For experienced transactional attorneys, a contract to sell a business has a familiar architecture that sorts the various statements and promises of the buyer and seller by function. An assertion that a fact is or will be true? Put it in the part of the contract for representations and warranties. The seller is promising to do something between now and the deal closing? Probably belongs in the part of the contract titled “Covenants” or a variant thereof.
It can happen that, in the course of negotiations, a sentence that contains a promise will be dropped in the middle of a set of related representations. Even though it might seem to stand on its own and have a clear enforceable meaning, a good transactional attorney will move that sentence to the part of the contract where it most naturally belongs. A failure to respect the function of the architecture of the purchase agreement can have fatal consequences.
Some form of this failure to understand how location affects meaning may have played a role in the disappointing outcome for the purchaser in Gaines Marina & Services, Inc., v. CMS Marine Storage, LLC, decided by the Supreme Court of New York, Third Department, on October 31, 2019 (No. 2019-07825). In that case, the purchaser had acquired the assets of the seller’s business. The purchaser subsequently sued the seller to recoup over $91 thousand in sales taxes arising out of the transaction, which the purchaser asserted were the seller’s responsibility.
The purchaser asserted that the seller’s obligation to pay any sales taxes arising out of the transfer of assets from seller to purchaser was found in the section of the agreement that stated which liabilities would be assumed by the purchaser after closing. The default rule in a sale of assets is that liabilities remain with the seller, unless explicitly assumed by the purchaser. As in most asset purchase agreements, the agreement in this case listed specific categories of liabilities that purchaser would take responsibility for at closing, and then confirmed the default rule with a description of liabilities retained by the seller:
The following liabilities (the ‘Retained Liabilities’) shall remain the sole responsibility of and shall be retained, paid, performed and discharged solely by Sellers. Retained Liabilities shall mean every Liability of Sellers other than the Assumed Liabilities, including… (ii) any Liability for Taxes, including… (B) any Taxes that will arise as a result of the sale of the Assets pursuant to this Agreement.
The purchaser argued that clause (B) of the language just quoted clearly and unambiguously stated the parties’ agreement that sales taxes arising out of the transaction would be the seller’s responsibility.
Both the trial court and the Supreme Court on appeal rejected the purchaser’s argument, referencing both the Retained Liabilities provision as well as the definition of “Taxes” (about which more below). While the appeals court put more weight on the Taxes definition, let’s focus for the moment on the Retained Liabilities language above. If the parties had intended to allocate the responsibility for transaction-related taxes to the seller, was this the right place to do so?
In most asset purchase agreements, you will find the provisions regarding the assumption and retention of liabilities either near the purchase price provisions or the description of the assets that are to be transferred at closing. Location aligns with function – since the default rule is that liabilities remain with the seller, a transfer of seller liabilities to the purchaser is a form of additional value given to the seller or an acknowledgement that the overall value of the transaction to the parties is enhanced by certain liabilities following the related assets into the purchaser’s hands. However viewed, the key point is that we are allocating SELLER liabilities that otherwise would remain the seller’s.
In this case, however, the sales taxes imposed on the transfer of assets from seller to buyer were, by statute, the responsibility of the PURCHASER. As such, they were outside the scope of the customary assumed / retained liabilities provision. The defined term “Retained Liabilities” should be a give-away – these are liabilities that are kept, that remain where they are.
Where did this agreement belong (again, assuming that the parties had truly intended for the seller to pay any transaction taxes)? A promise to pay all sales taxes would have been better placed as a covenant later in the agreement, either as part of a section allocating transaction costs or with other commitments regarding future actions in respect of taxes.
In the event, the appeals panel in this case focused on language in the “Taxes” definition that was equally fatal to purchaser’s claim. The definition of “Taxes” was as follows:
‘Taxes’ means any federal, state, local or foreign[] real property, personal property, sales, use, excise, room, occupancy, ad valorem or similar taxes, assessments, levies, charges or fees imposed by any Governmental Authority on Sellers with respect to the applicable Assets or the Business, including, without limitation, any interest, penalty or fine with respect thereto, but expressly excluding any: (i) federal, state, local or foreign income, capital gain, gross receipts, capital stock, franchise, profits, estate, gift or generation skipping tax; or (ii) transfer, documentary stamp, recording or similar tax, levy, charge or fee incurred with respect to the transactions described in th[e] Agreement.
The court focused in on the words “imposed by any Governmental Authority on Sellers,” which took the sales taxes at issue outside of the scope of the definition because they were imposed by statute not on the seller but on the purchaser. This definition provides an example of a drafting practice to be avoided – do not use defined terms that appear to cover a general topic such as taxes but that hide within the definition a limitation of the definition to only one of the parties. The risk is simply too great that, at some point, you will use Taxes as a term of general application to all the parties – if specific application to a given party is needed, use “Seller Taxes” as a subset of all Taxes.
