous blog post of the M&A blog series, we covered the differences between warranties and indemnities in a sale and purchase agreement. Typically, the share transaction is assumed to be the transaction structure for a business acquisition. In practice, however, we frequently see a different transaction structure: the asset/liability transaction. 

Share transactions and asset/liability transactions involve different approaches to negotiating the transaction documentation. Not only does the method of transferring the target company depend on the transaction structure, but both structures also have fundamentally different implications for the buyer and seller. As such, the parties’ preferences play a significant role in the choice of a particular transaction structure.

Before discussing the asset/liability transaction, let’s briefly highlight the difference with the share transaction. A key distinction here is the legal difference between the terms ‘business’ and ‘company.’ A ‘business’ refers to the entirety of activities aimed at continued participation in economic activity. A ‘company,’ on the other hand, refers to the legal form (legal entity) through which a business is operated (such as a private limited company, foundation, or partnership).

Share transactions

In a share transaction, the target company - or a part of the target company corresponding to the number of shares sold - is transferred. This, of course, is only possible when the capital of the target company is divided into transferable shares. Therefore, only shares in a public limited company or a private limited company are eligible for transfer through a share transaction. In a share transaction, the seller is the shareholder of the target company being transferred. 

This is because the business associated with that target company is inextricably linked to the company itself, and the buyer is responsible and liable for its performance. Consequently, a buyer in a share transaction cannot pick and choose the liabilities they want to assume.

Asset/liability transactions

Unlike a share transaction, in an asset/liability transaction, only specific assets and/or liabilities, along with the associated business, are sold. The company through which the business is operated typically remains unaffected. In this type of transaction, the company itself is the selling party. Because the company itself is not sold, the capital of the business being sold does not need to be divided into shares. As a result of the asset/liability transaction, the business operated through other legal entities besides public or private limited companies (such as a partnership, general partnership, foundation, or association) can also be transferred. 

In this type of transaction, the buyer can cherry-pick the assets they want and leave unwanted liabilities with the seller. For example, they might choose to acquire only the order portfolio or the inventory while leaving negative aspects of the business, such as latent tax liabilities or ongoing legal disputes, with the seller. The downside of this ‘selective transfer’ is that each business unit sold must be transferred as required by law. Additionally, the buyer must describe as fully and in as much detail as possible in the sale and purchase agreement what they wish to acquire - or not acquire (the excluded items) - from the seller - to avoid misunderstandings. 

Key considerations in asset/liability transactions

§  Each business unit sold must be transferred as required by law, making the asset/liability transaction often quite complex. Real estate, for example, is transferred through a notarial deed, contractual legal relationships require a deed and the cooperation of the counterparty, and inventory is transferred by placing it under the buyer’s control.

§  If the transaction qualifies as a ‘transfer of undertaking,’ employees (including their rights against the seller) are, in principle, automatically transferred to the buyer by operation of law, unless an employee explicitly states that they do not wish to continue their employment with the buyer. Whether a transfer of undertaking qualifies as such depends on the circumstances of the case, but it is important to note that the buyer’s intent is not relevant. By law, the buyer may be required to retain the target company’s employees they have expressly stated they do not wish to retain.

§  In general, risks associated with the business will continue to be borne by the seller unless the parties agree otherwise. 

§  As with a share transaction, it is important for a buyer to conduct thorough due diligence on the assets being acquired. The fact that this is an asset/liability transaction does not change this requirement.