Feedback on limiting liability in stock purchase 336(e) or similar

October 05, 2022

by a searcher from Purdue University in Phoenix, AZ, USA

I am looking at using an SBA loan to acquire a 25+ year old commercial cleaning company that was last sold 2 years ago. Organized as S-corp. Seller pushing for stock purchase agreement due to large number and type of contracts and fleet of vehicles. Lower middle market. Working with an attorney already, but his advice is just to avoid SPA, and I'm looking for solutions. He suggested purchasing as 336(e) held by an LLC treated as a disregarded entity.

Seller is open to 338(h)(10)/336(e) special election, so that solves the depreciation problem.

I am trying to figure out a way to get around the liability issue of 25+ years of unknowns under the same S-Corp, and most of that under a prior owner I can't even talk to.

Looked into TLPE insurance (micro R&W), but it seems like a policy would only cover the period of###-###-#### back to last sale).

Is there protection through doing an F-reorg or other entity conversion? Or is the only way to shed liability at sale time through APA?

Am I just overestimating the risk profile here? Or do you guys just treat it like driving into a roundabout, close your eyes and hope for the best?

Reply by a searcher
from University of Pennsylvania in Charlotte, NC, USA

I may be unclear on the situation or your objectives, but it sounds like there may be some confusion about what a 338h10 or 336 accomplishes. These elections serve to treat the transaction as a sale of assets for federal tax purposes, but do not, by themselves, affect the legal form or buyer's exposure to potential liability. In other words, despite one of those elections, the transaction is still a stock purchase in all respects except federal income taxes..

An APA doesn't automatically absolve you of all potential successor liability, and an SPA doesn't automatically expose you to all such liabilities. Either an APA or SPA can accommodate tailored provisions that allocate post-closing liability to meet the needs of the parties.. What is your counsel's reasoning for avoiding an SPA? I've heard many non M&A lawyers take this position reflexively, but experienced M&A counsel can help you explore the potential liability issues and draft either document to allocate risk/liability as agreed between you and seller. With appropriate/acceptable indemnification and escrow (or other mechanisms), the stock purchase your seller seeks may indeed be preferable for you, in part to avoid the time, expense and risks associated with transferring individual assets, rehiring employees, etc.

On a side note, if you're counting on a 338h10 or 336 to drive the economics of your transaction, be sure to have your counsel do thorough diligence to ensure that a past action has not compromised the S status, and of course ensure that your transaction structure does not bust the S election.

Reply by a searcher
from Harvard University in Fort Wayne, IN, USA

I don’t think your facing much risk if it is a cleaning company. No one is going to sue you for anything huge if something wasn’t cleaned well. The only thing I could think of would be an employee suing you for what type of cleaning products you (they) made them use. But you’ve got workers comp for that. Anything else?

I did a stock purchase with a 336, and it’s worked out great. It’s frankly way easier than an asset purchase because everything just keeps humming along thru the transition. Yes, you have to look at risks, but as long as your not dumping chemicals or manufacturing life saving equipment, you’re probably okay.

Just get a good insurance guy. Ben Johnson - redacted

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