Selling a Business With Debt: 7 Issues Buyers and Lenders Raise

A failing business can be sold, and its debts will be priced into the offer whether or not the seller raises them. Buyers discount what they cannot see. They discount more heavily what they discover late.

The seven issues below are the ones a buyer's counsel and the seller's lenders put on the table, usually in this order, and a seller who has answered them before the first meeting negotiates from a different chair. The separate question of whether selling beats settling is addressed elsewhere on this site; this page assumes the decision to sell has been made.

1. The Lien Search Comes Before the Price

A buyer's lawyer searches the UCC records under the seller's legal name before discussing value, because under New York's UCC 9-315 a security interest generally continues in collateral after it is sold unless the secured party authorized a disposition free of it, and it attaches to identifiable proceeds. A financing statement on file is a question the seller will be asked to answer.

Answer it with paper. For each filing, the seller should hold the underlying agreement, a current payoff statement, and the secured party's written commitment to terminate on payment. Where a debt is already paid, a signed demand under 9-513 obliges the secured party to clear the filing within 20 days if the statutory conditions are met; a stale filing left on the record costs a seller more at the table than the demand letter costs to send.

2. Lender Consent Is a Condition of Closing

Read the security agreement before listing the business. Where it restricts sale of the collateral, a sale without consent is a default, and the lien follows the equipment to its new owner regardless.

Consent is usually purchased with a payoff. The seller who approaches the lender early learns the price of that consent while there is still time to negotiate it.

3. Asset Sale or Equity Sale Decides Which Debts Cross

A buyer of the company's shares or membership interests acquires the company itself, together with every debt, lawsuit, tax assessment and signed guaranty the company is party to. A buyer of assets acquires chosen property and, as a general rule, leaves the seller's liabilities with the seller's entity.

That is why buyers of distressed businesses prefer assets. It is also why an asset sale leaves the selling entity holding its debts with the price as its only remaining asset, and why each party reports an asset acquisition to the IRS on Form 8594. Contracts, licenses and leases do not move automatically in an asset sale; each needs assignment or replacement, and a landlord or key customer who declines can reduce the price by more than any creditor.

4. Successor Liability Is the Buyer's Unspoken Worry

New York's Court of Appeals, in Schumacher v. Richards Shear Co. (1983), stated the general rule that a corporation acquiring another's assets is not liable for the seller's torts, and listed four exceptions: the buyer expressly or impliedly assumed the liability, the transaction amounted to a consolidation or merger, the buyer is a mere continuation of the seller, or the transaction was entered into fraudulently to escape the obligations. The case concerned a product injury. Its framework is the one buyers' lawyers reach for when creditors of the seller come calling.

The exceptions have practical shape. A buyer owned by the seller's family, operating from the same premises, under a similar name, with the same customers and staff, looks less like a purchaser and more like the old business wearing a new coat (the resemblance matters because a creditor arguing mere continuation will photograph the storefront, pull the new entity's filing, and compare the employee list, and a buyer who paid fair value to strangers rarely fits that picture). An arm's length price, documented, is the buyer's best protection and therefore the seller's best selling point.

Whether a given court would extend these exceptions to a particular contract creditor is a question counsel answers for the state involved.

5. New York Bulk Sale Rules Put Tax Liability on the Buyer

This is the issue sellers learn about last and buyers learn about first. Under New York Tax Law 1141(c), when a sales tax vendor sells any part or the whole of its business assets in bulk, outside the ordinary course, the purchaser must notify the Tax Department by registered mail at least ten days before taking possession or paying, whichever comes first; the Department's form for this is AU-196.10.

The consequences for a buyer who skips the step are severe enough to change the deal. A purchaser who fails to comply becomes personally liable for the seller's sales taxes, whether determined before or after the sale, up to the greater of the purchase price or the fair market value of the assets. The consideration payable to the seller becomes subject to a first priority right and lien for those taxes, and the purchaser may not pay it over until the state releases it.

The timing is, if one reads the bulletin closely, less alarming than the statute suggests. The Tax Department's bulletin says that within five business days of receiving the notice it issues either a release (Form AU-197.1) or Form AU-196.2, and the statute gives the Department ninety days to respond before the purchaser's duty to withhold lapses.

A seller who is behind on sales tax should assume the buyer will find out.

The seller's own duties run alongside. The Tax Department requires the seller to give the purchaser Form TP-153, a notice to prospective purchasers, and to file a final sales tax return within 20 days of the sale. None of this reaches the seller's private debts: the bulk sale lien protects the state's taxes and makes the buyer answerable for nothing owed to a funder or a bank.

6. The Advance Funder Will Say the Receivables Are Already Its Own

Where the advance was written as a purchase of the merchant's future receipts and the funder filed a financing statement describing receivables and their proceeds, a sale of the business is, from the funder's side of the table, a disposition of its collateral.

The funder can make that visible to customers. After default, UCC 9-607 permits a secured party to notify account debtors to pay it directly, and under 9-406 a customer who has received proper notice cannot discharge its debt by paying the seller, a result a buyer who purchased those receivables will not accept.

The buyer will therefore want the funder's written release of its claim to the receivables being sold, a termination of the financing statement, and a payoff figure the funder has signed. The owner's guaranty of the advance, if one exists, remains the owner's; a sale of assets resolves nothing about it unless the funder's release says so.

7. The Proceeds Go to the Payoff List Before They Reach the Seller

A seller should expect the price to pass through escrow or a closing agent, disbursed first to secured creditors and to any tax release, with the seller receiving the remainder. A buyer who pays the seller directly while liens remain has bought the liens as well.

The seller's work is to make the payoff list short and accurate before closing. The list, once agreed, is the deal.

When the Debts Exceed the Price

A sale that cannot pay every secured creditor in full needs their consent or a court. Outside bankruptcy, the unpaid lienholder can refuse; inside a chapter 11 case, section 363(f) permits a sale free and clear only under stated conditions, one being that the price exceeds the aggregate value of all liens on the property. Where the merchant cash advance is the obstacle, Delancey Street offers a free, confidential review of whether a negotiated payoff can fit inside the transaction. The company negotiates balances; it is not a law firm, it works alongside independently licensed attorneys where legal questions arise, and the purchase agreement itself belongs with a transaction lawyer. A buyer's lawyer reads a closing statement the way a customs officer reads a manifest, looking for the line that does not match the cargo.