A recurrent theme one encounters in the sale of a business is the fear of its creditors that the new owners will ignore long standing debts that were incurred by the prior owner or the even greater fear that the key assets of the entity will be sold, the old owners pocket the money, and the creditors will be left with no assets in a company that owes them a great deal of money.
Such a fear is not misplaced and it is common for companies in trouble to seek to maximize the value going to the owners to the detriment of the creditors or tax authorities.
An equal danger is to the new owners. The new owner may find angry creditors or tax agencies claiming that since they bought the company or its assets, they are liable to the creditors even if the debt was originally undertaken by the prior owner who promised to pay them off…but did not. See our article on “Transfers to Defraud Creditors.”
Recognizing the need to protect creditors and new owners as well, California has enacted various procedures by which a buyer of a business can know that the creditors are either paid off or are barred from seeking relief against the buyer, assuming the procedures are met. As seen in our article on Due Diligence, it is vital for any buyer to conduct the appropriate investigation of the seller’s assets and liabilities. However, adherence to the bulk sales law can allow a buyer of assets to know that potential future liabilities are limited or banned by adherence to the law.
Bulk Sales Law is designed to protect Buyers and Creditors. It was written to prevent owners from (1) selling businesses to good faith Buyers and vanishing with the proceeds, or (2) selling under market value (“sweetheart deals”) to avoid paying Creditors the full amount owed.
The key elements of a “Bulk Sale” are:
- any sale outside the ordinary course of the Seller’s business
- of more than half the Seller’s inventory and equipment
- as measured by the fair market value on the date of the Bulk Sale Agreement (“Agreement”).
In order for California Bulk Sales Law to apply, the following two conditions must be met:
- Seller’s principal business is the sale of inventory from stock, including those who manufacture what they sell, or a restaurant owner;
- Seller is located in California.
Exemptions & Distinctions
California Bulk Sales Law does not apply to sales of assets with a net value (post-lien and security interest calculations) of less than $10,000 or more than $5 million on the date of the Agreement.
If the net value of the assets is equal to or greater than $10,000 but less than $2 million, the Bulk Sale is considered a Small Cash Sale. Additional Notice and distribution requirements, detailed later, apply. In general:
Net value of assets on date of Agreement
$0 - $9,999 Exempt from Bulk Sales Law
$10,000 - $2M Considered Small Cash Sales with extra notice & distribution requirements
$2M - $5M "Standard" Bulk Sales
over $5M Exempt from Bulk Sales Law
Buyer’s Obligations & Liabilities
Under Bulk Sales Law, the Buyer is required to provide notice of the proposed sale (“Notice”) in compliance with the following procedures.
- Buyer obtains from Seller a complete list of business names and addresses used by Seller for the past three years.
- Buyer gives notice of the Bulk Sale.
At least twelve (12) business days before the Date of Bulk Sale, Buyer must complete these three acts regarding the Notice:
- Recordation. Buyer must record the Notice with the Recorder of every county in which the tangible assets for sale are located. If Seller is located in a different county, the Notice must be recorded with that county’s Recorder as well.
- Publication. Buyer must publish the Notice in a newspaper of general circulation in the county in which the tangible assets for sale are located. If Seller is located in a different county, the Notice must be recorded with that county’s Recorder as well.
- Delivery. Buyer must deliver the Notice by registered or certified mail to the county Tax Collector in the county in which the tangible assets for sale are located.
Notice must contain:
- A statement that a Bulk Sale is pending;
- All business names and addresses used by Seller and Buyer within the past three years;
- Location and general description of assets to be sold;
- Location and (expected) date of the Bulk Sale;
- Whether the Bulk Sale is a Small Cash Sale.
If the Bulk Sale is a Small Cash Sale, the Notice must also contain:
- Name and address of the person to file claims with; and
- The last day to file claims (which must be the business day before the Noticed Sale Date).
Failure to comply. In California, should Buyer fail to provide proper Notice, the transaction remains valid. But, the Buyer becomes liable to a Creditor for damages equal to the difference between Creditor’s total claim and the amount Creditor could have recovered if Buyer had complied with the Notice requirements.
The Creditor has the burden to prove the validity and amount of the claim.
The Buyer has the burden to prove the amount Creditor could have recovered if proper Notice had been given. However, a good faith exception may apply.
Creditors wishing to bring a claim against the Buyer (or auctioneer or liquidator) must do so within one year after the Date of the Bulk Sale.
No Creditor may file an unliquidated or contingent claim (where the amount sought in damages may not be determined by operation of law or is dependent upon a future event which may not happen, i.e. a jury’s determination of the exact amount), or have one brought on their behalf.
Specific Tax Liabilities
Sales and Use Tax. Bulk Sales are an opportunity for the California State Board of Equalization (BOE) to audit the Seller’s sales and use tax payments for previous years.
Buyer must place in escrow an amount sufficient to cover any tax liability owed to the BOE until the Seller produces a receipt from the BOE indicating that all taxes have been paid or until the BOE issues a “Certificate of Tax Clearance” indicating that no amount is due. Note that even if all amounts have not been paid, the BOE may issue a Tax Clearance Certificate if the amount due is secured to the BOE’s satisfaction.
If Buyer fails to comply with Notice Requirements and Seller has failed to pay taxes completely, Buyer may become liable for the unpaid taxes. A tax penalty against the Buyer may also be imposed as a lien on any personal property conveyed.
The “occasional sale exemption” (see Revenue and Taxation Code §§ 6367 and 6006.5) is typically not available when the Seller has a sales tax permit and is making taxable sales.
Personal Property Tax. Bulk Sales may also trigger an additional personal property tax, separate from a deed transfer or recordation tax. The Buyer generally pays this tax, but it may be paid by the Seller. If, however, the Buyer fails to provide proper Notice as discussed above, Buyer will be required to pay the personal property tax.
Employment Taxes. If Buyer purchases a business with employees, Buyer must also place in escrow an amount sufficient to pay contributions, interest and/or penalties due or owing by Seller for unemployment compensation insurance benefits or disability insurance. As with sales and use tax, the amount withheld is released upon issuance of a Tax Clearance Certificate, in this case issued by the Employment Development Department (EDD). Failure to withhold sufficient funds may result in Buyer’s personal liability for the above payments. (See Unemployment Insurance Code §1731).
Options for Buyer’s Protection:
Buyer should consider including one of the following provisions in the Bulk Sales Agreement:
- Seller is obliged to convey all personal property free and clear of liens and other encumbrances, specifically including tax obligations.
- Seller must place a portion of the closing proceeds into escrow, to be released only after parties receive a Tax Clearance Certificate from the appropriate taxing authority.
- Seller agrees to indemnify Buyer for any tax liability arising from the period prior to closing, secured by a letter of credit or a guaranty from a qualified entity or individual.
Small Cash Sales
As stated above, Bulk Sales valued between $10,000 - $2,000,000 have additional requirements. Specifically:
- if the consideration for a Bulk Sale is at or below $2 million (but equal to or greater than the $10,000 exemption), and
- consideration is substantially all cash, or an obligation by the Buyer to pay cash to Seller in the future, or some combination of the two, then additional requirements apply:
Statutory Distribution Requirements. Buyer (or escrow agent if applicable) must submit Creditor claims to Seller to approve or reject. Buyer or escrow agent must pay Creditors before paying the Seller, provided Creditor meets these two conditions:
- Creditor’s claim is due and payable on or before the Date of the Bulk Sale; and
- Creditor has filed their claim in writing on or before the last date to file claims as specified in the Notice (see above).
Payment of Undisputed Claims. Within 45 days of closing, Buyer or escrow agent must pay timely claims to the extent of the cash consideration.
Payment of Disputed Claims. If Seller disputes the claim amount or the claim’s status as being due and payable on the Date of the Bulk Sale, Buyer (or escrow agent) must reserve an amount from distribution as set forth in California (Uniform) Commercial Code §6106.2(c).
Buyer must then institute an interpleader action to join Creditors as defendants in order to avoid exposure to double or multiple liability to the different Creditors. Filing an interpleader does not enable Buyer to avoid personal liability entirely (nor does it release Buyer from liability on any unpaid taxes due). In this situation, additional notice and distribution requirements apply. See Cal. Comm. Code §6106.2(e).
California Commercial Code §§ 6101 – 6111
Revenue and Taxation Code §§ 6367 and 6006.5
Unemployment Insurance Code §1731