BUYING OR SELLING A SMALL BUSINESS - NYSBA

1 © Copyright 2017 Hodgson Russ LLP

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BUYING OR SELLING A SMALL BUSINESS

I. INTRODUCTION.

The legal representation of the purchaser or seller of a business, regardless of the size of the business, requires an understanding of the goals of the parties to the transaction and the role of their advisors, familiarity with the typical acquisition process and agreements, and an understanding of specific legal issues and tax planning considerations to the parties. This outline provides an overview of each of these issues concerning the purchase or sale of a small business.

While the term “small business” is relative to each attorney’s practice and experience, for purposes of this outline, a “small business” is considered a private company doing business solely in the United States which is owned by a small group of family members and/or other owners and sold to a United States purchaser. Similarly, the discussion focuses upon “operating” companies, rather than companies which solely own investment or real estate assets, or professional or not-for-profit entities. In addition, although most of the information provided is applicable to a small business organized as a sole proprietorship, general partnership, limited liability company (“LLC”), or corporation, most of the discussion is focused upon corporations, whether taxed under Subchapter C of the Internal Revenue Code (“C corporation” or “Cco”) or under Subchapter S of the Internal Revenue Code (“S corporation” or “Sco”). Similarly, although the legal issues that need to be addressed in the purchaser’s due diligence process and in the acquisition documents are similar whether the acquisition is structured as a sale of stock versus sale of assets, this outline will focus upon sales of assets. Finally, this outline concerns transactions which are taxable to the sellers of a business, and does not discuss methods to achieve a tax-free merger or acquisition, which generally requires the seller’s receipt of stock in exchange for the stock or assets of the business sold.

II. GENERAL BUSINESS CONSIDERATIONS.

There are a number of general business considerations that the parties and their advisors should evaluate either before entering into a proposed transaction or during the early stages, including:

A. The Business. It is essential that there is thorough understanding of the type of business involved, size of business, compatibility with other businesses, quality of personnel, labor issues, supplier and customer relationships, reputation of business, geographic issues, future prospects (stable, growing) and assets and liabilities.

B. Purchase Price. Purchase price is the most negotiated item in any transaction. Unfortunately, unlike buying a television with a fixed price, buying a business often has multiple components to the purchase price. The purchase price can include cash, promissory notes, assumptions of liabilities, dividends of cash or assets out of a company before a sale, deferred portions of the price, “disguised” purchase price components, and other forms of consideration.


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C. Financing. How will the purchaser fund the acquisition? Third party lenders create complexity. Deferral of the price (seller “taking back paper”) increases the risk of the deal. Are guaranties required?

D. Liabilities. Litigation, environmental issues, employment issues, and other liabilities make sales more complex.

E. Insurance. Insuring of liability risk is becoming more common.

F. Secrets. Can they be protected?

G. Personalities of Parties. Are they compatible?

H. Form of Entity. If the purchaser is interested in purchasing the stock of an entity, or desires to form an entity to be the acquiring party, the purchaser and their advisors should have an understanding of the legal and tax considerations for different types of entities. Attached as Exhibit “A” is a discussion of choice of entity considerations.

III. THE PARTIES.

A. The Client – Buyer or Seller. A lawyer must understand who is the client is in any business transaction. This sounds simple, but can be surprisingly complicated, particularly when the lawyer is asked to represent multiple parties, an entity and/or the entity owners. Obviously, the representation of multiple parties raises the possibility of potential conflicts of interests which must be addressed. In addition, the lawyer needs to confirm that the client has obtained the requisite entity and owner approvals, and has the requisite authority to retain counsel and proceed with the transaction. Each of these important considerations should be discussed with the client and confirmed in the client engagement letter.

B. The Buyer’s and Seller’s Accountant. The accountant for the buyer or seller plays a critical role in all stages of the transaction and should work closely with the client, counsel and other advisors.

Before the buyer enters into a letter of intent or any other agreement with the seller, the buyer’s accountant should be consulted concerning whether the transaction should be structured as a purchase of assets, stock, or stock treated as an asset sale, and whether buyer should form an entity to acquire the business. The buyer’s accountant is also involved in the due diligence process - confirming value and buyer’s proposed financing of the transaction, in addition to reviewing and analyzing financial statements, other financial records, and tax returns, compliance and potential tax consequences of the transaction. The buyer’s accountant should also be involved in the preparation, review and revision of any transaction document with particular focus upon any financial terms or tax consequences which affect the purchase price, payment, representations and warranties, and covenants. Finally, the buyer’s accountant will work with the parties and advisors to prepare and/or review any post-closing purchase price adjustments, working capital, and/or earn out computations and preparing and filing any necessary tax elections, reports and returns.


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The role of the seller’s accountant is similar and equally important as the buyer’s accountant. The seller’s accountant also should be consulted concerning whether the transaction should be structured as a purchase of assets, stock, or stock treated as an asset sale, and the tax consequences of the transaction to the seller. The seller’s accountant plays a valuable role during the due diligence process – preparing and explaining annual and interim financial statements and other financial records, assisting with the determination of value, payment terms, working capital, earn outs, and other financial computations, and working with counsel concerning the review and revision of seller representations and warranties and covenants. Finally, the seller’s accountant will work with the parties, counsel and other advisors to prepare and/or review any post-closing purchase price adjustments, working capital, and/or earn out computations and preparing and filing any necessary tax elections, reports and returns.

C. The Buyer’s and Seller’s Attorney. The attorney for both the buyer and the seller must provide both practical and technical advice. The attorney’s role should be to assist the client in his or her understanding of the process. Things to consider and tasks to accomplish include:

1. Is client unsophisticated or experienced in the process?

2. What are client’s motives?

3. Is client ready to sell or buy? Are there skeletons in the closet?

4. Coordinate work and information flow with lenders, accountants, consultants and other attorneys.

5. Assist with client’s understanding of valuation

6. Legal review and obtain searches (title, UCC, good standing).

7. Negotiate, draft and close

The attorney should be part of the solution, not part of the problem. Negotiating the transaction is a process. No deal can be completed without the parties going through the process. The buyer and seller must get along post-closing. Accordingly, it is important that the attorney play a reasonable role in maintaining the relationship among the parties. It is important for the attorney to always take control of the drafting if it can be reasonably accomplished.

D. Investment Banker/Business Broker. While there are many ways to find businesses to buy, the most common is for the buyer or seller to work with an investment banker or business broker. One of the roles of the investment adviser or business broker is to search out the business opportunity, but they also play a very important role in helping to determine fair market value of the business and by assisting the seller in improving business operations and preparing materials to assist with marketing the company. The investment banker or broker will also work with the parties and counsel concerning the preparation, review and negotiation of any letter of intent and transaction documents, and help control the due diligence and negotiation process, particularly if there are more than one potential buyer.


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IV. THE ACQUISITION PROCESS

A. Mutual Non-Disclosure Agreement. Before the parties begin to discuss or exchange any important proprietary or confidential financial or business information, the parties should enter into a non-disclosure agreement (“NDA”). Typically, the terms of the agreement are mutual since both the seller and buyer will need to reveal confidential information which should be protected. Attached as Exhibit “B” is a sample NDA. Typical terms include:

1. Purpose: To insure that the recipients of confidential information do not use the confidential information to the detriment of the disclosing party.

2. Definition of Confidential Information: The definition of confidential information is important.

3. Term: Consider what items should remain confidential indefinitely.

4. Equitable Remedies: Damages are insufficient remedy.

5. Governing Law and Venue: Consider where a client will have to travel to enforce the agreement.

6. Other Issues: Be careful that contained within the Confidentiality Agreement are not unwanted standstill or non-competition covenants.

B. Letter of Intent. If the parties are interested in proceeding with a potential transaction, it is typically recommended that they enter into a “non-binding” letter of intent (“LOI”). While some clients may view this as an unnecessary delay or expense, more often than not, the parties may not have considered all the critical aspects of the deal and the time spent on the LOI will save more considerable time preparing and revising the more substantial acquisition documents, and sometimes may result in the parties realizing that they don’t have a meeting of the minds and want to terminate the deal. Attached as Exhibit “C” is a sample LOI. Typical terms include:

1. Purpose: The basic purpose is to establish the basic understanding of the terms of the transaction.

2. Terms: Be careful to delineate those terms that are binding and those that are not. Non-binding terms typically outline the basic terms of the transaction. The binding terms typically are:

i. Standstill

ii. Confidentiality

iii. Non-solicitation

iv. Governing Law


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v. Access to Information

3. Caution: Be careful not to unwittingly create an obligation of good faith. The law is changing in this area and varies from state to state.

C. Due Diligence Procedures or Process. The purpose of due diligence is to understand the history of the company being acquired, the quality of the business being acquired and the prospects for the future. Lawyers are not the only parties that participate in a complete due diligence project. Accountants, investment bankers or advisors, environmental engineers and other parties with expertise need to review the company being acquired.

1. Due Diligence Checklist. Attached as Exhibit “D” is a sample Due Diligence Checklist. A quick review of the checklist will make clear that there are many things to review to properly evaluate a company being purchased. Due diligence is not the same for every transaction. Each due diligence project must be thought through before being undertaken and the due diligence checklist tailored to the particular business being acquired.

2. Issues. The major categories of diligence include financial matters; tax matters; labor matters; litigation; insurance; real, personal and intellectual property; business matters; bank and credit arrangements; legal matters; and consultant and engineering reports.

i. Financial Matters. Include reviewing prior financial statements, auditors’ letters, auditors’ work papers, capital budgets, operating budgets, projections, business and marketing plans, contingent and unrecorded liabilities, guaranties and indebtedness.

ii. Tax Matters. Include review of tax returns, federal, state and local for several years, tax audits and revenue agent reports.

iii. Labor Matters. Include labor contracts, severance issues, pay rate schedules, relationships with unions, employment manuals, key employees, organizational charts, labor dispute history, confidentiality and non-compete agreements, employee benefits, plan documents, pension plans, profit sharing plans, stock options, surety bonds, employment contracts, accrued vacation, loans to employees, officers and directors, workers compensation issues, employees receiving disability payments and understanding any other benefits provided to the work force.

iv. Litigation Matters. Include reviewing insurance loss runs, litigation (past and present), potential litigation, consent decrees, reserves for existing litigation and understanding regulatory compliance issues.

v. Insurance Matters. Require a review of past and current insurance, an understanding whether insurance is “claims made” or “occurrence based” coverage, understanding whether tail insurance needs to be obtained, obtaining lists of sureties, description of insurance claims history and a description of insurance claims.

vi. Real, Personal and Intellectual Property. Analysis requires understanding each piece of real property, reviewing deeds, ground leases (including rights of first refusal and estoppel agreements), surveys, title insurance policies, appraisals, environmental


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reports, building condition reports, site inspection reports, mortgages, contracts and options to purchase, leases, liens for taxes, encumbrances, certificates of occupancy, permits, licenses and certificates of authority, zoning issues, utility issues, transfer taxes, lists of fixed assets, building and health code issues, accounts receivable, intellectual property matters, licenses and royalty agreements, list of leases of personal property and trade names.

vii. Business Matters. Include understanding all contracts, including whether they are assignable, understanding sales in the preceding 12-24 months, transactions with affiliates, restrictions imposed by contracts, exclusive agency and license agreements, management contracts, liquor licenses, long term agreements, agreements requiring the payments of significant sums of money, service agreements, confidentiality and non-compete agreements and contractual warranty issues.

viii. Bank and Creditor Arrangements. Include reviewing financing documents, loan transactions and guaranties.

ix. Legal Matters. Include reviewing minute books, lists of directors and officers, principal shareholders, understanding the stock issued, whether there are options and warrants, reviewing minute and stock record books, organizational charts, policy manuals, indemnification agreements, conflicts of interest, dividends and contingent liabilities.

3. Real Estate, Environmental and Intellectual Property Issues.

i. Title and Ownership Considerations:

a. Lease vs. own: Should purchaser purchase or lease real estate on which business is conducted? Typically less liability with lease.

b. Title Search; Survey: Important part of due diligence. Search and survey should be obtained in either stock or asset sale. Title clearance process is similar to a straight real estate transaction. Helps uncover environmental and other issues. See Paragraph iv(a) of this Section of the outline.

c. Title Insurance: Always a good idea whether stock or asset transaction. If a stock acquisition, buyer may be able to take advantage of existing policies. What does title insurance insure against? What are common exceptions to coverage?

d. Ownership of Property: Oftentimes buyers in closely held corporations will place real estate in separate entity and lease to operating entity. This arrangement allows for compensation to be paid to principals without FICA/employment taxes. Purchaser often sets up multiple entities to acquire the assets for liability and tax purposes.

ii. Leases:

a. Lease: Is lease assignable? Does lease contain right of first refusal that prevents sale? Is there rent escalation provision? Can lease be sublet or assigned in the future?


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b. Estoppel Certificates. Always insist on estoppel certificate from landlord if acquiring a tenant’s interest in the transaction or from tenants if acquiring property or business that has tenants.

iii. Recording Issues:

a. Only necessary in asset transaction.

b. Deeds are optional in stock transactions, and are used only to confirm transfers occurring by virtue of the stock transaction.

iv. Environmental Concerns: See Section IV(D)(2)(iv)(a). of this outline for discussion of successor liability.

a. Liability for Contaminated Property: The first environmental consideration in buying or selling a business is whether any of the property on which the business is being conducted (or has been conducted) is contaminated. The standard devices for investigating that issue are the Phase I Environmental Site Assessment or Transaction Screen. Those environmental site assessments are intended to comply with the standard of good commercial and customary practice for identifying recognized environmental conditions. The term “recognized environmental conditions” means the presence or likely presence of various contaminants on a property under conditions that indicate an existing release, past release or a material threat of a release into structures on the property or into the ground, groundwater, or surface water of the property. Recognized environmental conditions need to be identified because, under various federal and state statutes, the owner of real property is liable for the cost of addressing that contamination. Environmental site assessments are also appropriate when transactions in which the property on which the business is conducted is leased, and not owned, because those same statutes impose liability on the “operator” of a contaminated site.

If the Phase I or Transaction Screen identifies recognized environmental conditions, a Phase II Environmental Site Assessment will often be conducted. The purpose of a Phase II Environmental Site Assessment is to collect samples from potentially-contaminated media to determine the nature and general extent of the suspected contamination. The liability risks associated with contaminated property can be allocated in the transaction using a number of approaches including, representations and warranties, indemnification provisions, escrow arrangements and specialized environmental insurance policies.

b. Compliance with Environmental Laws: The second environmental consideration in buying and selling a business is whether the business is being operated in compliance with all applicable environmental laws and can continue to be operated in compliance without significant capital or additional operating and maintenance expense. Consequently, in a transaction where the base business will continue to be operated after the transaction, an environmental audit to determine whether the business is being operated in compliance with applicable laws (including permits and licenses) should be performed. Those audits typically will examine compliance with laws governing emissions to the air; discharges to waterways, including discharges to wastewater treatment plants; the generation, storage, treatment, transportation and disposal of waste; the storage, handling and use of hazardous materials;


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compliance with both worker right-to-know and community right-to-know laws concerning hazardous materials at the facility; and structural and operational conditions that may pose environmental occupational health risks to workers.

Even if the business is currently in compliance with applicable law, a critical evaluation of whether it can continue to be operated in compliance without significant capital expenditures (for example, for the retro-fitting or installation of new and expensive pollution control equipment) or significant additional operation and maintenance expenses (for example, the need to operate and maintain systems for treating waste streams) is necessary.

The liability risks associated with non-compliance are traditionally handled in these transactions using pre- and post-closing covenants, representations and warranties coupled with indemnification provisions, and escrow arrangements.

v. Intellectual Property:

a. Trade secrets.

• what steps have been take to protect the trade secret?

• have the employees signed confidentiality/ noncompetition agreements?

• is access limited to those having a need to know the trade secret?

• do employees understand their obligations?

• who has the most knowledge about the trade secrets - are they staying?

• do independent contractors have access to trade secrets?

• what business advantage is achieved via the trade secrets?

• who owns the trade secrets?

• are the trade secrets licensed?

b. Patents and patent applications.

• have all the inventors assigned their rights?

• have all ownership documents been filed with the USPTO?

• what do the USPTO ownership records indicate?

• have the maintenance fees been paid?

• has the validity been challenged?


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• are there any opinions regarding validity or enforceability?

• what does the prosecution file history say?

• are there any license agreements- what do the agreements say?

• what are the closest patents owned by others?

• what business advantage is achieved by owning the patents/patent applications?

c. Trademarks and trademark registration applications.

• are there any licensees and what do the license agreements say?

• if the trademarks are licensed, has the licensor exercised control over the use?

• are the trademarks registered, and if so, where? have renewals been timely made?

• are the trademarks currently being used, and if so, how?

• how frequently has the use been monitored?

• have the trademarks been challenged? enforced?

• are there similar marks owned by others?

• where have the marks been used?

d. Copyright and copyright registration applications.

• who were the creators?

• have the creators assigned their rights?

• were the creators employees hired to create such material?

• have the copyrights been registered?

• have the copyrights been challenged? enforced?

• are there any licensees - what do the agreements say?

e. General matters applying to all types of IP.

• has the IP been pledged as collateral?

• has a list been made describing each piece of IP in detail?


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• what are the written policies pertaining to IP?

D. The Acquisition Agreement.

1. Basic Structure.

i. Basic Structure and Terms.

a. Form of Asset Purchase Agreement. Attached as Exhibit “E” is a sample form of Asset Purchase Agreement. A Stock Purchase Agreement is similar except that there are more detailed descriptions of the stock being acquired and representations and warranties dealing with the stock. A merger agreement also is similar but contains provisions describing the company that survives the merger, the new board, the new officers and what happens to the stock of the company that does not survive.

b. Format. Agreements are set up with several basic parts: parties to the agreement, definitions, description of transaction, closing, representations and warranties, covenants, conditions, indemnifications and miscellaneous.

c. Parties. Typically the parties include the buyer, the seller and any guarantors or principal shareholders. It is very important to consider who is buying and who is selling to understand the kinds of representations and warranties to be made, the quality of the indemnification to be received, the authorizations to be obtained to insure that the agreement is binding and enforceable against the parties and that the signature lines are accurate and complete and match the parties to the transaction.

d. Definitions: Often agreements contain a set of definitions to clarify common meanings to words used throughout the document. Most agreements include all the definitions in one place in the agreement for ease of reference. Defined terms are placed in alphabetical order and capitalized throughout the rest of the agreement to remind the reader that the term is defined elsewhere.

e. Description of Transaction; Purchase Price and Payment Terms. Perhaps the most important section of the agreement are the sections describing the transaction, the purchase price and payment terms. These section cover what is being bought and sold, the amount of the purchase price, the type of payment, when payment is made, what adjustments are to be made to the purchase price, the type of funds to be used and a clear description of the assets or stock being sold.

f. Conditions and Contingencies. Conditions or contingencies are events which if they do not occur or are not satisfied, the closing will not take place. Typical conditions or contingencies include obtaining bank financing, environmental conditions, satisfactory due diligence and regulatory approval. The agreement should deal with the consequences of a condition not being satisfied. For example, if a closing condition is the requirement that all representations are true at closing and one of the representations at closing is not true, may the buyer close anyway and sue the seller for breach? What happens if there is damage or destruction to the assets? Will closing occur and the price be reduced? What about insurance proceeds?


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g. Representations and Warranties; Indemnification. Two of the most difficult and hotly-negotiated sections of any agreement are the representations and warranty provisions and corresponding indemnification provisions. The purpose of the representations and warranties is to two-fold – it provides additional due diligence to the parties, but also provides the means to allocate any past or future risk among the parties. The indemnification provisions address the financial and legal consequences in the event of a parties breach of these provisions. A more in-depth discussion of these provisions is provided below.

h. Miscellaneous. The final section of the agreement covers other general matters. Typical items covered are dispute resolution mechanisms, notice provisions, governing law, signature in counterparts, effect of notice by email or facsimile and electronic signatures.

2. Selected Issues in Asset Negotiation.

i. Escrows. An escrow protects the indemnified party from the wasting of the proceeds of the sale. Typical escrow amounts are ten to twenty percent of the purchase price. The escrow funds are held by a third party and are available for a period of time to assure that the representations and warranties are true. Although these are highly negotiable, it is not unusual to see an escrow reduced after a certain period. In other words, the escrow might last for one year and if no claims are made after six months, the escrow can be reduced by fifty percent. Another form of escrow is an offset right against future payments. If there is a promissory note in the transaction or an earnout, buyers may offset against amounts due under the promissory note losses from breaches of representations and warranties.

If the lawyer acts as the escrow agent and also represents one of the parties, it is important that the lawyer obtain an informed waiver of the inherent conflict in the relationship of escrow agent and counsel. Should there be a dispute between lawyer and client regarding whether or not funds should be released from escrow, if lawyer is not careful, the lawyer will have to resign from representation in order to represent itself in the escrow dispute. Attached as Exhibit “F” is a sample form of Escrow Agreement that contains a sample waiver provision.

The Escrow Agreement should clearly articulate the conditions for release. Preferably, consent of both parties to release of funds. If funds are held in escrow, it is important to obtain appropriate tax information so that interest income in reported properly.

ii. Legal Opinions. Do they serve a useful purpose? Many transactions have done away with the legal opinion requirement because of increased cost and expense. Lawyers should try to keep the technical discussions regarding opinions outside the actual deal process. Clients do not understand what the opinions mean and often can poison a transaction. However, the financing portion of a transaction will always involve legal opinions.

iii. Dealing with Liabilities. There are many business reasons for choosing one structural alternative over another. One important reason to choose an asset purchase over a stock purchase is to prevent the buyer from being held responsible for pre-closing liabilities of the seller. In either a stock purchase or a statutory merger, the buyer, by operation of law, will succeed to the liabilities of the selling corporation. As a result, buyers often prefer asset purchases,


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all other things being equal. However, under certain circumstances, even an asset purchase may result in buyers succeeding to the selling corporation’s pre-closing liabilities. This may be true despite the fact that the buyer did not expressly assume such pre-closing liabilities in the asset purchase agreement.

iv. Environmental Issues.

a. CERCLA/Superfund. Congress drafted Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) in order to provide the Environmental Protection Agency (EPA) with a powerful means of responding promptly and effectively to cases of environmental contamination. CERCLA permits the EPA to respond to actual or threatened releases of hazardous substances by conducting the cleanup itself and suing a wide range of responsible parties for reimbursement. Specifically, CERCLA lists four broad categories of “covered persons” which may be held jointly and severally liable for the cost of clean up as Potentially Responsible Parties (PRPs). PRPs include:

• owners and operators of facilities;

• persons who at the time of disposal of hazardous substances owned or operated a facility at which such substances are disposed;

• generators of hazardous substances or any person who arranges for their disposal or treatment; and

• transporters of waste, if they participate in the selection of the disposal site or facility.

Generally, in the case of a merger, stock sale or other consolidation, the successor corporation or new corporation, as the case may be, is liable for the debts, contracts and torts of its predecessors. Under CERCLA, the government generally has taken the position that the successor corporation in a merger, stock sale or other consolidation assumes the potential environmental liabilities of its predecessors. With respect to asset purchasers, the general rule is than an acquiring corporation does not, merely by purchasing or acquiring another’s property, assume the liabilities of the acquired company. Nevertheless, the government generally maintains, and the courts have held, that CERCLA liability can be imposed on a successor that continues essentially the same manufacturing or business operation as its predecessor.1

A minority of states impose successor liability whenever the purchaser’s business operations retain substantial continuity with those of the seller even if there is a significant change in ownership. In determining whether there is substantial continuity between the purchaser and the seller, courts traditionally balance the following eight factors:

1 NOTE: When the assets purchased include the contaminated property, general corporate law principles are largely

irrelevant, since the acquiring corporation likely will face liability as a current owner under CERCLA § 107(a)(1).


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• retention of the seller’s employees by the asset purchaser;

• retention of the same supervisory personnel;

• retention of the same production facilities and location;

• production of the same product;

• retention of the same name;

• continuity of assets between the seller and purchaser;

• continuity of general business operations; and

• representations by the asset purchaser holding itself out to the public as a continuation of the seller’s enterprise.

After evaluating these factors, courts decide whether an asset purchaser is the legal successor to the seller’s CERCLA liability. The broad sweep of this test, developed under federal common law, tends to subject asset purchasers to successor liability where traditional principles of state corporate law would not. However, in recent years, the U.S. Supreme Court, in its decisions in U.S. v. Bestfoods2, Atherton v. FDIC3, and O’Melveny & Meyers v. FDIC4, cast serious doubt upon the continuing viability of the substantial continuity test. Specifically, in the Atherton and O’Melveny opinions, the U.S. Supreme Court condemned the creation of expansive federal common law rules which, like the “substantial continuity” test, function to abrogate traditional principles of state law. Previously, the Second Circuit applied the substantial continuity despite the Supreme Court decisions. The United States District Court for the Eastern District of New York, in State of New York v. National Services Industries, Inc.,5 refused to apply New York state corporation law in a CERCLA liability case. Relying on the Second Circuit’s decision in B.F. Goodrich v. Betkoski,6 the court found that the easily evaded New York successor liability laws defeated the goals of CERCLA. As a result, the District Court declined to depart from the Second Circuit precedent and applied the substantial continuity test. The Court held that the defendant was the legal successor and, therefore, responsible for the cleanup costs under CERCLA.

2 U.S. v. Bestfoods, 524 U.S. 51 (1998).

3 Atherton v. FDIC, 519 U.S. 213 (1997).

4 O’Melveny & Meyers v. FDIC, 512 U.S. 79 (1994).

5 State of New York v. National Services Industries, Inc., E.D.N.Y., No. 99-CV-2745.

6 B.F. Goodrich v. Betkoski, 112 F.3d 88; 1997 U.S. App. LEXIS 8768 (2d Cir. 1997).


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However, in December of 2003, the Second Circuit reversed the District Court’s decision and held that the “substantial continuity” doctrine no longer applies in CERCLA successor liability cases.7 Overturning its own decision in Betkoski, the Second Circuit found that New York state successor liability law should determine whether a corporation is the legal successor after an asset purchase. The court ultimately held that, after the Supreme Court’s decision in U.S. v. Bestfoods,8 successor liability under CERCLA should be determined by common law rules and not the federal common law CERCLA rule.9 Although the court recognized that the substantial continuity test still applies in the labor law and some products liability contexts, it rejected the test in the CERCLA context.

The Second Circuit’s rejection of CERLA federal common law principles is favorable to asset purchasers, as the New York state successor liability laws are less likely to impose liability. New York state laws apply successor liability to asset purchasers if one of four conditions are met: “(1) the successor expressly or impliedly agrees to assume the liabilities, (2) the transaction may be viewed as a de facto merger or consolidation, (3) the successor is the ‘mere continuation’ of the predecessor, (4) or the transaction is fraudulent.”10 The mere continuation exception, from which the substantial continuity test was derived, “requires the existence of a single corporation after the transfer of assets, with an identity of stock, stockholders, and directors between the successor and predecessor corporations.”11 The National Services court emphasized that the mere continuation test focuses on ownership, rather than continuity of the business as under the substantial continuity test.12

Because each of the four New York state law exceptions have distinct ownership and continuity requirements, courts are less likely to find that a corporation is the legal successor of another corporation after an asset purchase. Thus, these changes may have a substantial effect on the potential environmental liability of asset purchasers.

b. Underground Storage Tanks. In the 1984 Hazardous and Solid Waste Amendments, Congress directed the Environmental Protection Agency to issue regulations governing underground storage tanks (UST), which were ultimately promulgated by EPA in 1988. These rules had a profound impact on the business community because USTs are commonly used by manufacturing and other facilities to store petroleum products and hazardous liquids. The rules not only regulate the installation of new tanks but also mandate changes for existing tanks. In 2015, new Federal regulations were promulgated regarding USTs focusing primarily on proper maintenance and operation. The majority of states (38 and the District of

7 See State of New York v. National Services Industries, Inc., 352 F. 3d 682 (2d Cir. 2003).

8 U.S. v. Bestfoods, 524 U.S. 51 (1998)

9 State of New York v. National Services Industries, Inc., 352 F. 3d at 685.

10 Id. (quoting United States v. Carolina Transformer, 978 F. 2d 832, 838 (4th Cir. 1992)).

11 Id. (quoting Carolina Transformer, 978 F. 2d at 838.

12 National Service Industries, 352 F. 3d at 685.


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Columbia) have delegated oversight authority of the UST program within their borders, meaning they are required to promulgate regulations at least as stringent as the Federal regulations.

The UST regulations define a UST as any tank (and associated piping) at least 10 percent of which is underground, except for certain specifically excluded types of tanks.13 In addition, even if a tank falls within the definition of a UST, it must contain a regulated substance to be subject to the UST rules. Regulated substances include petroleum, petroleum products and hazardous substances (other than hazardous waste) as listed in CERCLA. Some states, such as New York, regulate USTs under separate, but parallel, bulk storage programs depending on whether petroleum-related products or a hazardous substance is being stored. UST rules include provisions which address spills and leaks, secondary containment requirements, operator training, procedures for closing tanks, and reporting and record-keeping requirements for UST owners. When confronting the issue of a leaking storage tank on the premises, the owner may be subject to the rules of Federal or New York State laws and regulations, depending on the jurisdiction. If the contamination consists of petroleum products (such as gasoline and oil), a specific set of New York State laws and regulations apply. Part 613 of the New York Code of Rules and Regulations identify the specific administrative requirements. Article 12 of New York’s Navigation Law, commonly known as the Oil Spill Act, addresses leaks or spills of “oil or petroleum of any kind and in any form including, but not limited to, petroleum, fuel oil, sludge, oil refuse, oil mixed with other wastes and crude oils, gasoline, and kerosene.” Furthermore, Article 12 provides the state with a strong and self-explanatory remedy by stating that, “[a]ny person who has discharged petroleum shall be strictly liable, without regard to fault, for all cleanup and removal costs and all direct and indirect damages, no matter by whom sustained.”14 For all other types of contamination, Federal and State law provide potential remedy options. Under CERCLA, like the Navigation Law, liability is “strict” and attaches to any person who owns and operates property at which hazardous substances were disposed. In New York State, the New York State Inactive Hazardous Waste Registry Program acts as an analog to the Federal program, and allows the State similar options. This includes, but is not limited to, the ability to seek recoupment of costs incurred for having to remediate certain releases to the environment.

v. Product Liability. Under traditional corporate law, there is a universally accepted general rule that a corporation which purchases the assets of another corporation does not, simply by virtue of the asset purchase transaction, become liable for the obligations of the seller. However, there are four traditional exceptions in which an asset purchaser may be deemed liable as a successor:

13 Exclusions encompass tanks that, although technically underground, are not exposed to the same risk of leaks as

those buried in the ground. Thus, tanks located in a basement but situated on or above the surface of the floor are not considered to be underground tanks. Also excluded are farm and residential tanks of 1,100 gallons or less holding motor fuel for non-commercial purposes, tanks used to store heating oil consumed on the premises where the oil is stored, septic tanks, storm water and waste water collection systems, flow through process tanks, tanks of 110 gallons or less and emergency spill and overflow tanks.

14 Article 12, New York Navigation Law.


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a. if the purchasing corporation expressly or impliedly agrees to assume the liability;

b. if the transaction amounts to a “de-facto” consolidation or merger;15

c. if the purchasing corporation is merely a continuation of the selling corporation;16 or

d. if the transaction was fraudulently entered into in order to escape liability.

As in the area of environmental liability, an asset purchaser generally is not liable as a successor unless one of these four exceptions applies.

In the tort context, many courts have concluded that this traditional corporate law approach to successor liability leads to a narrow application of the exceptions to nonliability. Placing an emphasis on the form rather than the practical effect of a particular transaction, the approach has been criticized as being inconsistent with the rapidly developing principles of strict liability in tort and unresponsive to the legitimate interests of a products liability plaintiff.

To remedy inconsistencies with tort law, courts have developed two additional theories of successor liability: the continuity of enterprise theory and the product line continuation theory. These exceptions have not received much attention in the United States and have only been accepted by a handful of states.17 In several jurisdictions, a successor may also be subject to liability based not on its status as a successor, but on an independent duty to warn arising from the

15 In general, a transaction is in reality a de-facto merger when all four of the following factors are present: (1) there

is a continuation of the enterprise of the seller in terms of continuity of management, personnel, physical location, assets and operations; (2) there is a continuity of shareholders; (3) the seller ceases operations, liquidates and dissolves as soon as legally and practically possible; and (4) the purchasing corporation assumes the obligations of the seller necessary for uninterrupted continuation of business operations.

16 The “mere continuation” exception may potentially form the basis for corporate successor liability. Under this

exception, the court considers a series of factors, which include whether the purchaser: (1) retains the same employees and production facilities; (2) produces the same products; (3) maintains the same assets and business operations; (4)retains the same business name; (5)holds itself out to the public as a continuation of the previous enterprise.

17 As of October 2003, the continuity of the enterprise exception in various successor liability cases has been adopted

in Alabama and Michigan, recognized in Ohio, referred to favorably in Pennsylvania and New Jersey, and rejected in Arkansas, Colorado, Delaware, Indiana, Iowa, Illinois, Kentucky, Maryland, Missouri, Nebraska, New York, North Dakota, South Dakota, Vermont, Virginia, and Wisconsin.

The product line exception has been adopted in California, New Jersey, Washington, and New Mexico, referred to favorably in Pennsylvania, and rejected in Colorado, Florida, Georgia, Illinois, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, New Hampshire, North Dakota, Ohio, Oklahoma, South Dakota, Texas, Vermont, Virginia, and Wisconsin. Gerald T. Saltarelli and Edward M. Shin of Butler Rubin, “A Pain in the Assets: Avoiding Successor Liability.” Corporate Counsel October, 2003.


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successor having entered into a special relationship with the predecessor’s customers. These three exceptions are discussed in greater detail as they arise in the following sections.

In New York, the State’s highest court has not adopted either the “continuity of enterprise” or the “product line” exception to the general rule that successor corporations are not liable for their predecessor’s tort, and the 1st and 3rd Departments of the Appellate Division have issued contradictory rulings on this issue. However, New York courts have found the potential for liability under a duty to warn.

e. Continuity of the Enterprise Exception. The continuity of the enterprise doctrine focuses on the continuation of management and ownership between the predecessor and successor corporations. A key element is the common identity of the officers, directors and stockholders in the selling and purchasing corporations. The same principals who previously had conducted a business through one controlled corporation must be conducting the same business through a different controlled corporation. Even when a formal change in management and ownership has occurred, this doctrine still applies where the change is deemed a sham, for example, where the directors and shareholders of the successor are relatives of the directors and shareholders of the predecessor.

If the continuity of the enterprise exceptions is otherwise applicable, successor liability will not be imposed unless two essential elements are established. First, successor liability depends upon the lack of availability of a remedy against the predecessor; in other words, the doctrine is not available where the predecessor is still in existence. Second, a transfer of the assets of the business must have taken place. Thus, even where an alleged successor has the same shareholders, same name and conducts a related business, there can be no successor liability where there has been no transfer of the predecessor’s assets or continuation of its manufacturing activities. In applying the mere continuation doctrine, courts have rejected the “totality of the circumstances” standard and instead have insisted that all of the necessary elements be established. To date, the continuity of enterprise exception has neither been adopted, nor rejected, by the New York Courts. However, a Second Circuit case emphasized that this exception and the product line exception (discussed below) have not been accepted by the New York Court of Appeals in the products liability context.

f. Duty to Warn. Several courts have recognized that a successor to the manufacturer of a defective or dangerous product may be charged with an independent duty to warn third parties, such as the predecessor’s customers, of those defective or dangerous conditions. The independent duty to warn is based largely on the existence of some connection or special relationship between the successor company and the plaintiff or owner of the injury-causing product to create and independent duty on the part of the company to warn of defective or dangerous conditions associated with the product, along with knowledge on the part of the successor company of that defective or dangerous condition.

In New York, there have been a small number of cases in which plaintiffs were injured by products manufactured and sold by a successor company where the courts have rejected the successor company’s argument that it did not have an independent duty to warn their predecessors’ customers of the defective or dangerous condition of products. The Court’s decisions were based


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in part due to agreements on the part of the successors to continue to service products issued by their predecessors.18 A New York case affirmatively rejected an alleged successor corporation’s duty to warn when the dangerous nature of the product was open and obvious. The court stated, “As a matter of common sense, plaintiff should have appreciated the danger of placing his fingers in the path of an automatically traversing and rapidly spinning saw blade. The open and obvious nature of that risk negates any duty to warn on the part of the defendants.”19 Thus, a New York successor corporation may still have a duty to warn where it has assumed liabilities through an agreement or where the product is not obviously defective or dangerous.

vi. Trade Creditor Liability and Non-Tort Liabilities. An asset

purchaser can be liable as a successor corporation for the contract debts of the selling corporation. Courts apply the traditional corporate successor liability laws of the state to attribute the debts to the successor corporation. However, asset purchase agreements generally dictate the assumption of this liability and further successor liability analysis is not usually necessary.

The Second Circuit affirmatively rejected the broader theories of successorship, such as the continuity of the enterprise and product line liability exceptions applied in the tort context, in the contract liability context. The court stated “we are confident that the doctrine of de facto merger in New York does not make a corporation that purchases assets liable for the seller’s contract debts absent continuity of ownership.” Cargo Partner AG v. Albatrans, Inc., 352 F.3d 41, 46 (2nd Cir. 2003).20 While the Second Circuit never mentioned whether the successor had contractually assumed liability, the lower court did note that neither party argued this point.21

The Second Circuit ultimately found that the essential factor in determining whether a de facto merger has occurred is the continuity of stockholders and the transfer of stock to the successor corporation. The court noted that, “continuity of ownership might not alone establish a de facto merger, but as the magistrate judge correctly observed, it ‘is the 'substance' ‘of a merger.”22 Clarifying the terms “continuity of ownership” and “continuity of stockholders,” the court stated that “the former is simply a more general way to state the latter. And, for our purposes, it is a

18 Beck v. Roper Whitney, Inc., 190 F. Supp. 2d 524 (W.D. N.Y. 2001); Klumpp v. Bandit Industries, Inc., 113 F.

Supp. 2d 567, (W.D. N.Y. 2000) (applying New York law); Case v. Paul Troester Maschinenfabrik, 139 F. Supp. 2d 428, (W.D. N.Y. 2001).

19 Lamb v. Kysor Indus. Corp., 759 N.Y.S. 2d 266, 268 (4th Dep’t 2003).

20 In this case, Chase-Leavitt entered into an agreement to purchase all of Albatrans Inc.’s assets. Chase-Leavitt was to provide some brokerage services to Albatrans and would also be paid a percentage of Albatrans’ profits generated by a “profit center” consisting of the assets Chase-Leavitt had purchased. Albatrans Inc. was indebted to Cargo, who then sued Chase Leavitt under the de facto merger doctrine.

21 Cargo Partner v. Albatrans Inc., 207 F. Supp. 2d 86 (S.D.N.Y. 2002).

22 Cargo Partner v. Albatrans, 352 F. 3d 41, 47 (2d. Cir. 2003) (citing Cargo Partner, 207 F.Supp.2d at 104 (emphasis in original)).


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distinction without a difference.”23 As a result, the broader corporate continuity principles espoused in the product liability and labor law contexts did not meet the stricter requirements imposed by the Second Circuit in the contracts arena.

vii. Labor Law. A buyer of a business may succeed to a number of employment-related liabilities of the seller. These liabilities can include unfair labor practices, employment discrimination claims and unexpected responsibility for employee benefits.

a. Unfair Labor Practices. The National Labor Relations Board (NLRB) has, over the years, taken varying positions as to when a particular employer becomes a successor employer required to remedy unfair labor practices committed by its predecessor. In 1967, however, the NLRB adopted its current stance toward successor liability. The NLRB now finds such liability should be imposed where the successor acquires and continues the operation of the business in basically unchanged form, and had notice, at the time of the acquisition of the business, of unfair labor practice charges against the seller.

In the principal case of Golden State Bottling Co. v. NLRB,24 the Supreme Court held that the NLRB has broad powers to issue remedial orders against successor employers in order to further the policies of the National Labor Relations Act. The court observed that where a successor employer continues a business without interruption or substantial change, requiring the successor to remedy its predecessor’s unfair labor practices avoids labor unrest, protects the exercise of rights guaranteed by the Act and offers the victims of the unfair labor practices a meaningful remedy. The Court noted that these goals are accomplished at a relatively minimal cost to the successor employer, who, having notice of its predecessor’s unfair labor practices, can take into account the possibility that it may be required to remedy these practices by negotiating a lower sale price for the business, or by requesting an indemnity clause in the sale contract. Since Golden State, litigation on the issue of an employer’s liability as a successor for its predecessor’s unfair labor practices has largely centered on whether, in a particular case, the requirements of continuity and knowledge have been satisfied. These determinations have been characterized as “fact-intensive,” and the reported decisions frequently cite several factors as bearing on the decisions with regard to each requirement. In New York, the question of enforcement of an order by the New York State Employment Relations Board against successors and assigns has resulted in conflicting decisions as to whether such a board has the power to make its orders applicable to successors of the original employer. For example, following the granting of an application for enforcement of an order of the state labor relations board against an employer in New York State Labor Relations Bd. v. Holland Laundry,25 a motion was made by the Board to resettle the enforcement order so as to direct its

23 Cargo Partner, 352 F. 3d at 47.

24 Golden State Bottling Co. v. NLRB (1973) 414 US 168, 38 L Ed 388, 94 S Ct 414, quoting Perma Vinyl Corp. (1967) 164 NLRB 968, enforced, review den (CA5) 398 F2d 544.

25 New York State Labor Relations Bd. v. Holland Laundry, Inc. (1943) 180 Misc. 1031, 42 NYS2d 183, reh den 180 Misc. 1040, 46 NYS2d 524, enforcement den. 269 AD 827, 49 NYS2d 411, revd on other grounds 294 NY


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provision not only against the corporate employer, but also against “its officers, agents, successors and assigns.” The court granted the motion to the extent of directing that the order run against the respondent corporation, its successors and assigns, and denied it otherwise. However, in State Labor Relations Bd. v. Loram Realty Corp.,26 the court in granting the Board’s application for enforcement of its order modified it to exclude “successors and assigns” from the order, stating that the Board had authority to issue an order directed not only against the respondent corporation but also against its officers and managing agents, and adding: “I do not find any authority, however, which permits the enforcement of the Board’s order against the ‘successors and assigns’ of the respondent.”

While the enforcement of orders by the New York Labor Relations Board against successors and assigns remains unsettled, it certainly should be a concern to parties involved in a merger or acquisition.

b. Employment Discrimination. When a business has allegedly participated in discriminatory employment practices changes its ownership or form of ownership, the question of the liability of the successor business to the claim arises. Applying the doctrine of successor employer liability in unfair employment practices claims under the National Labor Relations Act (“NLRA”) to Title VII claims, the courts in the following cases ruled that successor businesses may be liable to Title VII claims filed against their predecessors, but that such liability depends on the facts of each individual case, including the continuity of business operations and the existence of notice to the successor of the pending claim at the time of the change in ownership.

In EEOC v. MacMillan Bloedel Containers, Inc.,27 the court ruled that Title VII of the Civil Rights Act of 196428 mandates the application of the successor doctrine developed in unfair labor practice cases to employment discrimination cases. The court reasoned that Title VII was molded, to a large degree, after the NLRA, and that considerations set forth by the Supreme Court as justifying a successor doctrine under the NLRA are equally applicable to Title VII cases. Thus, the court reasoned that the failure to hold a successor employer liable for the discriminatory practices of its predecessor could emasculate the relief provisions of Title VII by leaving the victim of discrimination without a remedy or an incomplete remedy. In the case where the predecessor company no longer had any assets, monetary relief would be precluded, and this result would encourage evasion in the guise of corporate transfers of ownership, the court stated. Similarly, the court continued, where relief involved seniority, reinstatement, or hiring, only a successor could provide relief. The court emphasized that the equities of the matter favored successor liability

480, 63 NE2d 69, reh den 295 NY 568, 64 NE2d 278; see also, Midland Windsor, Inc. v. State Labor Relations Bd. (1955) 286 AD 1038, 145 NYS2d 410; New York State Labor Relations Bd. v. George B. Wheeler, Inc. (1941) 177 Misc. 945, 31 NYS 2d 785, mod on other grounds 265 AD 970, 39 NYS 2d 40, affd 291 NY 562 50 NE2d 658;

26 State Labor Relations Bd. v. Loram Realty Corp. 1952) 3 Misc. 2d 709, 113 NYS2d 311.

27 EEOC v. MacMillan Bloedel Containers, Inc. 503 F2d 1086, (6th Cir., 1974).

28 Title VII of the Civil Rights Act of 1964 (Pub. L. 88-352) (Title VII), as amended, as it appears in volume 42 of the United States Code, beginning at section 2000e. Title VII prohibits employment discrimination based on race, color, religion, sex and national origin.


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because the successor has benefited from the discriminatory employment practices of its predecessor. Thus, the primary concern is to provide the victim with full relief and such relief may be awarded against the successor. The court concluded that the evaluation of a successor’s liability should include consideration of the following factors:

• whether the successor company had notice of the charge;

• the ability of the predecessor to provide relief;

• whether there has been a substantial continuation of the business operations;

• whether the new employer uses the same plant;

• whether the same or substantially the same work force is used;

• whether the same or substantially the same supervisory personnel is used;

• whether the same jobs exist under substantially the same working conditions;

• whether the same machinery, equipment and method of production are used; and

• whether he produces the same product.

The reasoning of MacMillan and the nine-part test which that court applied to determine successor liability under Title VII have been widely quoted and relied upon by the courts subsequently considering the successorship issue. The MacMillan test has successfully been applied by the courts in New York to establish successor liability for employment discrimination. In EEOC v. Sage Realty Corp.,29 the Southern District Court of New York determined that a corporation engaged in the business of providing cleaning services was a successor of another corporation, which had conducted the same business but which no longer had any assets or actively engaged in business, and was therefore liable to a sex discrimination complaint brought under Title VII by a former employee of the inactive corporation. The court observed that both corporations furnished cleaning services at an office building where the plaintiff had been employed as a lobby attendant, and that the management of the office building had given permission to the inactive corporation to sell all of its right, title and interest in its contract to clean the office building to the new corporation. The new corporation further purchased all the cleaning equipment of the inactive corporation and hired over 90 percent of its employees, including lobby attendants, who continued to perform similar duties. Noting finally that hiring arrangements with the building management had not changed, that the president of the inactive corporation was now a full-time consultant to the new corporation, and that the new corporation had constructive notice of the sex discrimination complaint, the court found that the new corporation was a successor to the inactive corporation and was liable for the discriminatory acts of its predecessor.

29 EEOC v. Sage Realty Corp. (1981, SD NY) 507 F. Supp 599, later op (SD NY) 521 F. Supp. 264.


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c. Employee Benefits.

• ERISA. Generally, in an asset sale, a buyer does not acquire a seller’s pension liabilities (including the seller’s liabilities under Employee Retirement Income Security Act or “ERISA”) unless the buyer agrees to continue and assume the seller’s pension liabilities. However, if a transaction is undertaken with the principal purpose of evading liability, the successor organization will be deemed responsible for all ERISA liabilities.30 This is true even in the sale of assets.

While most mergers, consolidations, or acquisitions, are unlikely to be an event that results in successor liability, they are event that requires notification prior to taking place. Under ERISA § 4043, an event that may be indicative of a need to modify or terminate an employee benefit plan is likely to require the plan administrator to notify the Pension Benefit Guaranty Corporation thirty (30) days prior to the effective date of such an event.

• Health Care/COBRA. The responsibility for providing COBRA rights in such business reorganizations generally falls into two categories - sales of stock and sales of assets. Under new regulations,31 sellers would continue to have the primary responsibility for providing COBRA rights under either a sale of stock or a sale of assets. However, when the seller does not provide group health plan coverage to any employee after such a transaction (and thus is not responsible for COBRA rights under the statute), the new regulations would require that the buyer of stock or substantially all of the assets assume responsibility for the COBRA rights.

Before the new regulations were adopted, traditional interpretation of COBRA had held that in a stock sale the buyer assumed responsibility for COBRA because the buyer was a successor employer by virtue of acquiring the stock of the seller. In such a case, the buyer would be liable for all rights owed to employees, including fulfilling the employees' COBRA rights.

However, in asset sales in which there was no agreement between the parties with respect to COBRA responsibilities, common law principles would generally provide that the buyer would not be responsible for the providing the COBRA benefits to the seller's employees unless specifically agreed to as part of the transaction.

Because the COBRA rights of employees end when an employer ceases to sponsor any group health plan, the new regulations most clearly impact the situation in which the asset seller terminates its group health plans or goes out of business after the transaction. In such a situation prior to the adoption of the new regulations, an employee terminated as a result of an asset purchase transaction and not hired by the buyer would have no right to receive continued coverage from

30 ERISA § 4069.

31 These regulations became effective on January 10, 2001, but the rules of COBRA’s application in business reorganizations apply to transactions occurring on and after January 1, 2002.


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either the buyer's or seller's plan. The new regulations require the buyer of the assets to provide the COBRA rights to employees from the buyer's plan in this situation.

The regulations contain examples, noting that the sale of a business' assets may involve several separate transactions that, when taken together, relieve the buyer of responsibility for COBRA rights. Such a situation may occur because the seller temporarily continues to maintain a group health plan after the sale, or because the buyer acquires only part of the assets and a subsequent purchaser buys the remaining assets.

The change in regulations represent a significant departure from previous regulations under which a bona fide buyer in an asset purchase transaction was not responsible for COBRA rights unless specified in the acquisition agreement. The additional liabilities imposed by the new regulations make it imperative for parties to a purchase agreement to give special consideration to how they wish to allocate these new COBRA responsibilities.

viii. Unpaid Taxes.

a. Payroll Tax and Other “Trust Fund” Taxes. “Trust Fund” Taxes are best described as those taxes collected by a private agent from the actual taxpayer on the government’s behalf. The agent collects these taxes and holds them “in trust” for the government before finally remitting them to the taxing authority. Such taxes include state and federal withholding taxes, sales and use taxes, the employee portion of FICA and certain other taxes.32

In some jurisdictions, personal liability for trust fund taxes may be imposed on a corporate officer or employee, which may also include penalties and interest due on the tax. For personal liability to be imposed, the officer or employee must have a duty or be responsible for filing the corporation’s tax return or payment of such taxes under some statute. Those responsible for these duties may include a variety of people including those officers or employees who play an active role in the corporation’s overall management, or those who have authority to exercise control or supervision over tax return and tax payment activities without having actual financial control. On the other hand, an officer or director or employee who has little or no supervision or control over such activities may be relieved from liability where circumstances warrant such relief. In New York, like most other states, liability for trust fund taxes can extend beyond the corporate entity, and personal liability for their payment can attach to the person or persons responsible for their payment or nonpayment, as the case may be.33 However, liability for trust

32 Use taxes are treated as trust fund taxes even though they may be “self-assessed” where there is no collecting

agent. For instance, a corporation would have trust fund tax liability for the use tax on merchandise purchased from a vendor located outside New York where the vendor lacks the requisite nexus with New York to require it to collect and remit the tax. The corporation must self-assess the use tax in such circumstances, and it will have trust fund tax liability if it does not.

33 See IRC §§ 6671, 6672; New York Tax Law §§ 1131, 1133. See also, Ouziel v. State of N.Y., 174 Misc. 2d 900, 667 N.Y.S.2d 872 (Ct. Cl. 1997) (personal liability for corporation’s unpaid sales taxes may be imposed on corporate officer or employee); Lorenz v. Dept. of Taxation and Finance of State of N.Y., 87 N.Y.2d 1004, 642 N.Y.S.2d 621, 665 N.E.2d 191 (1996) (allowing the inclusion of penalties or interest due on tax); Hall v. Tax Appeals Tribunal of State of N.Y., 176 A.D.2d 1006, 574 N.Y.S.2d 862 (3rd Dept. 1991).


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fund taxes in New York usually only extends to include either those officers and employees who played an active role in the corporation’s management or those who had a duty to file the return or pay such taxes under the statute.34 Additionally, New York will impose penalties unless the taxpayer shows that failure to file or pay the proper tax was due to “reasonable cause and not due to willful neglect.35

While the number of people who may be held responsible, and ultimately liable, for the payment of trust fund taxes is rather large, responsibility for such taxes will not fall upon a successor entity unless it was part of an attempt to evade or defeat tax collection.

b. Income Tax. Section 6901 of the Internal Revenue Code

provides for the assessment and collection of income tax liabilities from transferees of delinquent taxpayers. The Regulations define transferees to include “the successor of a corporation.” However, application of these provisions has been limited to cases involving transfers for less than a fair consideration, which failed to leave equivalent value available for payment of the tax liability. In any event, the IRS must exhaust its remedies against the taxpayer before it may pursue the transferee, except where the taxpayer is insolvent or otherwise unable to satisfy the liability.

Although Section 6901 has been held applicable to the surviving corporation after a statutory merger or consolidation, it does not appear to have been applied to other types of successorship, traditional or innovational.

3. Representations and Warranties (General).

i. Representations and Warranties. Representations and warranties are promises made by parties to the transactions about the nature and quality of the business being sold, the parties themselves and the prospects for the business.

Representations and warranties are included in a contract for a variety of purposes. The two most important are to help the due diligence process by forcing a seller to disclose the condition of the company and to allocate responsibility and liability for the condition of the company being purchased.

ii. Negotiation of Representations and Warranties. The longest and most arduous task in negotiating a purchase and sale agreement is negotiating the representations and warranties and the related indemnifications. In fact, the negotiations often take on a life of their own. Lawyers representing buyers and sellers should think about the practical effect of a breach of a representation or warranty and not get caught up in worrying about hypothetical circumstances that are likely never to occur. Major points in the negotiation of representations and warranties typically include the description of a “knowledge” modifier to the representations and warranties and the definition of knowledge. Sellers prefer to make representations only to their actual knowledge and only to their own actual knowledge and not the knowledge of everyone

34 Cohen v. State Tax Com’n of State of N.Y., 128 A.D.2d 1022, 513 N.Y.S.2d 564 (3rd Dept. 1987).

35 20 N.Y.C.R.R. § 2392.1(a)(1). The regulations provide examples of circumstances that constitute reasonable cause, such as death, illness, or absence, among others.


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in his or her company. Buyers would like to have absolute representations unlimited by an individual’s actual knowledge or the knowledge of a reasonable person. Another major issue is the liability for a breach of a representation and warranty. The typical liability is indemnification by the breaching party. However, if there is no practical damage for a breach of a representation or warranty, it is pointless to argue with opposing counsel about the representation or warranty itself.

4. Representation and Warranties of the Seller.

The following are typical representations and warranties made by sellers:

i. Legal Status. Legal status of the seller as a corporation, partnership,limited liability company and its qualification to do business in other states and foreign countries;

ii. Power and Authority. The power and authority of the seller to enterinto the transaction documents and to perform the transaction;

iii. Enforceability. The enforceability of the transaction;

iv. No conflict or violation. Whether or not the transactions violate by-laws, contracts, laws applicable to the buying company or the seller;

v. Consents or Approvals. Whether or not consents or approvals needto be obtained for the transaction. The consents can be of a wide variety, including consents from governmental agencies, consents under existing contracts and consents under permits or licenses;

vi. Legal Proceedings. Whether or not there are any proceedingsagainst the company that affect the transaction;

vii. Capitalization. The capitalization of the company;

viii. Corporate Records;

ix. Financial statements. Perhaps the most important representation isthe representation regarding the financial statements of the company. The financial statements are typically the audited year-end statements as well as unaudited interim statements. Representations should make clear that the financial statements are prepared from the books and records of the company, are prepared consistently in accordance with general accepted accounting principals and fairly present the financial condition of the company;

x. Assets. The quality of the assets, real, personal and leased;

xi. Compliance with laws;

xii. Litigation;

xiii. Labor and employment matters;


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xiv. Employee benefit plans;

xv. Transactions with affiliates. This is a critical representation in the understanding of whether the financial statements accurately reflect the condition of the company. If the business was operated with transactions with affiliated parties that cannot be duplicated by a new buyer, the purchase price may have been developed on an unreasonable basis;

xvi. Tax matters;

xvii. Insurance;

xviii. Inventory;

xix. Accounts receivable. It is important that the representation regarding accounts receivable be tied to the indemnification. If the business transaction is that the seller is being paid full value for the receivables and a receivable is not in fact collected by the buyer, the representations and warranties and related indemnifications need to provide the mechanism for the buyer to reduce the purchase price by the amount of the receivables not collected;

xx. Contracts. Important contracts for the business must be delivered to the buyer and necessary to transfer to buyer obtained. A common misconception is that a buyer only needs to worry about assignability of contracts in asset transactions. Most contracts contain change of control provisions which are triggered by a stock sale;

xxi. Suppliers and customers;

xxii. Business records;

xxiii. Bank accounts and directors and officers;

xxiv. Environmental matters. The environmental representation is a highly negotiated representation. In most cases, representations are made to the knowledge of the seller. However, there are transactions in which the seller retains absolute liability for environmental matters;

xxv. Absence of certain changes from a specified date;

xxvi. Responsibility for payment of broker’s fees must be allocated;

xxvii. Product warranties; and

xxviii. Material misstatements or omissions.

5. Representation and Warranties of the Buyer.

The following are typical representations and warranties made by the buyers:


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i. Organization and good standing of the buyer;

ii. The authority, authorization and binding effect of the transaction on the buyer;

iii. That the transaction does not conflict or violate any documents to which the buyer is a party;

iv. Whether or not any consents or approvals need to be obtained;

v. Whether or not there are any proceedings that could stop the transaction; and

vi. Responsibility for payment of broker’s fees.

6. Covenants of the Seller and Buyer.

i. Covenants. Covenants include promises by both seller and buyer during the period of time from the signing of the agreement to the closing and the period after the closing.

Typically banks require the borrower to promise to refrain from doing certain things during the term of the loan. These are typically known as “affirmative” and “negative” covenants. Examples include: a borrower must agree not to sell its assets outside of the ordinary course of business, not to change its business form, not to change its business location, to maintain certain operating and asset ratios (fixed asset ratios, debt equity ratios, net worth ratios) and not to default on other material contracts. The purpose of the covenants are to expand upon the general covenants of operating a business in good faith and in the ordinary course. The covenants provide early warning signals to lenders and equity investors as to the health and welfare of the business. When negotiating with a lender with respect to covenants, it is important to remember that the covenants are highly negotiable and require careful scrutiny. If a borrower is not careful, there can be much disagreement between borrower and lender about when a covenant is met or breached. The affirmative and negative covenant sections of loan agreements are by no means “boilerplate” language. Lawyers need to involve both the principals and accountants to be sure that the covenants work for the particular transaction.

7. Closing and Termination Provisions.

i. Closing. The date, time and place of closing must be specified. It is important to specify whether closing occurs on the open or close of business of the closing date to pinpoint liability transfer and to be sure that profits and losses for the day of closing are allocated to the proper party.

ii. Purchase Price Adjustments. The purchase and sale agreement is executed prior to the closing. It contains representations and warranties and covenants that cover the period of time from the time the agreement is signed to the time the agreement closes. The business will change from the time the agreement is signed to the time it closes. Receivables will be paid and generated, inventory will be created and sold, assets will be sold in the ordinary course,


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lines of credit drawn upon, and other events will occur in the life of the company. The purchase price adjustment is designed to cover those changes as well as allocating to the appropriate party the profit or loss from operation of the business in the interim. Typically, a purchase price adjustment is based on an estimated purchase price which is estimated as of closing and then adjusted following an audit period. The estimated price is often calculated using an inventory conducted close to the closing which inventory is then finalized in the weeks following the closing. Purchase price adjustment provisions typically contain audit rights, cover the payment of the purchase price adjustment, whether interest is included and if the amount of the discrepancy is of significant size, the payment of the third party auditor fee is paid by the party creating the large discrepancy.

8. Indemnification Provisions.

i. Indemnification. Indemnification and escrows describe the process and responsibility if the representations and warranties are breached or covenants are not performed.

ii. General. The indemnification provisions are the remedy to a buyer and seller in the event that a representation made by either buyer or seller is breached or a covenant to be performed is not performed. It is important to distinguish between the breach of a representation and warranty and the non-performance of a covenant. Once a representation is breached, it cannot be cured. The breach may not be material, but it cannot be cured. A failure to perform a covenant can be cured by completing performance. This distinction is important when discussing the operation of baskets and caps on liability.

iii. Indemnification Provisions. The typical indemnification provision should define who are the indemnifying parties and the indemnified parties. The indemnified parties should be broad enough to include the aggrieved party together with any parties that are likely to be aggrieved, including successors and assigns, affiliates and reasonable transferees. The indemnifying parties should include the party to the agreement and any party to whom the assets of that party are transferred. When negotiating indemnification provisions, the indemnifying party wants to limit the parties obligated to indemnify as well as the scope of the indemnification. The indemnified party would like to expand the persons obligated to indemnify as well as the scope of the indemnification. The indemnification should be carefully drafted. It should obligate the indemnifying party not only to indemnify but to defend the indemnified party from liability. This is an important distinction. Indemnification should include responsibility for all costs, liabilities and other matters arising out of a breach or non-performance including the payment of legal fees. There is indemnification available at common law. However, the common law right to indemnification excludes attorneys’ fees.

The indemnification should cover indemnification for breaches of representations and warranties and for the failure to perform covenants. In a typical agreement both buyer and seller indemnify each other from breaches and non-performances. To the extent the indemnification covers matters other than the breach of the representations and warranties, the indemnifying party is at greater risk of being obligated to indemnify for a liability which the indemnifying party did not intend. For example, a blanket indemnification against anything that happens prior to the closing negates the carefully drafted and limited representations regarding financial statements,


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because anything that goes wrong will be covered by the indemnification. Consequently, it is important that a seller only indemnify for breaches of representations and warranties, not for other matters. In the same fashion, a buyer should only be assuming specified liabilities. If the buyer highly negotiates the liabilities being assumed and then indemnifies against anything that happens to the business following closing, there was little point in limiting the liabilities being assumed.

iv. Limitations on Indemnification. Buyers want the indemnification to survive the closing forever while sellers do not want representations to survive the closing. The survival period is a highly negotiated item. Again the distinction between the survival period for breaches of representations and warranties versus performance of covenants is an important one. There should be no survival limitation on performance. A promise is either performed or it is not. It should survive closing until it is performed and there should be a remedy for any failure to perform. The survival period for representations and warranties typically is different for each representation and warranty. Representations as to title usually are unlimited while representations regarding financial conditions are much shorter. Representations for payment of taxes usually are for the statute of limitation period. Representations for environmental issues also are highly negotiated.

v. Baskets and Caps. Liability for breaches of representations and warranties is often limited to liabilities which exceed a certain amount of loss. Typically this is thought of as a deductible. The maximum amount of liability is often capped. Baskets, thresholds and caps are highly negotiated. Typically, baskets or thresholds are between one and five percent of the purchase price. Caps are often the purchase price or the tax affected amount of the purchase price. In other words, the amount made by the seller after tax is the limit of his or her liability. Exceptions to the amount of baskets, caps or thresholds are usually fraud and for those representations and warranties which are dollar for dollar. Typically, collection of accounts receivables are exceptions to the basket. The difference between a basket and a threshold is that a basket acts as a true deductible which means that the first amount of losses are borne by the buyer whereas a threshold is an amount once passed, the buyer is indemnified from dollar one.

Other limitations on indemnifications are repayment in the event amounts are collected from third party sources like insurance or in the event there is a tax benefit to the loss. These are very difficult to calculate but often are negotiated. If the indemnified party receives insurance after the indemnifying party pays, the indemnified party is obligated to repay the indemnifying party. In the same fashion if the indemnified party obtains a tax benefit as a result of the loss, the agreement is often written to not obligate the indemnifying party to provide a windfall to the indemnified party by the amount of the tax effect. Sometimes indemnification provisions are written such that if the purchase price was based on a multiple of earnings and the earnings would have been different as a result of the breach, the purchase price would be reduced by a multiple of the amount of the loss. In other words, if the purchase price was five times earnings and the earnings of the company were $100, the purchase price is $500. If the actual earnings, as a result of the breach were only $80, the purchase price should have been $400. The loss then would be $100.


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V. GENERAL TAX PLANNING CONSIDERATIONS

In structuring a business acquisition, three options are generally available to the parties:

� A stock purchase transaction in which the buyer purchases all of the capital stock of the selling corporation directly from the selling corporation’s shareholders.

� A statutory merger in which the buyer, either directly or through a newly created, wholly owned subsidiary, merges with a selling corporation, and pursuant to the merger the selling corporation’s shareholders receive cash, stock or other consideration.

� An asset purchase where the buyer purchases certain business assets from, and assumes certain specified liabilities of, the selling corporation. In this scenario, the selling corporation ordinarily dissolves after the merger and distributes the purchase price to its shareholders.

As discussed in Exhibit “A”, when forming a business, the choice of entity must take into account significant tax consequences. Similarly, the sale of a business is accompanied by a host of additional tax considerations. The following sections provide an overview of stock sales and asset sales, highlighting some of the relevant tax considerations for each type of sale.

Generally, sellers prefer stock sales because such sales tend to be simpler and a C corporation shareholder will only recognize a single layer of tax on the sale of his or her stock, ordinarily taxed at the preferable capital gains rate. Typically, a sale of stock is an easier transaction to accomplish. In a sale of stock, the corporation or other entity stays the same, its ownership changes. Many contracts, leases, licenses, permits and other important matters to a corporation are not changed by a change of ownership. Consequently, the transfer of stock often requires less third party interaction.

In contrast, buyers generally prefer an asset sale because the buyer buys individual assets and allocates a value to those assets allowing the buyer to “step up” the basis in the purchased assets which allows for greater depreciation deductions. In a stock sale, the purchaser obtains the “carryover” basis of the seller in the stock sold. In addition, the buyer can select the assets and liabilities to purchase and leave unwanted assets and unwanted liabilities behind. A stock sale, by operation of law, requires that all liabilities contained in the corporation stay with the corporation. While there are ways to ameliorate this problem, most would agree that a claim against a corporation in a stock sale is easier to make than a claim against the purchaser in an asset sale.

The inherent tension involved in the sale structure preferences between a buyer and seller provides an opportunity for negotiation and strategic tax planning during deal-making, some of which is discussed here. The following summarizes some of the advantages and disadvantages of stock versus asset sales and then addresses some strategic tax considerations specific to C corporation sellers. Attached as Exhibits “G” and “H” are two articles from Practical Law entitled Asset Acquisitions: Tax Overview and Stock Acquistions: Tax Overview which provide additional information concerning the tax consequences and differences between a sale of assets versus a sale of stock.


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A. Sale of Stock.

1. Advantages and Disadvantages of a Taxable Stock Sale.

i. Advantages:

a. Simpler for seller. No need to liquidate.

b. May leave “problems” in corporation.

c. Avoids assignment of leases, contracts, patents, etc.

d. May avoid triggering mortgage acceleration clauses.

e. Avoids bulk sales compliance.

f. Avoids sales tax on underlying assets.

g. Buyer need not set up new corporation.

h. Seller may avoid tax recapture costs.

i. Buyer may utilize some net operating losses.

j. Corporate and shareholder approval not required.

k. Single level of tax and capital gain preference.

l. May generate state tax exempt income.

ii. Disadvantages:

a. Buyer may acquire undisclosed liabilities.

b. Certain tax attributes may remain.

c. Buyer may obtain unwanted assets. Cannot be selective.

d. Buyer may not want a corporation.

e. Corporation may be defective in some way.

f. Contract and transaction may be more complex, especially representations and indemnification clauses.

g. Problem if not all shareholders will sell.

h. No step-up in basis of assets.


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i. Buyer may offer a lower price because assets retain their carry-over basis.

2. Stock Sale – Tax Consequences.

i. Capital gain or loss for seller at price less basis. Acquiror’s basis in the target’s stock is generally the amount paid for the stock plus acquisition expenses; assets retain carry-over basis.

ii. Tax Rates - ordinary income is taxed to individuals at a maximum of 39.6%, and long term capital gain is taxed at a maximum of 20% (federal rate). New York State maximum income tax rate is 8.82% for 2016 (12.696% for NYC). New York State does not have a preferential rate for long-term capital gain.

iii. Alternative minimum tax may apply as the result of large state and local income tax payments.

iv. Special situation: I.R.C. § 338 permits treatment of stock purchase by a corporation as an asset purchase if certain tests are met (see V(A)(3), below).

v. Use of net operating losses may be limited or prevented. See I.R.C. § 382.

vi. In a partnership, the sale of a partnership interest is similar to a sale of stock. The transfer of a partnership interest generally gives rise to gain or loss equal to the difference between the value paid for the interest and the partner’s adjusted basis in the interest; however, gain may be characterized as either ordinary or capital.36

B. Sale of Assets.

1. Advantages and Disadvantages of a Taxable Asset Purchase.

i. Advantages:

a. Buyer may be selective in selling or retaining items; seller may sell only a portion of the business.

b. May choose new S corporation, C corporation, partnership, LLC or proprietorship.

c. Buyer avoids problems of built in gains or losses.

d. Allocation of purchase price to specific assets results in basis step up for buyer.

36 See IRC 751(a).


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e. Assets may be split between various entities.

f. Gain may be apportioned for state tax purposes.

ii. Disadvantages:

a. Selling entity is taxed when appreciated assets are sold at a gain.

b. Loss of capital gain preference.

c. May result in double tax if liquidation of corporation involved.

d. Seller has expense of liquidation; buyer may have expense of new corporate formation.

e. Licenses, contracts may not be assignable.

f. Sales tax on certain assets.

g. Bulk sales compliance.

h. Board authorization and two-third shareholder approval required for sale of substantially all assets. N.Y.B.C.L. § 909.

2. Asset Sale – Tax Consequences.

i. Primary tax motivation for this sale structure is for a purchaser to obtain cost basis in target’s assets equal to the amount paid. This allows the buyer greater depreciation deductions.

ii. Seller has capital gain for capital or I.R.C. § 1231 assets, ordinary income for others. Depreciation recapture and recognition of gain from sales of inventory occur immediately, even if other gain is deferred under installment method.

iii. If seller is a corporation, corporate level gain, due to legislative repeal of General Utilities. See I.R.C. § 311, as amended. If proceeds of sale distributed to shareholders, second tax (at shareholder level) will result on shareholder’s stock gain (property received less basis of stock surrendered). Note, C corporations do not have preferential rates for long-term capital gains.

iv. If seller is a S corporation or taxed as a partnership, e.g., LLC, double tax normally avoided (unless 10 year built in gains rule of amended I.R.C. § 1374 violated for an S corporation, which states that if a target filed its S corporation election after Dec. 31, 1986, the entity must pay a corporate level tax on gains from its sale of assets during its first 10 years as an S corporation).


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v. Alternative minimum tax. (See V(A)(1)(ii)(c), above.)

vi. Federal bulk sale provision resembles N.Y. Tax Law § 1141(c) but requires that transferor was insolvent or rendered insolvent by transfer. See I.R.C. § 6901; see also CBC Super Markets, 54 T.C. 882 (1970).

3. Allocation of Purchase Price in an Asset Sale.

i. Allocation of purchase price was once left to parties, but I.R.C. § 1060 now requires adherence to special allocation rules to ensure proper allocation to goodwill. Price is allocated to identifiable assets based on fair market value and excess value or premium is allocated to goodwill or going concern value. Under I.R.C. § 1060, the total purchase price is allocated among seven asset classes in the following order: (1) cash; (2) marketable securities; (3) market to market assets and accounts receivable; (4) inventory; (5) assets not otherwise classified; (6) Section 197 intangibles other than goodwill and going concern; and (7) goodwill and going concern value.

ii. Class (6) and (7) assets (described above) contained in I.R.C. § 197 were added to the Code by the 1993 Tax Act. Section 197 intangibles acquired after the enactment of the 1993 Act are now generally amortizable on a straight line basis over 15 years (irrespective of the asset’s actual useful life). Section 197 intangibles include the following:

a. Goodwill – defined as the value of a trade or business attributable to the expectancy of continued customer patronage. This expectancy may be due to the name or reputation of a trade or business or any other factor. Treas. Reg. § 1.197-2(b)(1).

b. Going concern value - defined as the additional value that attaches to property by reason of its existence as an integral part of an ongoing business activity, which includes the value of a business to continue functioning or creating income without interruption despite an ownership change. See Treas. Reg. § 1.197-2(b)(2).

c. Workforce-in-place

d. Books, records, operating systems, or other information

e. Patent, copyright, formula, or similar knowhow

f. Any customer-based or supplier-based intangible

g. License, permit, or other government issued rights

h. Covenant not to compete

i. Franchise, trademark, or trade name

iii. Goodwill is divided into two categories: (i) customary or business goodwill and (ii) personal goodwill. Customary goodwill arises from the intangible assets of the


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business. Personal goodwill derives from the individual skill, ability, personality, and reputation of a single person working for a business.37

iv. There is a tension between buyers and sellers during the purchase price allocation process. Sellers generally prefer to allocate purchase price to assets that will produce either a long-term capital gain or ordinary loss. Buyers, on the other hand, typically want value attributed to assets that are currently deductible or to depreciable assets with short recovery periods. Allocation under I.R.C. § 1060, if reasonable, will generally be respected for state sales and transfer tax purposes.

v. Consider investment tax credits during allocation process.

C. Deemed Asset Sale (IRC Section 338(h)(10) Election).

1. This election provides a corporate purchaser with the convenience of a stock purchase and the tax benefits of an asset purchase (with the principal benefit being the purchaser receives the target’s assets with a “stepped up” tax basis).

2. Eligible purchasers: limited to corporations, including those business entities that elected to be treated as corporations. (As of May 2013, under I.R.C. § 336(e), entities other than corporations may elect to treat a qualifying stock purchase as a deemed asset sale.)

3. Eligible targets: limited to domestic entities where the target is either (i) a member (not the parent) of an affiliated group of corporations or (ii) an S-corporation.

4. Purchaser must make a “qualified stock purchase” of the target’s stock, meaning the purchaser acquires 80% of the target’s stock “by vote and value” within a 12 month period. See I.R.C. § 338(d)(3).

5. The Section 338(h)(10) election must be made by the purchaser and the target’s shareholders.

6. Once the election is made, the following is deemed to occur: (1) the purchasing corporation creates a new corporation (“new target”); (2) the new target purchases the assets of the target (“old target”) at a price that reflects the price paid for the old target’s stock; (3) the old target is liquidated; (4) the sale of the old target’s stock is essentially ignored and the old target’s shareholders pay only one layer of taxation.

7. What makes this election advantageous compared to others (e.g., I.R.C. § 338(g)) is that this election typically results in one level of tax, thus making this election a tax efficient method of obtaining basis step-up in the target’s assets.

37 See Darian M. Ibrahim, The Unique Benefits Of Treating Personal Goodwill as Property in Corporate Acquisitions,

30 Del. J. Corp. L. 1 (2005).


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D. Special Considerations for C Corporation Shareholders.

1. Sale of Assets: Under many circumstances, a C corporation seller will experience double taxation on the gain from an asset sale distributed to C corporation shareholders. For the shareholders of a closely-held C corporation, however, there may be three strategies available for alleviating a portion of the double taxation from an asset sale. These strategies include the allocation of purchase price to (i) personal goodwill, (ii) non-compete agreements, and/or (iii) consulting agreements, discussed below. See illustration attached as Exhibit “I” of these tax strategies.

2. Personal Goodwill: Allocating purchase price to personal goodwill may have beneficial tax consequences for the buyer and seller. For example, if the shareholder of a closely-held C corporation sells personal goodwill, the gain on that sale is only taxable to the individual shareholder at capital gains rates.38 Personal goodwill is considered a separate asset of the shareholder. The C corporation avoids paying taxes on the sale of personal goodwill at corporate income tax rates. The buyer may then amortize personal goodwill over 15 years, as long as the personal goodwill is associated with the acquisition of the trade or business.39

Distinguishing between customary/business and personal goodwill requires a fact-specific inquiry. Personal goodwill exists almost exclusively in closely-held corporations. The proponent of personal goodwill must show that the shareholder never transferred his goodwill to the business (e.g., the shareholder did not enter into a non-compete agreement with the selling corporation). In addition, a buyer must protect its value allocation to personal goodwill by preventing the selling shareholder from continuing to use or share his personal asset. A buyer may insist the shareholder sign a non-compete agreement at closing or partake in an earn-out to assist with the transfer of personal goodwill assets to the buyer.40

3. Non-Compete Agreements: Allocating part of the purchase price to a non-compete agreement with the selling shareholder results in a single level of gain to the shareholder taxed at ordinary income rates. The purchaser may amortize the value allocated to the non-compete agreement over 15 years. See I.R.C. § 197.

4. Consulting Agreements: Allocating part of the purchase price to a consulting agreement with the selling shareholder results in a gain to the shareholder taxed at ordinary income rates. The purchaser may deduct the value allocated to the consulting agreement as it is expensed to the extent of the services performed by the shareholder.

38 See id. (note, this analysis assumes the Court will consider personal goodwill to be property).

39 See Martin Ice Cream Co. v. Commissioner, 110 T.C. 189 (1998); see also Bross Trucking, Inc., et al. v.

Commissioner, T.C. Memo. 2014-107.

40 See 30 Del. J. Corp. L. 1, supra note 26; see also Robert W. Wood, Bross Trucking Reaffirms Martin Ice Cream, Tax Notes, Sept. 29, 2014, p. 1607; 144 Tax Notes 1607 (Sept. 29, 2014).


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5. Small Business Corporation Stock: The Code also gives preferential treatment to equity investments in small business corporations.41 Section 1045 allows the tax-deferred rollover of gain realized on the sale of stock of one qualified small business corporation into stock of another qualified small business corporation. Section 1202 allows a significant exclusion for gains recognized with respect to stock of qualified small business corporations. Section 1244 allows ordinary loss treatment with respect to the stock of small business corporations. In general, each of these provisions is only available to non-corporate shareholders and not all of these provisions apply to the same investors.

6. There are many technicalities and limitations to qualify for these provisions which are beyond the scope of this outline; however, the general requirements for each provision is as follows:

7. Section 1045 – allows a taxpayer to sell qualified small business (QSB) stock without recognizing gain if the taxpayer rolls that gain over into new QSB stock within a 60-day period beginning on the date of the sale, provided (a) the taxpayer is not a corporation, (b) the taxpayer sells the stock, (c) the taxpayer has held the QSB stock more than six months at the time of the sale; and (d) the taxpayer elects to apply the provisions of §1045. If a taxpayer meets all of these conditions, the taxpayer will only recognize gain to the extent that the amount realized on the sale of the QSB stock exceeds the cost of any QSB stock purchased.

8. Section 1202 - allows taxpayers other than corporations, to exclude from gross income some or all of gain recognized on the sale or exchange of QSB stock held for more than five years. As a general rule, the gain exclusion is 50%, but it is increased to 75% for QSB stock acquired after February 17, 2009, and before September 28, 2010, and to 100% for QSB stock acquired after September 27, 2010, and before January 1, 2014. Congress enacted §1202 in 1993, applicable to stock issued after Aug. 10, 1993. At the time that enacted, Congress had not yet reenacted the general capital gain preference. Therefore, stock cannot enjoy both the general capital gain preference and the §1202 exclusion.

9. Section 1244 – allows ordinary loss treatment to individuals (directly or through partnerships) who recognize a loss on §1244 Stock that was originally issued to them for money or property by a domestic small business corporation. However, the maximum amount of loss that an individual may treat as ordinary loss under Section 1244 is $50,000 ($100,000 if married filing jointly).

41 The definition of “qualified small business corporation” used in the gain provisions of IRC §§1045 and 1202 is

very different from the definition of “small business corporation” used in the loss provision (§1244). The gain provisions measure a corporation's gross assets and limit the provisions' applicability to corporations with no more than $50,000,000 in gross assets up through the time that they issue stock. On the other hand, §1244 measures a corporation's receipt of capital equity investments up through the time of stock's issuance and limits the provision's applicability to corporations that have received no more than $1,000,000 in equity capital. I.R.C. §1202(d)(1). Another important distinction is that the gain provisions are limited to C corporations but the loss provision applies to S corporations as well; however, since S corporations pass all losses through to shareholders, the benefit to S corporation shareholders may be limited.

© 2017 Hodgson Russ LLP

EXHIBIT A

BUYING OR SELLING A SMALL BUSINESS

CHOICE OF ENTITY

Thomas J. Collura

Hodgson Russ LLP �

Albany, New York

Saratoga Springs, New York

Palm Beach, Florida

�

(518) 433-2443

[email protected]

A-1 © 2017 Hodgson Russ LLP

I. CHOICE OF ENTITY.

A. Perhaps the most important decision for a business owner is the choice of entity to operate the business. There are many factors which must be weighed, examined and reevaluated to accomplish the business owner’s current and future concerns regarding ownership, management, operation and succession of the business. The following is a summary of various choices of entity and the business, financial, tax and other factors to consider in choosing the business form.

1. Sole Proprietorship – A business conducted in an individual owner’s capacity; not a separate business entity for federal tax purposes.1

2. Partnership (General or Limited) – An association of two or more persons carrying on a business for profit; a separate entity for federal tax purposes.2

3. “S” Corporation – A type of corporation where shareholders elect to have corporate level income treated as directly received by shareholders. See I.R.C. §§ 1361 -1362.3

4. “C” Corporation – A type of corporation created under state law that is separate and distinct from its owners; may be subject to double taxation. See I.R.C. § 1361(a)(2).

5. Limited Liability Company (“LLC”) – A hybrid entity created under state law that generally combines the liability protection of a corporation with the federal tax benefits of a partnership. See N.Y.L.L.C. § 102(m).4

B. Business Considerations.

1. Limited Liability: Available with a corporation, a limited liability company, and for limited partners in a limited partnership, but not for general partners. Note, however, a general partner admitted into a pre-existing partnership is only personally liable for obligations incurred after his or her admission.5

Corporation: A shareholder is not personally liable beyond the amount of his or her investment.

1 See Williams v. McGowan, 152 F.2d 570 (2d Cir. 1945) (this case established the rule that a proprietorship is not a

separate taxable entity).

2 See Uniform Partnership Act § 6(1) (1914).

3 I.R.C. refers to the Internal Revenue Code of 1986.

4 See also Limited Liability Companies FAQs, available at http://www.dos.ny.gov/corps/llcfaq.asp#whatisllc.

5 See Revised Uniform Partnership Act § 306(b) (1997).


LLC: A member has limited personal liability, even if a member is designated as a manager.6

Limited Partnership: A limited partner is only liable to the extent he or she contributed capital.7

For liability considerations, determine: Is adequate insurance available? At a reasonable cost? If not, consider using a corporation or LLC. Limited liability of corporate shareholders and LLC members may not exist for certain liabilities or certain shareholders (or members of an LLC), especially where they are responsible officers of the corporation. See

e.g. I.R.C. § 6672 and N.Y. Tax Law §§ 1131(1) and 1133(a) which impose personal liability for certain withholding taxes. See also N.Y. Business Corporation Law (“B.C.L.”) § 630, which imposes personal liability for certain wages. In addition, a manager of an LLC may be personally liable to LLC members if he or she fails to act in good faith or meet the conduct for governing outlined in the articles of organization. See N.Y.L.L.C. §§ 409, 417.

2. Centralized Management: Management can be concentrated in a board of directors of a corporation or in the general partners of a limited partnership. If a limited partner participates in the management or control of a partnership, he or she may risk the loss of limited liability status.8 In a general partnership, centralization may be more difficult but may be possible, to an extent, through designation of a managing partner or through other devices. An LLC will normally appoint managers and thus achieve centralization of management. In New York, unless the operating agreement provides otherwise, LLCs are considered to be “member-managed LLCs,” meaning each LLC member is deemed to participate equally in the management process. See N.Y.L.L.C. § 401-402.

3. Bringing in Investors: Requirements of investors may influence the choice of entity. Will the group of investors be large or small? Will they be active in the operation of the business? Some may want votes while others may want a preferred return on investment. Some may want full participation plus limited liability. Although classes of partnership and LLC interests can be used to accomplish certain objectives, if the number of investors is large or the objectives are varied, classes of corporate stock may be more desirable. Stock can be voting or nonvoting, preferred as to dividends,

6 See Uniform Limited Liability Company Act § 303 (1996).

7 See Revised Uniform Limited Partnership Act § 303 (2001).

8 See id.


liquidating distributions and redemptions, cumulative or noncumulative as to dividends, convertible into other classes of debt or equity, etc.

4. Transferability. Generally, investors prefer transferable or marketable interests. Shares of a corporation are usually more readily transferable than partnership interests or LLC membership interests, although transferability may be reduced, as a practical matter, because of buy sell agreements or the closely held nature of a business. Generally, the shares of a corporation are freely transferable by sale or gift. In contrast, when a general or limited partner sells his or her right in a partnership, the transferee usually obtains only economic rights (e.g., to a share of partnership profits). The transferee does not gain management control within the partnership unless admitted by a partnership vote.9 Under most circumstances, transfer of an LLC membership interest is subject to the same restrictions as transfer of a partnership interest.10 In New York, for example, an LLC member may assign his or her membership interest, but the assignee does not become an LLC member unless he or she gains approval through written consent or by a majority vote. See N.Y.L.L.C. § 603-604.

5. Continuity: The death of a partner or member may terminate a partnership or LLC, but the death of a shareholder does not affect a corporation’s legal status. A corporation exists in perpetuity unless the corporation’s articles of incorporation specify otherwise.11 But note that a corporation may lose its franchise due to unexpected problems such as failure to pay its state franchise taxes for two consecutive years (N.Y. Tax Law § 217), exceeding its legal authority (N.Y.B.C.L. § 101(a)(2)), a deadlock of directors or shareholders (N.Y.B.C.L. § 1104), oppressive action by those in control directed against complaining shareholders (N.Y.B.C.L. § 1104 a), etc. A partnership continues for the term identified in its partnership agreement.12 Likewise, an LLC continues for the term identified in its articles of organization.13 Similar to a corporation, aggrieved LLC members may petition for judicial dissolution of an LLC. See N.Y.L.L.C. § 702 (portions of the N.Y.B.C.L. may be considered in determining dissolution by operation of law. See N.Y.B.C.L. § 1104).14

6. Nature of the Business. Partnerships are often used for small businesses, for tax preferred investments, for professional services businesses (e.g.

9 See Revised Uniform Partnership Act §§ 502, 503 (1997).

10 See Uniform Limited Liability Company Act §§ 502, 503.

11 See Model Business Corporation Act § 3.02 (1999).

12 See Revised Uniform Partnership Act § 801 (1994).

13 See Uniform Limited Liability Company Act § 203(a)(5).

14 See also Schindler v. Niche Media Holdings, LLC, 1 Misc. 3d 713, 772 N.Y.S. 2d 781 (Sup. Ct. 2003).


doctors, lawyers) and in other situations. LLCs are also versatile entities that have become more commonplace. In New York, for example, an LLC can be formed for “any lawful business purpose” and that purpose does not need to be disclosed in the articles of organization. See N.Y.L.L.C. § 401. Corporations are frequently used in high risk businesses such as construction companies and in larger or more complicated businesses where passive investors wish to delegate control to officers and directors. Certain businesses subject to state licensing requirements may find that they cannot use a normal business corporation for the licensed professions, but that a Professional Service Corporation can be used. See generally Part 15 of N.Y.B.C.L.; see § 1503(a) regarding engineering, architecture and other professions. Incorporation of certain businesses may require prior approval by regulatory bodies. See N.Y.B.C.L. § 201(d) (day care center for children requires social services approval); § 201(e) (hospital requires public health council approval). In addition, limited liability partnerships in New York allow the formation of a partnership to provide professional services. See

Article 8-b of N.Y. Partnership Law.

7. If a pass-through entity (an entity that is not, itself, subject to tax) is desired, an LLC deserves serious consideration. It affords its members protection from the organization’s tort and contract liabilities, like an S corporation. An LLC is also more flexible than an S corporation in that the types and number of members are not restricted, distributions need not be ratable, etc.

8. State tax issues may also have a bearing on the decision. Are the owners all in New York State? Will the entity do business in states other than New York? Not every state follows the federal treatment of S corporations and LLCs.

C. Financial Considerations.

1. Compare the added costs of incorporating and maintaining the corporation with the advantages to be derived. Do the advantages justify the added costs?

2. Costs include filing and organizational fees, legal fees, annual franchise taxes ($25 minimum in New York State15), costs of qualifying to do business in other states, additional or more complex tax returns, payroll taxes and returns, costs of bank accounts, costs of various types of insurance (e.g. liability, property, workers’ compensation, bonding, unemployment insurance), costs of obtaining taxpayer I.D. number, sales tax I.D. number, unemployment insurance I.D. number, permission to pay wages by check, permits, licenses, approvals, cost of letterhead and contracts in corporate name, costs of problems in assigning leases, contracts (e.g. manufacturers

15 See Definitions for Article 9-A Corporations, the NYS Dept. of Taxation and Finance, available at

http://www.tax.ny.gov/ bus/ct/def_art9a.htm#min tax.


rep or auto dealership) or other rights or obligations to the corporation, etc. There may be annual filing fees for other entities (i.e., LLC’s) as well. In addition, New York imposes a tax on LLC’s based on the number of LLC members.16 See Appendix A for a chart comparing New York State filing fees for different New York entities.

3. Banks, bonding companies or others may prefer a corporation because of the continuity, different interest ceilings for individuals and corporations, the ability to accumulate assets in the corporation, etc. If an individual owns several businesses and each is subject to separate risks (e.g. three restaurants each subject to food poisoning risks) banks and others may prefer three corporations because the limited liability provided by each corporation may insulate the assets of the other two corporations and help to assure the long term viability of the overall business.

D. Tax Considerations – General.

1. Generally, income from a sole proprietorship is reported on the individual owner’s federal income tax return and is subject to the income tax rates applied to individual taxpayers. See I.R.C. § 1.

2. Typically, partnerships are not taxable entities. Income, losses and credits flow through and are utilized by each partner. See I.R.C. § 701; N.Y. Tax Law § 601(f). The highest federal individual rate (on ordinary income reported on a joint return) is 39.6% for taxable income over $457,600. A partnership must file an information return, which includes the name of the partners and the amount of income, deductions, gains, or loss attributed to each partner. See I.R.S. Form 1065.

3. Generally, for capital assets held by an individual longer than 12 months, the gain recognized on the sale will be taxed at a maximum rate of 20%. This lower rate may also apply to dividend income.

4. There is no separate federal or New York State tax regime for LLCs. Under most circumstances, LLCs are treated as partnerships for federal tax purposes, although a taxpayer may elect to treat an LLC as a corporation (see Section 6). For New York State tax purposes, the State’s tax treatment of an LLC will conform to its federal classification.17

5. C corporations are taxable on their incomes at graduated rates that may or may not be lower than individual rates. See I.R.C. § 11. Federal rates for 2014 are as follows:

16 See also Limited Liability Companies FAQs, available at http://www.dos.ny.gov/corps/llcfaq.asp.

17 See New York State Dept. of Taxation and Finance, Publication 16, available at http://www.tax.ny.gov/ pdf/publications/multi/pub16.pdf.


Taxable Income Rate

$50,000 15%

$50,000-75,000 25%

$75,000-100,000 34%

$100,000-$335,000 39%

$335,000-10M 34%

$10M-15M 35%

$15M-18.333M 38%

$18.333M+ 35%

Consider, also, the important impact of New York State franchise taxes, which are the higher of $25 (minimum), 7.10% (6.5% for certain small businesses) of allocated entire net income (for 2014), 1.5% of allocated minimum taxable income or .15% of allocated business and investment capital.18 See N.Y. Tax Law § 210(1)(a).

Consider also the FICA (Federal Insurance Contributions Act) taxes of corporation shareholder employees versus the self-employment taxes of general partners and many LLC members. For 2014, the employer and employee each pay FICA taxes at a rate of 7.65% (15.3% total). This 7.65% breaks down to 6.2% for Social Security and 1.45% for Medicare hospital insurance. The 6.2% (but not the 1.45%) tax only applies to a certain portion of the taxpayer’s wages (the first $117,000 in 2014). For self-employed persons, rates are 12.4% for Social Security (subject to the same ceiling) and 2.9% for Medicare hospital insurance.19 An additional Medicare tax went into effect in 2013 and applies to wages, railroad retirement compensation, and self-employment income over certain thresholds (e.g., threshold for married filing jointly is $250,000). The additional Medicare tax rate is 0.9%.20

i. Employment tax distinctions between S corporations and LLCs: A managing member of an LLC is not considered an employee and is, therefore, required to pay the 15.3% self-employment tax on net earnings over $400. Generally, the amount subject to this tax is

18 Source for 2014 rates: see http://www.tax.ny.gov/bus/ct/def_art9a.htm#fix min tax.

19 Source for 2014 rates: see http://www.ssa.gov/policy/docs/quickfacts/prog_highlights/RatesLimits2014.pdf.

20 See Internal Revenue Service, Questions and Answers for the Additional Medicare Tax, available at http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax.


92.35% of a member’s net earnings from self-employment.21 This self-employment tax rate is two times higher than the tax rate of a shareholder-employee in an S corporation. An S corporation shareholder is considered a corporate employee if he or she provides employee services to the S corporation. As discussed above, an S corporation is subject to FICA taxes. The S corporation shareholder-employee pays one-half the employment tax of a managing LLC member (at a rate of 7.65%) for wages paid by the S corporation. The S corporation, itself, pays the other half of the employment tax for its shareholder-employees. The net income of an S corporation (not attributable to wages) passes through to the shareholders without being subject to employment tax.22 As a result, choice of entity can create significantly different tax consequences for employment tax purposes.

6. Special status corporations, such as Subchapter S corporations, may be appropriate in certain situations. The income of Subchapter S corporations is usually taxed at the shareholder level rather than at the corporate level. See generally, I.R.C. § 1373(a). Losses and credits also pass through on a pro-rata basis for each shareholder. To qualify for this treatment, an election must be made and certain tests must be met (e.g. fewer than 100 shareholders, only one class of stock outstanding, shareholders must be individuals). See I.R.S. Form 2553.

7. If most of the activities will be passive investment activities, such as the collection of rents, royalties, interest, dividends, etc., a corporation may not be desirable because of the personal holding company rules. See I.R.C. § 541 et. seq. These rules impose a corporate level penalty tax under certain circumstances.

8. If the business will generate large amounts of accumulated earnings and business reasons for retaining the accumulations do not exist, a corporation may be undesirable because of the accumulated earnings tax. See I.R.C. § 531 et. seq.

9. In the situations described in (7) and (8) above or where the owners wish to withdraw more cash from the business than they can justify as reasonable compensation, a partnership or LLC may be preferable because withdrawals from a corporation could be subject to double taxation (first as corporate earnings and second as dividends). A business is allowed to deduct a “reasonable allowance for salaries and compensation.” I.R.C. §

21 See Internal Revenue Service Topic 554 - Self-Employment Tax, available at http://www.irs.gov/

taxtopics/tc554.html.

22 See Internal Revenue Service Publication 15, Employer Tax Guide, available at http://www.irs.gov/pub/irs-pdf/p15.pdf.


162(a)(1). If the IRS disallows a compensation deduction for a C corporation, the C corporation’s taxable income increases and the IRS may treat the excess compensation as a taxable dividend. See Treas. Reg. § 1.162-7(b)(1). In determining whether the level of compensation is reasonable, the business must consider several factors including:

i. Size and complexity of business

ii. Qualifications of the salary earner

iii. Work performed

iv. Value to corporation of the employee

v. Relative success of business

vi. Comparable salaries in comparable companies

vii. Ratio of salary to income

viii. Past compensation (undercompensated?)

ix. Fixed or contingent payments?

x. When were rates fixed (before corporate earnings determined?)

xi. Relationship to company (shareholder?)

xii. Dividend history

xiii. Relationship between percentage of stock and level of compensation

xiv. Inflation and other economic conditions

It is impossible to establish a rule of thumb regarding a “safe” or “unreasonable” level of compensation. (Compare Helen L. Foos, 41 TCM 863, in which compensation of $1.6 million each was reasonable for mother and son, with Maryland Pikesville Distillery, 3 TCM 542, in which $300 was reasonable for father and $600 was reasonable for son because the corporation, a personal holding company, had minimal activities.)

E. Tax Considerations – Fringe Benefits and Deferred Compensation.

1. Fringe benefits may give employees tax free or tax reduced benefits. Certain fringe benefits for shareholder employees will not produce similar deductions for partner employees. In other instances, larger tax free to tax reduced benefits are available for shareholder employees than for partner employees. This is also true in the deferred compensation area. Where a business has the financial capability and the desire to maximize its use of


fringe benefits and deferred compensation, a corporation may be more desirable than a partnership or LLC.

F. Tax Basis – Nonrecourse Financing Distinctions between S Corporations & LLCs.

1. Generally, basis is a monetary value assigned to property (usually the cost of such property) used to determine a taxpayer’s investment and corresponding gain or loss on the property for tax purposes. The basis figure will be modified over time to accommodate changes to the property such as additional contributions and deductions, such as depreciation. See I.R.C. §§ 1011-1012. Whether debt used to purchase property is reflected in a business owner’s stock or membership basis depends on the type of entity. S corporation shareholders only receive basis for personal loans made directly to the corporation. See I.R.C. § 465. In contrast, members of an LLC may increase the basis in their membership interest by their share of entity-level, recourse or nonrecourse debt. See I.R.C. § 752. This distinction is especially important for an entity considering the purchase of real estate in a highly-leveraged transaction. For members of an LLC, basis generally includes the value of the recourse and nonrecourse loan, which permits for a significantly greater allowance of depreciation deductions.

G. Entity Classification & “Check-the-Box” Regulations.

1. “Check-the-Box” Regulations provide an entity classification system that allows certain eligible business entities, after considering the factors discussed above, to elect a federal tax classification. A business entity with two or more members may elect to be treated as (i) an association (taxed as a corporation) or (ii) a partnership. A single member entity may elect to be taxed as (i) an association (taxed as a corporation) or (ii) to be disregarded as an entity separate from its owner (in essence, a “tax nothing”).

By default, an entity with two or more members will be classified as a partnership and an entity with a single member will be disregarded as an entity separate from its owner. In order to elect a classification other than the default, the taxpayer must submit IRS Form 8832 and “check the box”. Generally, entities that do not qualify for the “Check-the-Box” election include corporations formed under state or federal law, trusts, insurance companies, and certain governmental entities formed exclusively under state or local law. See Treas. Reg. §§ 301.7701-1 to 301.7701-3; see also

Appendix B for a visual representation of “Check-the-Box” rules.

H. Termination of a Business Entity.

1. Termination of an entire business can occur through (i) sale to a third party of all ownership interests or (ii) a pro-rata distribution to the owners of all the assets held by the business during liquidation.


i. Corporation: During a complete corporate liquidation, a shareholder may receive cash and/or property. The shareholder is deemed to have exchanged his or her stock for the total amount received in the liquidation (property is valued at its fair market value). See I.R.C. § 331(a). Liquidation ordinarily results in capital gain or loss to a shareholder because the shareholder is treated as having sold the corporation back his or her own shares in exchange for the liquidating distribution. See I.R.C. §§ 1001, 1367. Typically, liquidation has no income tax impact at the corporate level, unless the corporation must sell assets to generate cash for distribution. Then the corporation must recognize gain or loss on the sale of assets. See I.R.C. § 1366(a)(1), for impact of asset sale on S-corporation shareholders. (For a discussion on sale to a third party, see Section II).

ii. Partnership: In complete liquidation of a partnership, all the partnership assets are collected and reduced to cash. During the “winding up process,” cash is paid out in the following order to settle outstanding debts: (1) to creditors, other than partners; (2) to partners, other than for capital contributions and profits; and (3) to partners for capital contributions. The remaining cash, if any, is distributed to partners for profit.23 Generally, a partner may recognize gain through liquidation to the extent the partner’s liquidation proceeds are greater than the adjusted basis of the partner’s interest immediately before liquidation. See I.R.C. § 731(a)(1). Similarly, a partner may recognize gain if he or she sells his or her partnership interest to a third party. See I.R.C. § 741. In either event - a liquidation or the sale of a partnership interest - gain may be characterized as capital and/or ordinary, depending upon the character of assets previously held by the partnership, e.g., accounts receivable (ordinary income asset) versus real estate (treated as a capital asset).24

23 See Revised Uniform Partnership Act § 802, 807 (1994).

24 Gain or loss is generally considered capital, except to the extent sale proceeds are attributable to “hot assets.” See I.R.C. § 741. Hot assets include unrealized receivables, inventory, and depreciation recapture subject to ordinary income. See I.R.C. § 751(a)(2).

B-1 © 2017 Hodgson Russ LLP

EXHIBIT B

SAMPLE NONDISCLOSURE/CONFIDENTIALITY AGREEMENT

THIS AGREEMENT, dated the _____ day of ______________, 20____, is between ABC COMPANY, INC. with an address at _____________________________________________ (“Company”) and XYZ COMPANY,

INC., with an address at ______________________________________________ (“Recipient”).

Company and Recipient desire to explore the possibility of a transaction involving the acquisition by Recipient of the business and assets of Company (the “Proposed Transaction”). During the course of negotiations regarding the Proposed Transaction, Company will disclose to Recipient and Recipient may otherwise have access to certain information which is not generally available to the public and which Company desires to keep confidential. In order to induce Company to disclose sufficient information to enable Recipient to evaluate the Proposed Transaction, and in order to facilitate discussion by the parties regarding the Proposed Transaction, Company and Recipient agree as follows:

1. For purposes of this Agreement, the term “Confidential Information” shall mean all proprietary, confidential and trade secret information of Company and all other information of Company which is not generally available to the public and which Company desires to keep confidential, including, without limitation, financial statements, records and information, sales data, trade secrets, marketing and promotional plans and information, information as to employees, customers, customer lists and suppliers, operating and business techniques and strategies, and union and other contractual arrangements, as well as all documents, plans, proposals, records and other tangible items relating to or containing any such information.

2. Recipient acknowledges and understands that any disclosure of the Confidential Information or the discussions between Company and Recipient relating to the Proposed Transaction to any employee, customer, supplier or competitor of Company who is not aware of the Proposed Transaction, or to the general public, will cause irrevocable harm to Company. Therefore, Recipient agrees that all Confidential Information disclosed to it by Company shall be made available only to the following individuals who have a need to know such information in order to evaluate the Proposed Transaction: _____________________ ___________________________________________________________________________________________________________________________________________________________, each of whom shall have been informed of and agreed to be bound by this Agreement. Recipient further agrees to be responsible for any breach of this Agreement by any of the foregoing individuals. Recipient will not in any way directly or indirectly (without the prior written consent of Company) disclose any such information to or discuss the Proposed Transaction with any other persons whatsoever.

Except as specifically permitted by this Agreement or with Company’s prior written consent, neither Recipient nor any of its agents, directors, officers or employees shall, directly or indirectly, (a) market, use (other than for the purpose of evaluating the Proposed


Transaction) or otherwise profit from any Confidential Information, (b) reproduce or otherwise copy any Confidential Information or (c) disclose, sell, license, offer to sell or license or otherwise transfer or make available any Confidential Information to any agency, corporation, firm, individual, partnership, person or other entity other than Company.

Notwithstanding the foregoing, Recipient shall not be required to maintain as confidential any information disclosed to it by Company which is (a) required to be disclosed by applicable law, after notice is given to Company, (b) publicly available or becomes publicly available through no fault of Recipient and not as a result of a breach of this Agreement, (c) is independently developed by Recipient without reference to any Confidential Information, or (d) was already lawfully in Recipient’s possession or is lawfully obtained by Recipient from a third party who is under no duty of confidentiality to Company.

3. Recipient shall accept and hold all Confidential Information in strict confidence and shall take (a) all reasonable precautions to safeguard the confidential nature of all Confidential Information and (b) any other precautions with respect thereto that Company, in its sole discretion, may reasonably request.

4. All Confidential Information furnished or disclosed by Company to Recipient shall be and shall remain at all times the sole and exclusive property of Company, and all documents, records, proposals, plans, writings and other tangible items that Company supplies to Recipient containing or relating to any Confidential Information shall, together with all copies thereof, be returned to Company upon demand or upon termination of discussions regarding the Proposed Transaction, whichever occurs first.

5. Except as may otherwise be set forth in a separate definitive agreement between Company and Recipient, Company shall not be deemed to have made any representations or warranties as to the accuracy or completeness of the Confidential Information. This Agreement does not constitute an agreement by Company or Recipient to enter into the Proposed Transaction and does not obligate either party to enter into further discussions or agreements.

6. Recipient acknowledges that its failure to comply with any provision of this Agreement will cause Company irrevocable harm and that a remedy at law for a breach of any provision of this Agreement would be an inadequate remedy for Company. Consequently, Recipient consents to Company seeking and obtaining specific performance, an injunction, a restraining order or other equitable relief in order to enforce any provision of this letter. Company’s right to obtain such equitable relief shall be in addition to any other remedy to which it is entitled under applicable law (including, but not limited to, monetary damages).

7. This Agreement (a) may not be amended or terminated orally or by any course of conduct, but may only be amended or terminated by a writing duly executed by Recipient and Company; (b) shall be binding upon and inure to the benefit of Recipient and Company and each of Recipient’s and Company’s legal representatives, successors and assigns; (c) constitutes the entire agreement between Recipient and Company with respect to the matter dealt with in this Agreement, and supersedes all oral and written proposals, representations, understandings and agreements previously made or existing with respect to such matters; and (d)


shall be governed by and interpreted and construed in accordance with the laws of the State of New York, without regard to principles of conflict of laws.

8. The execution and delivery by Recipient of this Agreement shall be a necessary condition to the release by Company of any Confidential Information to Recipient. This Agreement shall in no way bind or be construed to bind either party in any manner whatsoever with respect to the consummation of the Proposed Transaction.

9. The obligations of Recipient under this Agreement shall survive the termination of this Agreement.

IN WITNESS WHEREOF, Company and Recipient have duly executed this Agreement on the date first indicated above.

ABC COMPANY, INC.

By: _______________________________________ ____________________, President

XYZ COMPANY, INC.

By: _______________________________________ ___________________, President

C-1 © 2017 Hodgson Russ LLP

EXHIBIT C

SAMPLE LETTER OF INTENT

(SALE OF STOCK)

ABC Company, Inc. _________________ ________________

[DATE]

VIA ___________________

_______________________ _______________________ _______________________

Re: ABC Company, Inc.

Dear Mr./Ms. _____________________,

The purpose of this letter (the "Letter") is to set forth the intentions of ABC Company, Inc., an ___________ corporation ("ABC"), with respect to the proposed purchase by ABC from _________________________, (individually, a “Seller” and collectively, the “Sellers”) of all of the outstanding shares (the “Shares”) of capital stock of XYZ Company, Inc., a ________________ corporation (the “Company”), on the following terms and conditions:

1. The Acquisition; Closing.

(a) Subject to the conditions set forth herein, on the Closing Date (as hereinafter defined) ABC or an affiliate of ABC (“Purchaser”) will purchase from Sellers, and Sellers will sell to Purchaser, all of the Shares, which purchase and sale will transfer full and complete ownership to Purchaser of all of the assets, liabilities and current business of the Company.

(b) The parties will use their reasonable commercial efforts to cause (i) the purchase and sale contemplated herein (the “Acquisition”) to be memorialized in a definitive acquisition agreement (the “Definitive Agreement”) on or prior to _________________ and (ii) the closing (the “Closing”) of the Acquisition to occur by ____________________ (the “Closing


Date”). Sellers and Purchaser will cooperate to structure the Acquisition to the mutual tax benefit of the parties, provided that such structure does not impose burdensome requirements on either Sellers or Purchaser.

2. Purchase Price.

(a) The purchase price (the “Purchase Price”) for the Shares will be equal to _______________________.

(b) (The Purchase Price will be subject to an adjustment (the “Purchase Price Adjustment”) based upon ___________________.

(c) The Purchase Price assumes that (i) the transfer of the Shares will transfer full and complete ownership to Purchaser of all of the assets, liabilities and current business of the Company, including all of the assets set forth on the asset list of the Company as of ____________________ previously delivered to the Purchaser, other than (A) cash in the approximate amount of $___ million and (B) assets sold by the Company since _____________ in the ordinary course of business and (ii) the net shareholders’ equity of the Company as of the Closing Date (less any cash or cash equivalents), calculated in accordance with generally accepted accounting principles and in a manner consistent with the Company's financial statements as of and for the period ending ___________________, will be no less than $__________.

(d) Ten percent (10%) of the cash component of the Purchase Price will be held in escrow by a mutually acceptable escrow agent for a period of ___ months after the closing to partially secure the Sellers’ indemnity obligations and other obligations under the Definitive Agreement. Interest will be paid to the Sellers on the escrow funds at the applicable bank rate.

3. Definitive Purchase Agreement. This letter is intended to be, and will be construed only as, a summary of our discussions to date. Any rights and obligations of Purchaser, on the one hand, and Sellers, on the other hand, will be subject in all respects to the negotiation, execution and delivery of Definitive Agreement containing provisions substantially in accordance with this letter, together with such other appropriate terms and conditions as are mutually agreed upon by the parties. The Definitive Agreement will contain representations, warranties and indemnities customary for transactions of this type, including, but not limited to, representations, warranties and indemnities with respect to (i) title to the Shares; (ii) litigation; (iii) liabilities; (iv) receivables; (v) compliance with laws, including environmental and tax laws; and (vi) accuracy of financial statements. The Definitive Agreement also will provide that Sellers will indemnify Purchaser against, among other things, (i) all losses and expenses incurred after closing in connection with the defense, settlement and/or payment of judgments in all litigation arising out of acts, omissions or occurrences prior to the Closing Date and (ii) all tax obligations of the Company arising on or before the Closing Date. Purchaser will indemnify Sellers against any obligations arising out of acts, omissions or occurrences on or subsequent to


the Closing Date. In addition to other conditions that may be contained in the Definitive Agreement, the Closing will be subject to the following:

(a) Conduct of Business. From the date hereof until the Closing Date, (i) the business of the Company will be conducted solely in the ordinary course, (ii) no dividend or distribution of cash or capital stock of the Company will be declared or paid during such period, (iii) no additional share capital or other equity securities of the Company will be authorized or issued, and (iv) no material changes in compensation, benefit, severance or consulting arrangements will be entered into or granted by the Company.

(b) No Material Adverse Information. The investigation by Purchaser of the Company will reveal, in the sole judgment of Purchaser, no material adverse information with respect to the business, prospects, assets or financial condition of the Company.

(c) No Material Adverse Change. From ___________________ until the Closing Date there will not have been any material adverse change in the condition of the Company, including any legal proceeding or investigation, pending or threatened, which in the reasonable opinion of Purchaser may have a material adverse effect on the financial condition, business or prospects of the Company.

(d) Retention of Key Management Personnel. ________________ will have been retained by the Company for employment as President of the Company on terms mutually satisfactory to Purchaser and ___________________, for a 3-year period after the Closing Date. ABC places great value on its relationships with its management and employees, including the management and employees of the various operations it has acquired. As a result, although we have had a limited opportunity to meet with only a few of the Company’s senior managers, it would be our expectation that all personnel of the Company would be offered employment with the Purchaser upon acquisition of the Shares by Purchaser and would be eligible to participate in our existing employee incentive compensation programs, with prior service credit to be provided to the extent practicable under our employee benefit programs.

(e) Consents; Approvals. The Company, the Sellers and the Purchaser will have received all necessary consents and approvals of governmental bodies, lessors, lenders and other third parties.

(f) Non-Competition. As additional consideration for the Purchase Price, Sellers and certain additional key personnel of the Company will have agreed not to compete with the business of the Company for periods after the Closing Date as are enforceable under applicable law and agreed upon by the parties.

(g) Due Diligence. A due diligence exercise being carried out to the satisfaction of Purchaser, including the completion of all such reports and investigations by Purchaser's auditors or other professional advisers as Purchaser may decide upon.

4. Brokers' Fees. The parties hereto acknowledge that no broker or other person or entity, other than __________________, is acting on behalf of Purchaser, Sellers or the


Company and is or will be entitled to any finders, or brokers' fee or any other similar commission in connection with the transactions contemplated hereunder. The fees and disbursements of _______________________ in connection with this transaction will be paid by Sellers.

5. Legally Binding Provisions. Sellers recognize that, in negotiating the Acquisition, documents and information relating to the Company must be made available to Purchaser and that certain matters must be agreed to by the parties to facilitate such availability and the resulting due diligence. Accordingly, in consideration of Purchaser proceeding with due diligence in relation to the Company and with negotiation and preparation of the Definitive Agreement and related documents, thereby incurring expenses in terms of management time and advisers' fees and other costs, the parties hereto, intending to be legally bound, agree as follows:

(a) Due Diligence. From the date hereof through the date of execution and delivery of the Definitive Agreement (and thereafter as may be provided in the Definitive Agreement), in a manner not disruptive to the Company's normal operations, Sellers will permit and will cause the Company to permit Purchaser and its authorized representatives reasonable access during regular business hours to the business, properties, records, contracts, rights, liabilities and obligations of the Company for the purpose of an examination of the business of the Company, including financial, marketing, employee, legal, regulatory and environmental matters. The location of Purchaser's due diligence investigation will be mutually agreed upon by the parties.

(b) No Publicity. Purchaser does not wish to disclose the matters covered by this letter until the Definitive Agreement is executed and, therefore, no publicity of any type concerning the Acquisition or this letter will be released by Sellers or Purchaser. Sellers will not, and will cause the Company not to, release publicity of any type concerning the Acquisition, without the prior written consent of Purchaser, except as may be necessary to secure approvals or make disclosures required by a governmental or regulatory body or authority.

(c) Standstill. Until the earliest of (i) the execution of the Definitive Agreement, (ii) the delivery of written notice by the Purchaser to the Sellers that Purchaser is no longer interested in pursuing the Acquisition or (iii) ___________________ (and thereafter as may be provided in the Definitive Agreement), Sellers will not and will cause the Company not to directly or indirectly solicit or cause to be solicited any proposal or approach to acquire any or all of the assets, business or capital stock of the Company by any party other than Purchaser, and will not conduct any negotiations with the aim to enter into, reach or execute any agreement relating to any such acquisition, or furnish any information to, or respond to any unsolicited offer to acquire from, any person or entity other than Purchaser.

(d) Cooperation; Reasonable Efforts. Sellers and Purchaser will cooperate with each other in the performance of their respective obligations under this letter and will use reasonable efforts to bring about the execution and delivery of the Definitive Agreement promptly. Sellers and Purchaser will cooperate with each other in communicating with, and submitting necessary filings with, and applications to, any regulatory authorities as may be


required, and in taking other appropriate actions with a view toward prompt consummation of the transactions contemplated by this letter.

(e) Fees and Expenses. Sellers and Purchaser will be responsible for their own fees and expenses incurred in connection with the transactions referred to herein, whether or not such transactions are consummated.

6. Intent. It is understood that, with the exception of the provisions of Section 5 above, which are intended to be legally binding obligations, this letter is not intended to be legally binding, and is to be construed only as a letter of intent summarizing the principal terms of a proposed transaction and not as an offer subject to acceptance. It is further understood that the respective rights and obligations of the undersigned will be subject to negotiation, execution and delivery of a Definitive Agreement, which, subject to the exception of the provisions of Section 5 above, will supercede this letter of intent and all prior discussions. The parties hereto acknowledge agree that the Confidentiality Agreement, dated ________________, between the ABC and the Company remains in full force and effect.

7. Governing Law. This Agreement and any matter or dispute relating thereto will be governed by and construed in accordance with the laws of the State of New York, without regard to principles of conflict of law.

8. Counterparts. This letter may be executed in one or more counterparts, each of which will be deemed an original, but all of which together will constitute one and the same instrument.

9. Facsimile Signatures. Any party may execute this Agreement by facsimile signature and the other parties will be entitled to rely on such facsimile signature as evidence that this Agreement has been duly executed by such party.

If you agree with these principal terms, as outlined above, please sign and deliver to us the enclosed copy of this letter. If we do not receive such signed original by __________, 2006, this letter will be null and void.

Very truly yours, ABC COMPANY, INC. By:_______________________________ _______________, President


ACCEPTED AND AGREED TO this _____ day of _______________, 20____ XYZ COMPANY, INC. By: _______________, President

D-1 © 2017 Hodgson Russ LLP

EXHIBIT D

SAMPLE DUE DILIGENCE CHECKLIST

A. FINANCIAL MATTERS

ITEM

REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

1. Financial Statements (5 years)

2. Auditor’s reports and work papers to financial statements (5 years)

3. Auditor’s letters to management (5 years)

4. Auditor’s inquiry letters and replies (5 years)

5. Projections

6. Capital Budgets

7. Operating Budgets

8. Business/Marketing Plans

9. Indebtedness Details as to original and current amounts outstanding, due dates, interests, defaults regarding all:

1) Short- and long-term bank loans 2) Credit lines 3) Letters of credit 4) Bonds 5) Debentures


ITEM

REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

10. Guarantees

11. Unrecorded or Contingent Liabilities

B. TAX MATTERS

ITEM

REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

1. Tax Returns (federal, state and foreign) (3 years)

2. Federal Income Tax Status a. When Company was last audited b. Deficiency claims

3. State and Local Taxes a. Applicable taxes b. Unemployment tax rate c. Deficiency claims d. 3 years’ state franchise tax returns or

other local tax returns, including real estate tax receipts filed within the last year

4. Audits and revenue agents’ reports (federal, state and local)


C. LABOR ISSUES

ITEM

REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

1. Labor Contracts

2. Severance Pay

3. Pay Rate Schedules

4. Relations with Union: Information as to any strike, organizing activity, grievances filed, hearings held, etc.

5. Employee Manuals

6. Key Employees

7. Employee Organization Chart

8. Labor Dispute History a. Last twelve months, any notice,

written or oral, of any material violation of any labor law (federal, state, local)?

b. Unfair labor practice charge or other employee-related complaint pending? (3 years)

c. Open representation question?

9. Confidentiality and Noncompetition Agreements (including with employees?)

10. Employee Benefits and Accompanying Plan Documents (includes vacation, sick pay)

11. Pension Plans


ITEM

REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

12. Profit Sharing Plans

13. Stock Option; ESOP and stock bonus plans and agreements

14. Surety Bonds (employees (by title or position) presently covered by a fidelity or other surety bond)

15. Employment Contracts

16. Loans to employees, officers or directors exceeding $________.

17. Accrued vacation

18. Foreign Labor Has Company filed a valid form I-9 for each employee.

19. Fair Labor Has any governmental agency checked the Company within the last three years in regard to compliance with the Fair Labor Standard Act?

20. Workers’ Compensation Insurance

21. List of employees receiving disability payments and description of any arrangements for salary continuance currently in place.

22. Description of any other benefits


D. LITIGATION

ITEM REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

1. Insurance Loss Runs

2. List of all suits, actions, proceedings etc., pending or threatened, seeking an injunction, a declaratory judgment or involve a claim of $________________ or more.

3. Possible Litigation; Regulatory Compliance (Description of claims) (e.g. FTC, OSHA, EPA, EEOC)

4. Closed Litigation - past 5 years (claims of over $_____________)

5. All consent decrees - judgments, settlement agreements, etc (past 5 years)

6. Litigation Reserves


E. INSURANCE

ITEM REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

1. Insurance a. Obtain copies of all insurance

policies currently in effect and summary of same. 1) Insurance list

- Comprehensive all-risk and general liability insurance

2. - Workers’ compensation - Employees’ general liability insurance - Automobile insurance - Umbrella excess liability insurance - Errors and omissions insurance

- D&O insurance b. Adequate insurance on all

insurable property and all reasonable risk?

c. If insurance policies are in the name of a parent, is Company named as an additional insured?

d. Has any significant event ever occurred with regard to an uninsured property or risk?

3. List of Sureties

4. Description of insurance claims history

5. Description of major claims and lawsuits pending with respect to insurance coverage.


6. Insurance on “claims made” or “occurrence” basis as it relates to buyer’s coverage (tail coverage).

F. REAL, PERSONAL AND INTELLECTUAL PROPERTY

ITEM

REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

1. Real Property Address and brief description of each property whether owned or leased; lease provisions: (including assignment; change of control and renewals).

2. Deeds.

3. Ground Leases a. Right of first refusal b. Estoppel agreement

4. Surveys.

5. Title insurance policies, abstracts, title opinions.

6. Appraisals.

7. Environmental Reports.

8. Building Condition Reports.

9. Site Inspection Reports.

10. All mortgages (including deeds of trust).


ITEM

REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

11. All contracts and options for purchase.

12. All leases of real property. 1) Consider lease termination date 2) Consider powers to renew 3) Obtain list of leasehold

improvements, showing total cost by major items, amortization reserve, rates used, and present unamortized cost.

13. Liens for taxes or special assessments.

14. Describe all encumbrances and restrictions, including all material zoning, building, environmental and similar laws, ordinances and regulations regarding all properties.

15. Certificates of Occupancy

16. Permits, Licenses and Certificates of Authority

17. Liquor Licenses

18. Utilities

19. Zoning Verification Letters


ITEM

REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

20. Licenses to Other Parties for Electronic Transmission or Other Devices attached to property exterior

21. Identification of Transfer Taxes Due (Real Property)

22. List of All Fixed Assets

23. Building and Health Codes a. Is the Company in compliance

with all building and health codes (or other similar local governmental codes) which are applicable to it?

b. When was the last time the Company’s facilities were checked by local governmental authorities for possible violations of local governmental codes and what were the results of such investigation?

c. Obtain a list of any warnings the Company has received within the past three years, for the violations of any local or governmental codes.

d. Obtain a list of dates and amounts of fines, if any, paid to any local governmental authority within the past three years.

24. Identification of Transfer Taxes Due (Personal Property)

25. Accounts Receivable


ITEM

REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

26. Intellectual Property Operational matters: a. list of proprietary software and details, including samples of systems documentation and samples of program documentation, b. operating system configuration for each system and amount of system utilization, c. list of software owners’ licenses used in product development, d. third party software under maintenance, e. demonstration of proprietary software, f. quality control procedures, g. identify manual and automated systems used in production Other Intellectual Property Issues: a. documents that establish patents, trademarks, tradenames, copyrights, other intellectual property rights, etc., b. documents that establish title to acquired software products or internally developed software products, c. copy of all patents issued and applications pending or to be filed. Including disclosure documents and prior art searches and attorney correspondence. d. a copy of target’s privacy statement (personal data); a description of the types of personal data collected, period of time over which personal data has been collected; the uses to which personal data have been put; purchases of personal data from third parties; sales, licensing or rentals of personal data to third parties.


ITEM

REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

e. chronology of all computer programming and concomitant technical and user documentation developed by or for the company for use by the company and/or distribution to others. Chronology should include detailed descriptions of at least what was developed in detail as to, for example, language used, platform on which designed to perform, persons who performed development, status of such persons doing their development efforts (employee, contractor, other), state and country in which development efforts took place, alpha testing, beta testing and general release. f. chronology of what steps were taken to protect IPR under: • trade secret doctrine • copyright law • patent law

27. Permits, Licenses and Certificates of Authority

28. List all Licenses and Royalty Agreements for Intellectual Property

29. List all Leases of personal property (e.g. vehicle, computer, equipment).

30. Trade Names


G. BUSINESS MATTERS

ITEM

REC’D

Y/N

RESPONSIBLE

PARTY

COMMENTS

1. Contracts (written and oral) a. Review all substantial contracts,

presently in force, on which the Company, directly or indirectly, is bound. Consider: 1) termination 2) assignability 3) long or short term 4) any payment obligations 5) trouble spots

b. Are Company’s beneficial contracts assignable? 1) licenses and royalty agreements 2) employment agreements 3) leases 4) supplier’s contracts 5) collective bargaining agreements

c. Are any of Company’s beneficial contracts already subject to prior assignments, e.g. to lending institutions?

d. Will any of Company’s beneficial contracts terminate or increase incost, following acquisition?

2. Prior 12 Month: Sales by client, month and date

3. Restrictions Imposed by Contracts; Conflicts.

4. Exclusive Agency and Licensing Agreements


ITEM

REC’D

Y/N

RESPONSIBLE

PARTY

COMMENTS

5. Management Contracts

6. Liquor Licenses

7. Long Term Agreements (2 mos/$10,000) (oral or written)

8. Describe all agreements with payments over $10,000, currently in negotiation

9. Agreements involving payment of commissions or other consideration of discounts.

10. Confidentiality, Noncompetition and Trade Secret Agreements

11. Contract Forms Review any contract forms presently in use by the Company.

12. Any facts or circumstances which may give rise to cancellation or termination, or claim for damages or loss under any of the agreements.

13. Warranty and Service Guarantee Policy, current price list of all products, maintenance fees, subscription fees, etc.


H. BANK AND CREDIT ARRANGEMENTS

ITEM REC’D

Y/N RESPONSIBLE

PARTY

COMMENTS

1. Financing Documents (including notes and security agreements)

(list lender, amount borrowed, amount outstanding collateral/property mortgaged and repayment terms)

2. Loan transactions with Affiliates

3. Loan transactions with Related Parties

4. List guaranties or indemnity undertakings

I. LEGAL MATTERS (if applicable)

ITEM

REC’D

Y/N

RESPONSIBLE

PARTY

COMMENTS

1. Review of Minute Books of Company and all Subsidiaries

2. List of Directors and Officers

3. List of Principal Shareholders


ITEM

REC’D

Y/N

RESPONSIBLE

PARTY

COMMENTS

4. Stock a. Collect and review all

1) options, warrants, agreements relating to issuance of shares

2) agreements under which any person has registration rights

3) agreements under which any person has preemptive rights

4) buy-sell agreements 5) other agreements relating to the

shares of the Company. b. Any treasury shares? c. Any voting trusts or voting

agreements among shareholders? d. Voting rights of the various classes

of stock. e. Determine any potential voting

rights other than noted above, held by the holders of Preferred Shares, Convertibles, Debentures, Bonds, etc., which become effective on the happening of contingent events (such as the failure to pay dividends or make payments).

f. 1) list each issue of stocks, bonds, debentures, warrants, other convertibles, etc. indicating the amount, the authorized amount and the registration of each (federal and state), if any.

2) If applicable, indicate the date of each registration, and the terms for which registered.

5. Minute and Stock Record Books a. Where are the minute books of the

Company physically kept? b. Where are the stock record books of

the Company physically kept?


ITEM

REC’D

Y/N

RESPONSIBLE

PARTY

COMMENTS

6. Organization Chart

7. Policy Manual Does the Company have a policy manual containing the president’s policy statements and the written interpretations of policy issued by the officers, executives and general managers?

8. Indemnification Agreements (of any director, officer, shareholder, employee, or other agent of the Company)

9. Conflict of Interest Does the Company do business with any organization in which any officer or director, including spouses and other close relatives, has an interest of more than 5%?

10. Dividends a. Indicate the Company’s dividend

record on Common Stock for the past five years.

b. Has the Company ever paid a dividend without adequate earned surplus to cover it?

c. Determine whether all dividends paid by the Company within the last eight years have been validly declared and paid out of funds legally available for the payment of dividends.

d. Are any dividends or preferred stock presently in arrears? If so, indicate.

11. Contingent Liabilities


ITEM

REC’D

Y/N

RESPONSIBLE

PARTY

COMMENTS

12. Governmental Agency Reports All reports filed with any governmental agency (federal or state) (3 years)

J. COLLECTION OF INFORMATION FOR BUSINESS AND PROPERTY DESCRIPTION

ITEM

REC’D

Y/N

RESPONSIBLE

PARTY

COMMENTS

1. Review reports prepared by independent consultants relating to assets (e.g., appraisals and reserve studies) and reports prepared for investment and commercial bankers in connection with proposed financings and acquisitions and compliance with existing loan documents.

2. Real Estate Consultant Reports

K. ENGINEERING

ITEM

REC’D

Y/N

RESPONSIBLE

PARTY

COMMENTS

1. Reports or Recommendations of Consulting Engineers or Others


ITEM

REC’D

Y/N

RESPONSIBLE

PARTY

COMMENTS

Regarding Mechanical Systems Within Past Five Years, Including Any Regarding Retrofitting or Replacement of Equipment Using CFC’s, Actions Taken and any Quotations or Estimates.

2. Reports or Recommendations by Architects, Engineers or Others Regarding Structural Matters, Actions Taken in Connection Therewith, and Quotations for Same - Within Past Five Years.

3. Reports or Recommendations with Regard to Elevator or Escalator Maintenance, Repair or Modification of Elevators and Escalators, Within Past Five Years, and Quotations or Estimates.

4. List of Capital Improvements made in the last 5 years.

5. Statement of Operations; Operating Expenses; Budgets.

6. List of Material Repairs made in the last 5 years.


L. ENVIRONMENTAL

ITEM

REC’D

Y/N

RESPONSIBLE

PARTY

COMMENTS

1. Environmental engineering reports or studies.

2. List of all Hazardous Materials or other regulated materials used and method of disposal.

3. Environmental Permits (Act 250 approval of expansion plans).

4. Non-compliance; violations.


EXHIBIT E

SAMPLE ASSET PURCHASE AGREEMENT

Dated ____________ ____, 20____

By and Among

__________________________________,

__________________________________

and

__________________________________

- i - © 2017 Hodgson Russ LLP

TABLE OF CONTENTS

Page

ARTICLE 1

DEFINITIONS 1.1 Defined Terms ................................................................................................... 1 1.2 Other Defined Terms ......................................................................................... 8 1.3 Usage of Terms .................................................................................................. 9 1.4 References to Articles, Sections, Exhibits and Schedules ................................... 9

ARTICLE 2

PURCHASE AND SALE OF ASSETS OF SELLER 2.1 Transfer of Purchased Assets; Assumption of Assumed Liabilities ..................... 9 2.2 Liabilities Not Assumed ..................................................................................... 9 2.3 Consideration; Allocation.................................................................................... 9 2.4 Closing Certificate; Preliminary Purchase Price Adjustment; Physical

Inventory; Closing Date Financial Statements; Final Purchase Price Adjustment ....................................................................................................... 10

2.5 Payments by Buyer ........................................................................................... 11 2.6 Retained Amount .............................................................................................. 12 2.7 Taxes ................................................................................................................ 13

ARTICLE 3

CLOSING 3.1 Closing ............................................................................................................. 14 3.2 Conveyances at Closing .................................................................................... 14 3.3 Assumptions at Closing ..................................................................................... 14 3.4 Certificates and Other Documents ..................................................................... 14

ARTICLE 4

REPRESENTATIONS AND WARRANTIES OF

SELLER AND SHAREHOLDER 4.1 Organization, Good Standing and Authority of Seller to Conduct Business ....... 15 4.2 Power and Authority; Authorization; Binding Effect ......................................... 15 4.3 No Conflict or Violation ................................................................................... 15 4.4 Consents and Approvals .................................................................................... 16 4.5 No Proceedings ................................................................................................. 16 4.6 Capitalization .................................................................................................... 16

- ii - © 2017 Hodgson Russ LLP

4.7 Corporate Records ............................................................................................ 16 4.8 Financial Statements ......................................................................................... 16 4.9 Real Property .................................................................................................... 17 4.10 Tangible Personal Property ............................................................................... 18 4.11 Intangible Property ............................................................................................ 18 4.12 Compliance with Laws; Permits ........................................................................ 19 4.13 Litigation .......................................................................................................... 19 4.14 Labor Matters; Employee Contracts .................................................................. 19 4.15 Employee Benefit Plans .................................................................................... 20 4.16 Transactions with Certain Persons ..................................................................... 23 4.17 Tax Matters ....................................................................................................... 23 4.18 Insurance .......................................................................................................... 24 4.19 Inventory .......................................................................................................... 24 4.20 Purchased Accounts Receivable ........................................................................ 24 4.21 Contracts ........................................................................................................... 25 4.22 Suppliers and Customers ................................................................................... 25 4.23 Business Records .............................................................................................. 25 4.24 Bank Accounts, Directors and Officers ............................................................. 26 4.25 Environmental Matters ...................................................................................... 26 4.26 Absence of Certain Changes ............................................................................. 26 4.27 No Brokers........................................................................................................ 27 4.28 Absence of Certain Payments ............................................................................ 27 4.29 Products; Product Warranties ............................................................................ 28 4.30 Material Misstatements or Omissions ................................................................ 28

ARTICLE 5

REPRESENTATIONS AND WARRANTIES OF BUYER 5.1 Organization and Good Standing ....................................................................... 28 5.2 Authority; Authorization; Binding Effect .......................................................... 29 5.3 No Conflict or Violation ................................................................................... 29 5.4 Consents and Approvals .................................................................................... 29 5.5 No Proceedings ................................................................................................. 29 5.6 No Brokers........................................................................................................ 29

ARTICLE 6

COVENANTS AND CONDUCT OF

THE PARTIES PRIOR TO CLOSING 6.1 Investigation by Buyer ...................................................................................... 30 6.2 Notifications, Consents and Approvals .............................................................. 30 6.3 Environmental Audits ....................................................................................... 30 6.4 Conduct Pending Closing .................................................................................. 30

- iii - © 2017 Hodgson Russ LLP

6.5 Notification of Certain Matters .......................................................................... 32 6.6 Delivery of Interim Financial Statements .......................................................... 33 6.7 Non-Competition Agreement ............................................................................ 33 6.8 Waiver of Bulk Sales Laws ............................................................................... 33 6.9 Insurance Coverage ........................................................................................... 33 6.10 Offer of Employment to Seller’s Employees ..................................................... 33

ARTICLE 7

CONDITIONS TO SELLER’S AND SHAREHOLDER’S OBLIGATIONS 7.1 Representations, Warranties and Covenants ...................................................... 34 7.2 Consents, Approvals and Filings ....................................................................... 34 7.3 No Proceedings ................................................................................................. 34 7.4 Closing Certificate ............................................................................................ 34

ARTICLE 8

CONDITIONS TO BUYER’S OBLIGATIONS 8.1 Representations, Warranties and Covenants ...................................................... 35 8.2 Consents, Approvals and Filings ....................................................................... 35 8.3 No Proceedings ................................................................................................. 35 8.4 No Interruption or Adverse Change ................................................................... 35 8.5 Closing Certificate ............................................................................................ 35 8.6 [Intentionally Deleted] ..................................................................................... 35 8.7 No Casualty ...................................................................................................... 35 8.8 Agreements with ............................................................................................... 35 8.9 Lease ................................................................................................................ 35 8.10 Non-Competition Agreements ........................................................................... 35 8.11 Sales Tax Returns ............................................................................................. 36 8.12 Satisfactory Due Diligence ................................................................................ 36

ARTICLE 9


THE PARTIES AFTER CLOSING 9.1 Survival and Indemnifications ........................................................................... 36 9.2 Application of Retained Amount for Indemnification ........................................ 39 9.3 Use of Corporate Name or Trade Name............................................................. 39 9.4 Continuation Health Care Coverage .................................................................. 39 9.5 Access to Records and Personnel ...................................................................... 39 9.6 Assets Retained by Seller .................................................................................. 40 9.7 Collection of Purchased Accounts Receivable and Retained Accounts

Receivable ........................................................................................................ 40

- iv - © 2017 Hodgson Russ LLP

ARTICLE 10

MISCELLANEOUS 10.1 Further Assurances ............................................................................................ 41 10.2 Risk of Loss ...................................................................................................... 41 10.3 Termination ...................................................................................................... 42 10.4 Notices .............................................................................................................. 42 10.5 Public Statements .............................................................................................. 43 10.6 Choice of Law................................................................................................... 44 10.7 Expenses ........................................................................................................... 44 10.8 Titles ................................................................................................................. 44 10.9 Waiver .............................................................................................................. 44 10.10 Effective; Binding ............................................................................................. 44 10.11 Entire Agreement .............................................................................................. 45 10.12 Modification ..................................................................................................... 45 10.13 Counterparts...................................................................................................... 45 10.14 Consent to Jurisdiction ...................................................................................... 45

SCHEDULES Schedule Description 1.1(d) Assumed Contracts 1.1(u) Excluded Assets 2.1(a) Permitted Encumbrances 2.3 Allocation of Purchase Price 4.1 Jurisdictions Where Qualified; Tradenames; Equity Interests 4.3 Contractual Conflicts 4.4 Consents, Approvals 4.5 Proceedings 4.6 Capitalization 4.8 Financial Statements 4.9 Real Property, Liens, Encumbrances and Proceedings 4.10(i) Owned Tangible Personal Property; Encumbrances 4.10(ii) Leased Tangible Personal Property 4.11 Intangible Property 4.12 Permits, Licenses 4.13 Litigation

- v - © 2017 Hodgson Russ LLP

4.14(a) Employees; Labor Matters 4.14(b) Employee Contracts 4.15(a)(i) Pension Plans 4.15(a)(ii) Welfare Plans 4.15(f) Retirement Benefits 4.16 Transactions with Certain Persons 4.17 Tax Matters 4.18 Insurance 4.19 Encumbrances on Inventory; Consignment Inventory; Valuation 4.20 Encumbrances, Offsets and Discounts on Accounts Receivable 4.21 Contracts 4.22 Suppliers and Customers 4.24 Bank Accounts; Lock Boxes; Directors and Officers; Powers of Attorney 4.25 Environmental Matters 4.26 Changes Since December 31, 20____ 4.29 Product Warranties; Warranty Experience 5.4 Consents, Approvals (Buyer) 6.7 Key Management Employees

EXHIBITS

Exhibit Description 6.7 Non-Competition Agreement 8.9 ________________ Lease

E-1


ASSET PURCHASE AGREEMENT THIS ASSET PURCHASE AGREEMENT, dated ________, ____ is by and among __________________________, a ________ corporation with its principal place of business at _________________________________ (“Buyer”); ________________________, a ________ corporation with its principal place of business at ___________________________________ (“Seller”); and __________________, an individual with an address at _________________________________ (the “Shareholder”).

RECITALS:

Seller is engaged in the business of ______________________________

_____________________________________________________________________________.

Buyer desires to purchase from Seller, and Seller desires to sell to Buyer, substantially all of Seller’s assets and business upon the terms and conditions contained in this Agreement.

Shareholder is the sole shareholder of Seller and will benefit from the consummation

of the transactions contemplated by this Agreement, and Buyer has conditioned its willingness to enter into this Agreement upon Shareholder’s assuming certain obligations under this Agreement.

NOW, THEREFORE, in consideration of the mutual covenants and promises contained in this Agreement, and for other good and valuable consideration, the receipt and adequacy of which is hereby acknowledged, Buyer, Seller and Shareholder agree as follows:

ARTICLE 1

DEFINITIONS

1.01 Defined Terms. As used in this Agreement, the terms below shall have

the following meanings:

(a) “Accounts Receivable” shall mean all trade and accounts receivable of Seller reflected on the Closing Date Financial Statements, as determined in accordance with GAAP.

(b) “Affiliate” shall mean, as to any Person, any other Person which directly or indirectly controls, or is under common control with, or is controlled by, such Person. As

E-2


used in this definition, “control” (including, with its correlative meanings, “controlled by” and “under common control with”) shall mean possession, directly or indirectly, of power to direct or cause the direction of management or policies (whether through ownership of securities or partnership or other ownership interest, by contract or otherwise).

(c) “Agreement” shall mean, unless the context otherwise requires, this Asset Purchase Agreement together with the attached Schedules and Exhibits and the certificates and instruments to be executed and delivered in connection with this Asset Purchase Agreement.

(d) “Assumed Contracts” shall mean (i) the Contracts and the Employee Contracts relating to the Business identified on Schedule 1.1(d), and (ii) the Minor Contracts, all of which shall be assumed in writing by Buyer on the Closing Date.

(e) “Assumed Liabilities” shall mean (i) all liabilities of Seller reflected on the Closing Date Financial Statements, other than those which are included in the definition of Excluded Liabilities, and (ii) liabilities under the Assumed Contracts arising after the Closing Date (excluding, without limitation, contingent liabilities arising from events prior to the Closing Date).

(f) “Business” shall mean Seller’s business of ________________________ _____________________________________________________________________________ and all other activities which Seller is presently conducting or pursuing.

(g) “Business Records” shall mean all originals and copies of all operating data and records of the Business, including without limitation financial, accounting and bookkeeping books and records, purchase and sale orders and invoices, sales and sales promotional data, advertising materials, marketing analyses, past and present price lists, past and present customer service files, credit files, warranty files, written operating methods and procedures, specifications, reference catalogues, insurance files, personnel records and other records, on whatever media, pertaining to the Business, to the Purchased Assets, or to customers or suppliers of, or any other parties having contracts or other business relationships with, the Business.

(h) “Buyer’s Accountants” shall mean the firm of _________________.

(i) “Claims Period” shall mean, except as otherwise specifically provided in Section 9.1(a), the period beginning on the date of this Agreement and ending on the ______________ anniversary of the Closing Date.

(j) “Closing Date” shall mean the later to occur of (i) ____________ ____, _______ and (ii) five (5) business days after all consents, approvals and waivers necessary to permit Seller to transfer the Purchased Assets to Buyer, and Buyer to acquire the Purchased

E-3


Assets from Seller, have been obtained, or any other date as Seller and Buyer shall mutually agree.

(k) “Closing Date Financial Statements” shall mean the audited financial statements of Seller for the period ended at the Closing Date, consisting of a balance sheet, statement of income and retained earnings and statement of cash flows, as prepared by Buyer’s Accountants pursuant to Section 2.4.

(l) “Code” shall mean the Internal Revenue Code of 1986, as amended.

(m) “Contract” shall mean any written or oral contract, open order, lease and other agreement to which Seller is a party or by which Seller is currently bound (other than the Employee Contracts and the Minor Contracts) including, without limitation, all distributor, sales representative and dealer agreements, purchase and supply contracts, leases, maintenance contracts, license and royalty agreements, government contracts, partnering and joint development contracts, independent contractor agreements, indebtedness instruments, letters of credit, performance bonds, currency contracts, agreements with respect to guaranties, suretyships, mortgages, pledges, Encumbrances, security interests, covenants not to compete, confidentiality or indemnification by or for the benefit of Seller or by which Seller is bound, purchase and sale orders and all other contracts and agreements whatsoever, and all amendments relating to any of the foregoing.

(n) “Current Real Property” shall mean all Real Property currently owned or leased by Seller.

(o) “Customer Lists” shall mean all past and current customer and potential customer lists of the Business.

(p) “Employee Contract” shall mean any written or oral contract, agreement, arrangement, policy, program, plan or practice (exclusive of any such contract which is terminable within thirty (30) days without liability to Seller) directly or indirectly providing for or relating to any employment, consulting, remuneration, compensation or benefit, severance or other similar arrangement, insurance coverage (including any self-insured arrangements), medical-surgical-hospital or other health benefits, workers’ compensation, disability benefits, supplemental employment benefits, vacation benefits and other forms of paid or unpaid leave, retirement benefits, tuition reimbursement, deferred compensation, savings or bonus plans, profit-sharing, stock options, stock appreciation rights, or other forms of incentive compensation or post-retirement compensation or benefit, employment guarantee or security, or limitation on right to discipline or discharge, which (i) is not an Employee Plan, (ii) has been entered into or maintained by Seller, (iii) covers any one or more current or former director, officer, employee or consultant of Seller and (iv) under which any obligations remain outstanding.

E-4


(q) “Encumbrance” shall mean any claim, lien, pledge, option, charge, easement, security interest, right-of-way, encroachment, reservation, restriction, encumbrance, or other right of any Person, or any other restriction or limitation of any nature whatsoever, affecting title to the Current Real Property, the Tangible Personal Property, the Inventory, the Intangible Property or any other assets of Seller.

(r) “Environmental Claims” shall mean any written notice of violation, notice of potential or actual responsibility or liability, claim, suit, action, demand, directive or order by any Governmental Authority or other Person for any damage (including, but not limited to, personal injury, tangible or intangible property damage, contribution, indemnity, indirect or consequential damages, damage to the environment, environmental removal, investigative costs, response or remediation costs, nuisance, pollution, contamination or other adverse effects on the environment or for fines, penalties or restrictions on existing environmental permits or licenses) resulting from or relating to (i) the presence of, a Release or threatened Release into the environment of, or exposure to, any Hazardous Substance, (ii) the generation, manufacture, processing, distribution, use, handling, transportation, storage, treatment or disposal of any Hazardous Substances, (iii) the violation, or alleged violation, of any Environmental Laws or (iv) the non-compliance or alleged non-compliance with any Environmental Laws.

(s) “Environmental Laws” shall mean, whether now or hereafter in effect, any applicable statutes, ordinances, directives or other written, published laws, any written, published rules or regulations, orders, guidelines or policies, and any licenses, permits, orders, judgments, notices or other requirements issued pursuant thereto, enacted, promulgated or issued by any Governmental Authority, relating to pollution or protection of public health or the environment (including, but not limited to, any air, surface water, groundwater, land surface or sub-surface strata, whether outside, inside or under any structure), or to the identification, reporting, generation, manufacture, processing, distribution, use, handling, treatment, storage, disposal, transporting, presence, Release or threatened Release of, any Hazardous Substances. Without limiting the generality of the foregoing, Environmental Laws shall include the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, the Toxic Substances Control Act, as amended, the Hazardous Materials Transportation Act, as amended, the Resource Conservation and Recovery Act, as amended, the Clean Water Act, as amended, the Safe Drinking Water Act, as amended, the Clean Air Act, as amended, the Occupational Safety and Health Act, as amended, and all analogous laws enacted, promulgated or lawfully issued by any Governmental Authority.

(t) “ERISA” shall mean the Employee Retirement Income Security Act of 1974, as amended.

(u) “Excluded Assets” shall mean those specific assets of Seller listed on Schedule 1.1(u) and excluded from the Purchased Assets to be purchased by Buyer.

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(v) “Excluded Liabilities” shall mean (i) ____________________________ ____________________________________________, (ii) _____________________________ _______________________________________, (iii) federal, state, local and foreign income, franchise, business and occupation or similar taxes of Seller, (iv) legal, accounting and other expenses incurred by Seller or Shareholder in connection with the preparation and execution of this Agreement and the consummation of the transactions contemplated by this Agreement, (v) [OTHER?] and (vi) all other liabilities of Seller of whatsoever nature other than the Assumed Liabilities.

(w) “GAAP” shall mean, with respect to all accounting matters and issues, generally accepted accounting principles as in effect from time to time.

(x) “Goodwill” shall mean the goodwill of the Business.

(y) “Governmental Authority” shall mean any federal, state, local or foreign government, or any political subdivision of any of the foregoing, or any court, agency or other entity, body, organization or group, exercising any executive, legislative, judicial, quasi-judicial, regulatory or administrative function of government.

(z) “Governmental Requirement” shall mean any written, published law, statute, ordinance, directive or regulation of any Governmental Authority.

(aa) “Hazardous Substances” shall mean any pollutants, contaminants, substances, chemicals, carcinogens, wastes, dangerous wastes, and any ignitable, corrosive, reactive, toxic or other hazardous substances or materials, whether solids, liquids or gases (including, but not limited to, petroleum and its derivatives, PCBs, asbestos, radioactive materials, waste waters, sludge, slag and any other substance, material or waste), as defined in or regulated by any Environmental Laws or as determined by any Governmental Authority.

(bb) “Insured Claims” shall mean each claim, action, suit, proceeding, demand, investigation, judgment, cost and expense (including, but not limited to, legal and accounting fees and expenses) arising out of or relating to the operation of the Business prior to Closing and of a category or type which is subject to coverage under the Insurance (or under any other insurance policy which has been terminated but which provides coverage for occurrences prior to the date of its termination) or which would be subject to coverage if all of the Insurance were “occurrence” basis insurance, regardless of whether, for any particular occurrence, coverage is unavailable because the claim, loss or other injury is less than the applicable deductible or exceeds applicable coverage limits.

(cc) “Intangible Property” shall mean all intangible property of any nature owned by Seller or in which Seller has any interest including, without limitation, all patents, trademarks, service marks, trade names, copyrights and logos, all of Seller’s rights in and to the

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name “__________________,” and all grants, renewals, registrations and applications pertaining thereto.

(dd) “Inventory” shall mean all raw material, work-in-process, component parts and finished goods inventories of Seller.

(ee) “Knowledge” shall mean, with respect to Seller or Shareholder, actual knowledge, information or belief, as appropriate to the context of the statement in which the term is used, of Seller or any officer, director or Representative of Seller, or of Shareholder, after having made due inquiry of the appropriate employees or records of Seller or Shareholder with respect to the matters which are relevant to the representation, warranty, covenant or agreement being made or given; provided that Knowledge shall be attributed if such relevant information was available upon making reasonable due inquiry.

(ff) “Minor Contracts” shall mean any purchase and sale order under $_____, or any agreements relating to office equipment, maintenance, security or utilities, or other agreements which, in the aggregate for all agreements with any one Person, result in the incurrence of annual expenditures of less than $_____.

(gg) “Notes Receivable” shall mean any notes receivable of Seller.

(hh) “Other Current Assets” shall mean all prepaid expenses and deposits except for those included in the Excluded Assets.

(ii) “Owned Intangible Property” shall mean all Intangible Property owned by Seller.

(jj) “Owned Tangible Personal Property” shall mean all Tangible Personal Property owned by Seller.

(kk) “Permits” shall mean all permits, licenses, consents, franchises, approvals and other authorizations required from any Governmental Authority or other Person in connection with the operation of the Business and necessary to conduct the Business as presently conducted.

(ll) “Person” shall mean any Governmental Authority, individual, association, joint venture, partnership, corporation, limited liability company, trust or other entity.

(mm) “Predecessor” shall mean any Person to which Seller is or is deemed to be a successor in interest, whether directly or indirectly, by merger or otherwise.

(nn) “Purchased Accounts Receivable” shall mean all Accounts Receivable which are less than __ days old as of the Closing Date.

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(oo) “Purchased Assets” shall mean all right, title and interest of Seller in and

to all of the assets of Seller of whatsoever nature, tangible or intangible, real or personal (other than the Excluded Assets), including without limitation the following:

(i) the Assumed Contracts; (ii) the Business Records; (iii) the Customer Lists; (iv) the Goodwill; (v) the Other Current Assets; (vi) the Owned Intangible Property; (vii) the Owned Tangible Personal Property; (viii) the Permits (to the extent assignable); (ix) the Purchased Accounts Receivable; (x) the Purchased Cash; (xi) the Purchased Inventory; and (xii) the Notes Receivable.

(pp) “Purchased Cash” shall mean cash and cash equivalents of Seller as

reflected on the Closing Date Financial Statements.

(qq) “Purchased Inventory” shall mean all Inventory of Seller as reflected on the Closing Date Financial Statements, other than any such Inventory which is “obsolete” or “excess” (as such terms are hereinafter defined). Except to the extent otherwise specifically agreed by Seller and Buyer in writing, an item of inventory shall be deemed to be “obsolete” if (i) it has not already been excluded from Inventory as damaged or obsolete under GAAP and (ii) as of the Closing Date it has been in Inventory for a period in excess of one year. Except to the extent otherwise specifically agreed by Seller and Buyer in writing, Inventory shall be deemed to be “excess” if (i) it has not already been excluded from Inventory as damaged or obsolete and (ii) as of the Closing Date the total amount of any item of Inventory exceeds the aggregate usage of such item for the [______]-month period immediately preceding the Closing Date.

(rr) “Purchase Price” shall mean the purchase price for the Purchased Assets and shall be equal to (i) $_________ minus (ii) the aggregate amount of all Retained Accounts Receivable as reflected on the Closing Date Financial Statements, and minus (iii) the aggregate amount of all Retained Inventory as reflected on the Closing Date Financial Statements, as such amount may increase or decrease by the purchase price adjustment provisions of Section 2.4.

(ss) “Real Property” shall mean all real property now or in the past owned or leased by Seller or any Predecessor, or in which Seller or any Predecessor now has or in the past had any interest.

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(tt) “Release” shall mean any spilling, leaking, pumping, pouring, emitting, emptying, discharging, injecting, escaping, leaching, migration, dumping or disposing into the environment.

(uu) “Representative” shall mean any officer, director, principal, attorney, accountant, agent, employee or other representative of any Person.

(vv) “Retained Accounts Receivable” shall mean all Accounts Receivable which are __ or more days old as of the Closing Date.

(ww) “Retained Amount” shall mean the amount of $_______ to be withheld by Buyer from the Purchase Price payable to Seller at Closing and to be credited to Buyer or released to Seller in accordance with Section 2.6.

(xx) “Retained Inventory” shall mean all Inventory other than the Purchased Inventory.

(yy) “Seller’s Accountants” shall mean the firm of _________________.

(zz) “Tangible Personal Property” shall mean all tangible personal property (other than Inventory) owned or leased by Seller or in which Seller has any interest including, without limitation, production and processing equipment, warehouse equipment, computer hardware, furniture and fixtures, transportation equipment, leasehold improvements, supplies and other tangible assets, together with any transferable manufacturer or vendor warranties related thereto.

1.02 Other Defined Terms. The following terms shall have the meanings defined for such terms in the Sections set forth below: Term Section Buyer Parties 9.1(b) Casualty 10.2 Closing 3.1 Closing Certificate 2.4(a) COBRA 4.15(g) Employee Plan 4.15(a) ERISA Affiliate 4.15(d) Financial Statements 4.8 Insurance 4.18 Interim Financial Statements 4.8 Non-Competition Agreement 6.7 Losses 9.1(b)(i)

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PBGC 4.15(h) Pension Plans 4.15(a) Permitted Encumbrances 2.1(a) Registered Intangible Property 4.11 Qualified Person 9.4 Related Person 4.16 Retained Assets 9.6 Seller Parties 9.1(c) Third-Party Accountants 2.4(d)(iii) Welfare Plans 4.15(a)

1.03 Usage of Terms. Except where the context otherwise requires, words importing the singular number shall include the plural number and vice versa.

1.04 References to Articles, Sections, Exhibits and Schedules. All references in this Agreement to Articles, Sections, Exhibits and Schedules refer to the corresponding Articles, Sections, Exhibits and Schedules of or attached to this Agreement, unless the context otherwise expressly requires.

ARTICLE 2

PURCHASE AND SALE OF ASSETS OF SELLER

2.01 Transfer of Purchased Assets; Assumption of Assumed Liabilities. Subject to the terms and conditions contained in this Agreement, on the Closing Date:

(a) Seller shall sell, convey, transfer, assign, and deliver to Buyer, and Buyer shall acquire from Seller, the Purchased Assets, free and clear of any Encumbrances other than those Encumbrances set forth on Schedule 2.1(a) (the “Permitted Encumbrances”).

(b) Buyer shall assume the Assumed Liabilities.

2.02 Liabilities Not Assumed. It is expressly understood and agreed that, other than the Assumed Liabilities, Buyer shall not assume, nor shall it be liable for, and Seller shall retain and pay or perform, any liability or obligation of Seller, including without limitation all Excluded Liabilities. Furthermore, without limiting the foregoing, Seller shall pay or otherwise satisfy on the Closing Date out of the proceeds payable to Seller on the Closing Date pursuant to Section 2.5(a) the $_______ of long term debt and the $_________ of short term debt included in the Excluded Liabilities.

2.03 Consideration; Allocation. As consideration for the sale, transfer, assignment, conveyance and delivery of the Purchased Assets, Buyer shall pay to Seller an amount equal to the Purchase Price and shall assume the Assumed Liabilities. Such consideration shall be allocated as mutually agreed by Seller and Buyer and set forth on

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Schedule 2.3. It is understood and agreed by Seller and Buyer that Buyer shall be entitled to make reasonable adjustments to the basis of the equipment and other fixed assets included in the Purchased Assets and shall also be entitled, at its discretion in connection with such adjustments, to conduct an appraisal of any or all of such assets. Unless otherwise agreed in writing by Buyer and Seller, Buyer and Seller shall (i) reflect the Purchased Assets in their books and for federal, state, local and foreign tax reporting purposes in accordance with such allocation, (ii) file all forms required under Section 1060 of the Code and all other tax returns and reports in accordance with and based upon such allocation and (iii) unless required to do so in accordance with a “determination” as defined in Section 1313(a)(1) of the Code, take no position in any tax return, tax proceeding, tax audit or otherwise which is inconsistent with such allocation.

2.04 Closing Certificate; Preliminary Purchase Price Adjustment; Physical Inventory; Closing Date Financial Statements; Final Purchase Price Adjustment.

(a) Closing Certificate. On the third day prior to the Closing Date, an officer of Seller shall prepare and deliver to Buyer a certificate (the “Closing Certificate”) setting forth an estimated balance sheet of Seller as of the Closing Date and a proforma estimate of the retained earnings and total shareholder equity of Seller as of the Closing Date, which shall be subject to examination by Buyer and Buyer’s Accountants as to reasonableness. The Closing shall proceed, and the payments required to be made on the Closing Date pursuant to Section 2.5(a) shall be determined, on the basis of the Closing Certificate.

(b) Preliminary Purchase Price Adjustment. In the event that the total shareholder equity as of the Closing Date, as reflected on the Closing Certificate, is less than $_________ then the Purchase Price shall be adjusted downward as follows (the “Preliminary Purchase Price Adjustment”):

(c) Physical Inventory. There shall be conducted by Seller and Seller’s Accountants, and observed by Buyer and Buyer’s Accountants, in accordance with GAAP, a physical taking of Inventory of Seller on ____________ at Seller’s facilities located at ____________________________________________________________. With respect to any Inventory of Seller located at any premises not owned or leased by Seller, Seller or Seller’s Accountants shall obtain from each Person who is in possession of any such off-site Inventory, (i) for purposes of the Closing Certificate, written certification as to the amount of such off-site Inventory as of a date which is within ten (10) days prior to the Closing Date and (ii) for purposes of the Closing Date Financial Statements, written certification as to the amount of such off-site Inventory as of the Closing Date. The results of the physical inventory, as adjusted by additions to or deletions from Inventory to the Closing Date, shall be used in the preparation of the Closing Date Financial Statements pursuant to Section 2.4(d). Subject to the criteria for excess and obsolete inventory as set forth in the definition of “Inventory,” the valuation of Inventory will be computed by Seller’s Accountants in accordance with GAAP and the practices, procedures and other methods (including without limitation the method of computing overhead and other indirect expenses to be applied to inventory) used in computing the value of Inventory

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for purposes of preparation of the Financial Statements (except to the extent inconsistent with GAAP). Each party shall bear its own costs in connection with the physical inventory.

(d) Closing Date Financial Statements.

(i) As promptly as possible after the Closing, Buyer shall cause Buyer’s Accountants to conduct an audit of Seller and to prepare and deliver to Buyer audited financial statements of Seller as of the Closing Date in accordance with GAAP (the “Closing Date Financial Statements”). As promptly as reasonably practicable and, in any event, not later than forty-five (45) days after the Closing Date, Buyer’s Accountants shall deliver to Seller the Closing Date Financial Statements, together with their audit report. If Seller does not object to the Closing Date Financial Statements within 30 days after delivery to Seller, such Closing Date Financial Statements shall automatically become final and conclusive.

(ii) In the event that Seller objects to the Closing Date Financial Statements within the 30-day review period, Seller and Buyer shall promptly meet and endeavor to reach agreement as to the Closing Date Financial Statements. If Seller and Buyer are able to reach agreement, such Closing Date Financial Statements shall become final and conclusive. If Seller and Buyer are unable to reach agreement within 15 days after the end of Seller’s 30-day review period, then [_____________________] (the “Third-Party Accountants”) shall promptly be retained to undertake the determination of the Closing Date Financial Statements, which determination shall be determined as quickly as possible. The determination of the Third-Party Accountants shall be final and binding on Seller and Buyer.

(iii) All costs or expenses of Buyer’s Accountants incurred in connection with the preparation of the Closing Date Financial Statements, and attempts to resolve any disputes related thereto, shall be borne by Buyer. All costs and expenses of Seller’s Accountants incurred in connection with Seller’s review of the Closing Date Financial Statements, and attempts to resolve any disputes related thereto, shall be borne by Seller and Shareholder. All expenses of the Third-Party Accountants shall be borne by the party found by the Third-Party Accountants to be in greatest error in the calculation of the Closing Date Financial Statements.

(e) Final Purchase Price Adjustment. Within five (5) days after the Closing Date Financial Statements have been prepared in accordance with subsection (d) above, Seller and Buyer shall calculate the “Final Purchase Price Adjustment” on the basis of the total shareholder equity and retained earnings of Seller reflected in the Closing Date Financial Statements and otherwise in the same manner as the Preliminary Purchase Price Adjustment was determined pursuant to Section 2.4(b).

2.05 Payments by Buyer. Buyer shall pay to Seller the consideration set forth in Section 2.3 as follows:

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(a) On the Closing Date, Buyer shall pay to Seller an amount equal to the Purchase Price (as adjusted by the Preliminary Purchase Price Adjustment) minus the Retained Amount, in cash by wire transfer to an account designated by Seller to Buyer in writing at least three (3) business days prior to the Closing Date.

(b) On the Closing Date, Buyer shall assume the Assumed Liabilities.

(c) Within five (5) days after the determination of the Final Purchase Price Adjustment pursuant to Section 2.4(d), either Buyer or Seller, as the case may be, shall pay to the other the amount by which the Purchase Price, as adjusted by the Final Purchase Price Adjustment, is greater or less than the Purchase Price, as adjusted by the Preliminary Purchase Price Adjustment. If the Purchase Price, as adjusted by the Final Purchase Price Adjustment, is greater than the Purchase Price, as adjusted by the Preliminary Purchase Price Adjustment, Buyer shall pay such difference to Seller. If the Purchase Price, as adjusted by the Final Purchase Price Adjustment, is less than the Purchase Price, as adjusted by the Preliminary Purchase Price Adjustment, Seller shall pay such difference to Buyer. If either party fails to pay any amount owing to the other party pursuant to this subsection (d) within the specified five-day period, then the amount so owing shall be payable on demand and interest shall accrue on the unpaid amount from the date due until paid at a rate equal to the lower of (A) ten percent (10%) per annum or (B) the highest rate permitted by law.

2.06 Retained Amount.

(a) Accrual of Interest. Interest shall accrue at the rate of _____ percent (_%) per annum from and after the Closing Date with respect to the Retained Amount or the portion thereof from time to time remaining after (i) reduction of the Retained Amount pursuant to this Section 2.6 to reimburse Buyer for any Losses or estimated Losses for which Buyer is entitled to indemnification pursuant to Article 9, and (ii) payment of any portion of the Retained Amount to Seller as provided in this Section 2.6.

(b) Reduction of Retained Amount. For so long as any portion of the Retained Amount has not previously been applied pursuant to this subsection (b) or paid to Seller pursuant to subsection (c) below, the Retained Amount shall be reduced from time to time to the extent of any Losses with respect to which Buyer is entitled to indemnification pursuant to Article 9, but only if such Losses have been finally determined and are not subject to dispute.

(c) Payment of Retained Amount. The Retained Amount shall be paid to Seller by Buyer as follows:

(i) On the six-month anniversary of the Closing Date, Buyer shall pay to Seller an amount (not less than zero dollars) equal to (A) 50% of the initial Retained Amount (i.e., $_______) minus (B) the sum of all Losses previously deducted from the Retained Amount pursuant to subsection (b) above plus the aggregate estimated Losses expected to be incurred by

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Buyer with respect to any indemnification claims pending against Seller or Shareholder pursuant to Article 9 at such date; and

(ii) On the twelve–month anniversary of the Closing Date, Buyer shall pay to Seller an amount (not less than zero dollars) equal to (A) the remaining balance of the Retained Amount after application of subsection (c)(i) above together with all accrued interest earned with respect to the Retained Amount, minus (B) the sum of all Losses deducted from the Retained Amount pursuant to subsection (b) above from and after the six–month anniversary of the Closing Date plus the aggregate estimated Losses expected to be incurred by Buyer with respect to any indemnification claims pending against Seller or Shareholder pursuant to Article 9 at such date.

(d) Estimated Losses; Reconciliation. If on the occasion of the six–month or twelve–month anniversary of the Closing Date there exist claims for which Buyer is entitled to indemnification pursuant to Article 9 but with respect to which Buyer’s Losses are not yet determinable, then for purposes of applying subsections (c)(i) and (c)(ii) of this Section 2.6 the amount of Buyer’s Losses shall be based on a good faith estimate of such Losses as reasonably agreed between Buyer and Seller. In the event that the actual Losses incurred by Buyer with respect to such indemnification claims are less than the estimated Losses, then the difference between the estimated Losses and the actual Losses (the “Repayment Amount”) shall (i) if the determination of actual Losses occurs prior to the twelve–month anniversary of the Closing Date, be added back to the Retained Amount together with interest on the Repayment Amount at __% per annum for the period from the date the Repayment Amount was deducted from the Retained Amount to but not including the date when the Repayment Amount is added back to the Repayment Amount, and (ii) if the determination of actual Losses occurs after the twelve–month anniversary of the Closing Date, be paid by Buyer to Seller together with interest on the Repayment Amount at 7% per annum for the period from the date the Repayment Amount was deducted from the Retained Amount to but not including the date when Buyer pays the Repayment Amount to Seller.

2.07 Taxes. Seller shall be responsible for the payment of any transfer, excise, business and occupation, gross receipts or other similar taxes (other than sales and use taxes) imposed by reason of the transfer of the Purchased Assets pursuant to this Agreement and any deficiency, interest or penalty with respect to such taxes. Buyer shall be responsible for the payment of any sales and use taxes imposed by reason of the transfer of the Purchased Assets pursuant to this Agreement, and any deficiency, interest or penalty with respect to such taxes.

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ARTICLE 3

CLOSING

3.01 Closing. The closing of the transactions contemplated by this Agreement shall be held at 10:00 a.m. local time on the Closing Date at the offices of [___________________], or any other place as Buyer and Seller mutually agree (“Closing”). The Closing shall be effective as of the [close] of business on the Closing Date.

3.02 Conveyances at Closing.

(a) Instruments and Possession. On the Closing Date, Seller shall deliver to Buyer (i) one or more bills of sale conveying in the aggregate all of the Owned Tangible Personal Property, (ii) assignments of the Assumed Contracts, (iii) one or more assignments of the Owned Intangible Property in recordable form, (iv) a certificate of amendment to Seller’s certificate of incorporation, in proper form for filing with the Secretary of State of [_____________], and all other appropriate certificates for filing in other applicable jurisdictions, changing Seller’s name to a name that does not contain the words “_______” or any derivative or variation thereof, (vi) such other instruments of assignment and conveyance as shall be reasonably requested by Buyer to vest in Buyer title in and to the Purchased Assets in accordance with the provisions of this Agreement and (vii) such other documents and agreements as are contemplated by this Agreement.

(b) Form of Instruments. All of such instruments shall be in form and substance, and shall be executed and delivered in a manner, reasonably satisfactory to Buyer and Seller, but shall not diminish the status of title to the Purchased Assets required to be delivered by Seller pursuant to this Agreement.

3.03 Assumptions at Closing.

(a) Instruments. On the Closing Date, Buyer shall deliver to Seller (i) an assumption of the Assumed Liabilities, (ii) such other instruments of assumption evidencing Buyer’s assumption of the Assumed Liabilities as Seller shall deem necessary and (iii) such other documents and agreements as are contemplated by this Agreement.

(b) Form of Instruments. All such instruments shall be in form and substance, and shall be executed and delivered in a manner, reasonably satisfactory to Seller and Buyer, but shall not increase or decrease the liabilities and obligations required to be assumed by Buyer pursuant to this Agreement.

3.04 Certificates and Other Documents. Buyer, Seller and Shareholder shall deliver or cause to be delivered the certificates and other documents and items described in Articles 6, 7, 8 and 9 of this Agreement.

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ARTICLE 4

REPRESENTATIONS AND WARRANTIES OF

SELLER AND SHAREHOLDER Seller and Shareholder hereby, jointly and severally, represent and warrant to Buyer as follows:

4.01 Organization, Good Standing and Authority of Seller to Conduct Business. Seller is a corporation, duly incorporated, validly existing and in good standing under the laws of the State of [___________]. Schedule 4.1 sets forth each jurisdiction other than the jurisdiction of organization where Seller is qualified to do business. Seller is duly qualified to do business in, and is in good standing under the laws of each jurisdiction in which such qualification is necessary as a result of the conduct of the Business. Seller has full power and authority to conduct its Business as it is presently being conducted and to own, lease and operate its properties and assets. Except as set forth on Schedule 4.1, Seller does not have any stock or equity interest in any corporation, firm or organization, and Seller conducts its business directly and not through any other Person.

4.02 Power and Authority; Authorization; Binding Effect. Each of Seller and Shareholder has all necessary power and authority and has taken all action necessary to execute and deliver this Agreement, to consummate the transactions contemplated by this Agreement, and to perform its or his obligations under this Agreement. Copies of all resolutions of the board of directors and shareholders of Seller with respect to the transactions contemplated by this Agreement, certified by the Secretary or an Assistant Secretary of Seller, in form reasonably satisfactory to counsel for Buyer, have been delivered to Buyer. This Agreement has been duly executed and delivered by Seller and Shareholder and constitutes a legal, valid and binding obligation of Seller and Shareholder enforceable against Seller and Shareholder in accordance with its terms (subject to bankruptcy and similar laws affecting creditors’ rights and principles of equity).

4.03 No Conflict or Violation. The execution and delivery of this Agreement, the consummation of the transactions contemplated by this Agreement, and the fulfillment of the terms of this Agreement, do not and will not result in or constitute (i) a violation of or conflict with any provision of the certificate incorporation or by-laws of Seller, (ii) except as set forth on Schedule 4.3, a breach of, a loss of rights under, or an event, occurrence, condition or act which is or, with the giving of notice, the lapse of time or the happening of any future event or condition, would become, a material default under, or result in the acceleration of any obligations under, any term or provision of, any contract, agreement, indebtedness, encumbrance, commitment, license, franchise, permit, authorization or concession to which Seller or Shareholder is a party, (iii) a violation by Seller or Shareholder of any statute, rule, regulation, ordinance, code, order, judgment, writ, injunction, decree or award applicable to Seller or Shareholder or (iv) an imposition of any Encumbrance on the Purchased Assets.

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4.04 Consents and Approvals. Except set forth on Schedule 4.4, no consent, approval or authorization of, or declaration, filing or registration with, any Person is required to be made or obtained by Seller or Shareholder in connection with the execution, delivery and performance of this Agreement and the consummation of the transactions contemplated by this Agreement.

4.05 No Proceedings. Except as set forth on Schedule 4.5, there is no action, order, writ, injunction, judgment or decree outstanding, or claim, suit, litigation, proceeding, arbitral action or investigation pending or threatened against, relating to or affecting in any adverse manner the transactions contemplated by this Agreement.

4.06 Capitalization. Schedule 4.6 sets forth the authorized, issued and outstanding shares of capital stock of Seller, the ownership thereof and any Encumbrances thereon. Shareholder owns all of the issued and outstanding shares of capital stock of Seller. Except as set forth on Schedule 4.6, (i) there are no outstanding shares of capital stock of Seller or outstanding securities convertible into or exchangeable or exercisable for shares of capital stock of Seller, (ii) there are no bonds, debentures, notes, or other indebtedness having the right to vote on any matters on which Seller’s shareholders may vote, (iii) there are no outstanding options, warrants, rights, contracts, commitments, understandings or arrangements by which Seller is bound to issue, repurchase or otherwise acquire or retire any capital stock of Seller and (iv) there are no voting agreements, voting trusts, buy-sell agreements, options or rights or obligations relating to the shareholders or the capital stock of Seller.

4.07 Corporate Records. The minute books of Seller are complete and accurate in all material respects and contain a complete and accurate record of all material meetings and actions of shareholders and directors. The stock record book of Seller is complete and accurate and contains a complete and accurate record of all share transactions for Seller from the date of its incorporation. True and complete copies of the certificate of incorporation and by-laws of Seller, and similar governing and organizational documents for each other entity listed on Schedule 4.1, if any, have been delivered to Buyer, and true and complete copies of the minute book and stock record book of Seller have been made available for review by Buyer.

4.08 Financial Statements. Seller has delivered to Buyer (i) unaudited financial statements of Seller for the two-year period ended December 31, 20____ (consisting of a balance sheet, statement of income and retained earnings, a statement of cash flows) (the “Financial Statements”), and (ii) unaudited monthly interim financial statements of Seller (consisting of a balance sheet and a statement of income) for the period ended ______________ ____, 20____ (the “Interim Financial Statements”). Copies of the Financial Statements and the Interim Financial Statements are attached to Schedule 4.8. The Financial Statements fairly present the financial condition and the results of operations of Seller as of their respective dates and for the periods then ended and have been prepared in a manner consistent with past practice and procedures. The Interim Financial Statements fairly present the financial condition and the results of operations of Seller as of their respective dates and for the periods then ended and have

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been prepared in a manner consistent with past practice and procedures. The books and records of Seller from which the Financial Statements and the Interim Financial Statements were prepared fairly reflect the assets, liabilities and operations of Seller and the Financial Statements and the Interim Financial Statements are in conformity therewith. The Financial Statements and the Interim Financial Statements provide fully for all material fixed and non-contingent liabilities of Seller. Except as disclosed on Schedule 4.8, there are no liabilities or obligations of any nature, whether absolute, accrued, contingent, known, unknown, matured, unmatured or otherwise, and whether or not required to be disclosed or provided for in financial statements in accordance with GAAP, of Seller except (i) liabilities and obligations reflected or reserved for in the Financial Statements and the Interim Financial Statements, (ii) as otherwise specifically disclosed in this Agreement, or (iii) liabilities and obligations incurred between December 31, 20____ and the Closing Date in the ordinary course of the business of Seller, consistent with past practice, and as permitted by this Agreement.

4.09 Real Property. Schedule 4.9 contains a true, complete and correct list of the Current Real Property. Seller does not now own and has not in the past owned any Real Property. Except as set forth on Schedule 4.9, (i) Seller enjoys peaceful and undisturbed possession of the Current Real Property leased by Seller, (ii) Seller’s interest in the Current Real Property is not subject to any commitment for sale or use by any Person other than Seller, (iii) Seller’s interest in the Current Real Property is not subject to any Encumbrance which in any material respect interferes with or impairs the value, transferability or present and continued use thereof in the usual and normal conduct of the Business, (iv) no labor has been performed or material furnished on behalf of or at the request of Seller for the Current Real Property for which a mechanic’s or materialman’s lien or liens, or any other lien, has been or could be claimed by any Person on Seller’s interest in the Current Real Property, (v) the Current Real Property, and each user thereof, is in compliance in all material respects with all applicable Governmental Requirements and (vi) no default or breach exists with respect to any Encumbrance affecting Seller’s interest in the Current Real Property. There are no condemnation or eminent domain proceedings pending or, to the knowledge of Seller or Shareholder, contemplated or threatened against Seller’s interest in the Current Real Property or any part thereof. Except as set forth on Schedule 4.9, there are no existing or, to the knowledge of Seller or Shareholder, contemplated or threatened, general or special assessments affecting Seller’s interest in the Current Real Property or any portion thereof. Neither Seller nor Shareholder has received notice of, nor does Seller or Shareholder have any knowledge of, any pending or threatened action, suit, proceeding or investigation before any Governmental Authority which relates to the ownership, maintenance, use or operation of Seller’s interest in the Current Real Property. The buildings and improvements on the Current Real Property (including, without limitation, the heating, air conditioning, mechanical, electrical and other systems used in connection therewith) are in a reasonable state of repair, have been well maintained and are free from infestation by termites, other wood destroying insects, vermin and other pests. There are no repairs or replacements exceeding $______ in the aggregate for all Current Real Property or $_____ for any single repair or replacement which are currently contemplated by Seller or which, to the knowledge of Seller

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or Shareholder, should be made in order to maintain said buildings and improvements in a reasonable state of repair.

4.10 Tangible Personal Property. Schedule 4.10(i) lists each item of Tangible Personal Property owned by Seller having a value in excess of $_____, and Schedule 4.10(ii) lists each item of Tangible Personal Property leased by Seller (other than individual leases of office equipment having an annual rental of less than $_____). The Tangible Personal Property constitutes substantially all of the tangible personal property used in the operation of the Business and constitutes substantially all tangible personal property necessary and sufficient to conduct the Business. Except as set forth on Schedule 4.10(i), the Tangible Personal Property owned by Seller is free and clear of all Encumbrances. Except as set forth on Schedule 4.10(i), all of the Tangible Personal Property is located at the Current Real Property and there is no tangible personal property located at any of the Current Real Property which is not owned or leased by Seller. The Tangible Personal Property is, taken as a whole, in all material respects in reasonable working order and adequate for its intended use, ordinary wear and tear excepted. There are no repairs or replacements exceeding $______ in the aggregate for all Tangible Personal Property or $_____ for any single item of Tangible Personal Property which are currently contemplated by Seller or which, to the knowledge of Seller or Shareholder, should be made in order to maintain the Tangible Personal Property in reasonable working order.

4.11 Intangible Property. Schedule 4.11 contains a true, correct and complete list of United States federal, state and foreign grants, registrations and applications existing or outstanding with respect to any of the Intangible Property, (the “Registered Intangible Property”) and all other trademarks, trade names and service marks which constitute Intangible Property and to which Seller attributes any value. Except as set forth on Schedule 4.11, (i) the Intangible Property owned by Seller is free and clear of all Encumbrances and is used exclusively by Seller, (ii) there is not now, and there has not been during the past five years, any infringement or other violation of any intellectual property right of any third Person resulting from the conduct of the Business, and neither Seller nor Shareholder is aware that any such infringement or violation exists or will be alleged, (iii) neither Seller nor Shareholder knows of any activity by any third Person which does or might constitute an infringement or other violation of Seller’s rights in or to any Intangible Property, (iv) Seller has not entered into any license, consent, indemnification, forbearance to sue, settlement agreement or cross-licensing arrangement with any Person relating to the Intangible Property or any intellectual property right of any third Person, (v) there are no agreements to which Seller or Shareholder is a party relating to and materially affecting any Intangible Property of Seller or the use or ownership thereof, including, without limitation, license agreements, confidentiality and non-disclosure agreements, assignments or agreements to assign, development agreements, settlement agreements and other related agreements and (vi) neither Seller nor Shareholder is aware of any information which would or might materially adversely affect any of the Intangible Property or render any of the Intangible Property invalid or unenforceable. The Intangible Property constitutes all intangible property necessary and sufficient to operate the Business.

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4.12 Compliance with Laws; Permits. Seller and the conduct of the Business are in compliance in all material respects with all applicable Governmental Requirements. Neither Seller nor Shareholder has received any notice to the effect that, or otherwise been advised that, Seller is not in compliance with any applicable Governmental Requirement, and neither Seller nor Shareholder expects that any presently existing circumstances are likely to result in violations of any applicable Governmental Requirement, which would have a material adverse effect on the Business. Schedule 4.12 identifies all Permits issued to Seller and currently in effect. The Permits constitute all permits, consents, licenses, franchises, authorizations and approvals used in the operation of and necessary to conduct the Business. All of the Permits are valid and in full force and effect, no violations have been experienced, noted or recorded or are expected, and no proceeding is pending or, to the knowledge of Seller or Shareholder, threatened to revoke or limit any of them.

4.13 Litigation. Except as set forth on Schedule 4.13, there is no pending or, to the knowledge of Seller or Shareholder, threatened claim, legal action, suit, arbitration, Governmental Authority investigation or other legal or administrative proceeding, or any order, decree, or judgment against or relating to Seller, its officers, directors or employees, or its properties, assets or business.

4.14 Labor Matters; Employee Contracts. (a) Schedule 4.14(a) identifies for each current employee of Seller employed in the Business, his or her name, and position or job title, and his or her base compensation and bonus compensation earned in calendar-year 20____. Except as set forth on Schedule 4.14(a), (i) Seller does not have any obligations under any written or oral labor agreement, collective bargaining agreement or other agreement with any labor organization or employee group, (ii) Seller is not currently engaged in any unfair labor practice and there is no unfair labor practice charge or other employee-related or employment-related complaint against Seller pending or, to the knowledge of Seller or Shareholder, threatened before any Governmental Authority, (iii) Seller is not experiencing and has not in the past three years experienced a labor strike, labor disturbance, slowdown, work stoppage or other material labor dispute, arbitration or material grievance, and (iv) there is, to the knowledge of Seller or Shareholder, no organizational campaign being conducted or contemplated. Except as set forth on Schedule 4.14(a), Seller has complied in all material respects with, and is currently in compliance in all material respects with, all applicable Governmental Requirements relating to any of its employees or consultants (including, without limitation, any Governmental Requirement of the Occupational Safety and Health Administration), and neither Seller nor Shareholder has received within the past three years any written notice of failure to comply with any such Governmental Requirement.

(a) Schedule 4.14(b) contains a list identifying all Employee Contracts. All Employee Contracts are valid and binding on all parties thereto and enforceable in accordance with their terms (subject to bankruptcy and similar laws affecting creditors’ rights and principles of equity), are in full force and effect, and no party to any Employee Contract is in material default thereunder. Except as set forth on Schedule 4.14(b) or reflected or reserved for on the

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Financial Statements or the Interim Financial Statements or incurred by Seller in the ordinary course of the Business since the date of the last Interim Financial Statement, Seller does not have any liability for unpaid wages, salaries, bonuses, commissions, vacation pay, severance pay, health insurance, life insurance, or other form of employee compensation and all such amounts have been paid on a timely basis in accordance with Seller’s current practices and procedures. Except as set forth on Schedule 4.14(b), there is no amount in excess of $_______ owing to Seller from any current or former director, officer, employee or consultant, or owing by Seller to any current or former director, officer, employee or consultant. True and complete copies or descriptions of the Employee Contracts have been delivered to Buyer. Each Employee Contract has been maintained in substantial compliance with all applicable Governmental Requirements.

(b) Seller has completed a valid Form I-9 for each employee in the Business hired on or after November 7, 1986 and continuously employed on or after November 6, 1986. All of Seller’s employees currently employed in the Business are (i) United States citizens, or lawful permanent residents of the United States, (ii) aliens whose right to work in the United States is unrestricted, (iii) aliens who have valid, unexpired work authorization issued by the Attorney General of the United States (Immigration and Naturalization Service) or (iv) aliens who have been continually employed by Seller since November 6, 1986. Seller has not been the subject of an immigration compliance or employment visit from, nor has Seller been assessed any fine or penalty by, or been the subject of any order or directive of, the United States Department of Labor or the Attorney General of the United States (Immigration and Naturalization Service).

4.15 Employee Benefit Plans.

(a) Schedule 4.15(a)(i) contains a list identifying each “employee pension benefit plan,” as defined in Section 3(2) of ERISA, including any “multiemployer plan,” as defined in Section 3(37) of ERISA (the “Pension Plans”), and Schedule 4.15(a)(ii) contains a list identifying each “employee welfare benefit plan,” as defined in Section 3(1) of ERISA, (the “Welfare Plans”) that, in either case, are presently maintained, administered or contributed to by Seller, or which presently cover any employee or former employee of Seller (the Pension Plans and the Welfare Plans being the “Employee Plans”). Except as otherwise identified on Schedule 4.15(a)(i) and (a)(ii), and on Schedule 4.14(b), (i) no Employee Plan or Employee Contract is maintained, administered or contributed to by any entity other than Seller and (ii) no Employee Plan is maintained under any trust arrangement which covers any employee benefit arrangement which is not an Employee Plan. Each Employee Plan has been maintained and administered in compliance with its terms and with all applicable Governmental Requirements.

(b) Seller has delivered or caused to be delivered to Buyer true and complete copies of (i) the Employee Plans (and related trust agreements and other funding arrangements, if any, and adoption agreements, if any), (ii) any amendments to the Employee Plans, (iii) written interpretations of the Employee Plans to the plan administrator of such Employee Plan (iv) material employee communications by the plan administrator of any Employee Plan

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(including, but not limited to, summary plan descriptions and summaries of material modifications as defined under ERISA), (v) the three most recent annual reports (e.g., the complete Form 5500 series) prepared in connection with each Employee Plan (if any such report was required), including all attachments (including without limitation the actuarial valuation reports) and (vi) the three most recent actuarial valuation reports prepared in connection with each Employee Plan (if any such report was required).

(c) There are no pending or, to the knowledge of Seller or Shareholder, threatened claims, suits or other proceedings by any employees, former employees or plan participants or the beneficiaries, spouses or representatives of any of them, against any Employee Plan, the assets held thereunder, the trustee of any such assets, or Seller relating to any of the Employee Plans or Employee Contracts, other than ordinary and usual claims for benefits by participants or beneficiaries. Furthermore, there are no pending or, to the knowledge of Seller or Shareholder, threatened suits, investigations or other proceedings by any Governmental Authority of or against any Employee Plan, the trustee of any assets held thereunder, or Seller relating to any of the Employee Plans or Employee Contracts.

(d) No liability has been incurred by Seller during the past three (3) years or by a trade or business, whether or not incorporated, which is deemed to be under common control or affiliated with Seller within the meaning of Section 4001 of ERISA or Sections 414(b), (c), (m) or (o) of the Code (an “ERISA Affiliate”) for any tax, penalty or other liability with respect to any Employee Plan and such Employee Plans do not expect to incur any such liability prior to the date of Closing.

(e) Neither Seller nor Shareholder has engaged in any transaction or acted or failed to act in a manner that violates in any material respect the fiduciary requirements of Section 404 of ERISA with respect to any Employee Plans, and will not so engage, act or fail to act prior to the date of Closing. None of Seller, Shareholder or any fiduciary with respect to any Employee Plan has engaged in any “prohibited transaction” within the meaning of Section 406(a) or 406(b) of ERISA, or of Section 4975(c) of the Code with respect to any Employee Plan, and, to the knowledge of Seller or Shareholder, no other “party in interest,” as defined in Section 3(14) of ERISA, or “disqualified person,” as defined in Section 4975(e)(2) of the Code, has engaged in any such “prohibited transaction.”

(f) Except as set forth on Schedule 4.15(f), no Employee Plan provides benefits, including without limitation, death, disability, or medical benefits (whether or not insured), with respect to current or former employees of Seller beyond their retirement or other termination of service other than (i) coverage mandated by applicable law, (ii) death, disability or retirement benefits under any Pension Plan, (iii) deferred compensation benefits or (iv) benefits, the full cost of which is borne by the current or former employee (or his or her beneficiary).

(g) The Welfare Plans that are group health plans (as defined for the purposes of Section 4980B of the Code and Part 6 of Subtitle B of Title I of ERISA, and all regulations

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thereunder, (such provisions of law and regulations are hereinafter referred to as “COBRA”)) have complied in all material respects with requirements of COBRA to provide health care continuation coverage to qualified beneficiaries who have elected, or may elect to have, such coverage. Seller or its agents who administer any of the Welfare Plans have complied in all material respects will continue to comply in all material respects through the date of Closing, with the notification and written notice requirements of COBRA. There are no pending or, to the knowledge of Seller or Shareholder, threatened claims, suits, or other proceedings by any employee, former employee, participants or by the beneficiary, dependent or representative of any such person, involving the failure of any Welfare Plan or of any other group health plan ever maintained by Seller to comply with the health care continuation coverage requirements of COBRA.

(h) Each Pension Plan is “qualified” within the meaning of Section 401(a) of the Code, and has been qualified during the period from the date of its adoption to the date of this Agreement, and each trust created thereunder is tax-exempt under Section 501(a) of the Code. Seller has delivered or caused to be delivered to Buyer the latest determination letters of the Internal Revenue Service relating to each Pension Plan. Such determination letters have not been revoked. There are no pending or, to the knowledge of Seller of Shareholder, threatened proceedings in which the “qualified” status of any Pension Plan is at issue or in which revocation of the determination letter has been threatened. Each Pension Plan has not been amended or operated, since the receipt of the most recent determination letter, in a manner that would materially adversely affect the “qualified” status of the Plan. No distributions have been made from any Pension Plan that would violate in any material respect the restrictions under Treas. Reg. Section 1.401(a)(4)-5(b). To the knowledge of Seller or Shareholder, there has been no partial termination as defined in Section 411(d) of the Code and the regulations thereunder, of any Pension Plan. Seller has made all required contributions under each Pension Plan on a timely basis or, if not yet due, adequate accruals therefor have been provided for in the Financial Statements or the Interim Financial Statements. No Pension Plan has incurred any “accumulated funding deficiency” within the meaning of Section 302 of ERISA or Section 412 of the Code and no Pension Plan has applied for or received a waiver of the minimum funding standards imposed by Section 412 of the Code. Except for required premium payments, no liability to the Pension Benefit Guaranty Corporation (the “PBGC”) has been incurred by Seller with respect to any Pension Plan. Seller has complied with all requirements for premium payments, including any interest and penalty charges for late payment, due to PBGC with respect to each Pension Plan for which any premiums are required. No proceedings to terminate, pursuant to Section 4042 of ERISA, have been instituted or, to the knowledge of Seller or Shareholder, threatened by the PBGC with respect to any Pension Plan (or any Pension Plan maintained by an ERISA Affiliate). To the knowledge of Seller or Shareholder, no reportable event, within the meaning of Section 4043 of ERISA, has occurred with respect to any Pension Plan.

(i) There has been no amendment to, written interpretation or announcement (whether or not written) by Seller relating to, or change in employee participation or coverage under, any Employee Plan that would increase materially the expense of maintaining such

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Employee Plan above the level of expense incurred in respect of such Employee Plan for the most recent plan year with respect to Employee Plans.

4.16 Transactions with Certain Persons. Except as set forth on Schedule 4.16 or as otherwise disclosed in this Agreement, (i) no shareholder, officer, director or employee of Seller, nor any Person related to any such shareholder, officer, director or employee by blood or marriage, nor any corporation, partnership, trust or other entity in which any such Person has a substantial interest as a shareholder, officer, director, trustee, partner or otherwise, or any Affiliate of any of the foregoing (each, a “Related Person”), is presently or at any time during the past five years has been a party to any material transaction with Seller, including, without limitation, any material contract, agreement or other arrangement (A) providing for the furnishing of services to or by, (B) providing for the rental or sale of real or personal property to or from, or (C) otherwise requiring payments of an amount in excess of $______ annually to or from (other than for services as officers, directors of Seller), such Related Person and (ii) no shareholder, officer or director of Seller is related to any other shareholder, officer or director of Seller by blood or marriage. Except as set forth on Schedule 4.16, there is no outstanding amount in excess of $______ owing (including, without limitation, pursuant to any advance, note or other indebtedness instrument) from Seller to any Related Person or from any Related Person to Seller. Each of the Related-Person transactions set forth on Schedule 4.16 was entered into between Seller and the Related Person on an arms-length basis on terms no less favorable to Seller than could be obtained from an unrelated third party.

4.17 Tax Matters. Except as set forth on Schedule 4.17, (i) Seller has duly filed all tax reports and returns required to be filed (including, but not limited to, all federal, state, local and foreign tax returns and reports) with any Governmental Authority and all such returns and reports were correct and complete in all material respects, (ii) Seller has paid in full all taxes required to be paid by Seller before such payment became delinquent, and no deficiencies have been or, to the knowledge of Seller or Shareholder, will be assessed with respect thereto for any such period through December 31, 20____, (iii) all taxes which Seller has been required to collect or withhold have been duly collected or withheld and, to the extent required when due, have been or will be duly paid to the proper taxing authority, (iv) the income tax returns of Seller have not been examined by any Governmental Authority for any period on or after December 31, _________, there are no audits of Seller’s tax returns pending, and there are no claims which have been or may be asserted relating to Seller’s tax returns filed for any year, (v) Seller is not a party to any tax-sharing agreement or similar arrangement with any other party, (vi) there are no federal, state, local or foreign tax liens upon any of the properties or assets of Seller and there are no unpaid taxes which are or could become a lien on the properties or assets of Seller, except for current taxes not yet due and payable and (vii) there have been no waivers of statutes of limitations by Seller with respect to any Governmental Authority. Seller has elected to be treated as an __ corporation for federal and [_________] State income tax purposes for all periods from and after [___________, ____]. Correct and complete copies of all tax returns and reports of Seller for the past five (5) years have been provided to Buyer. For the purpose of this Agreement, any income, franchise, sales, use, transfer, payroll, personal property, real property,

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occupancy or other tax, levy, impost, fee, imposition, assessment or similar charge, together with any related addition to tax, interest or penalty thereon, of any Governmental Authority, is referred to as a “tax.” Seller has not agreed or been required to make any adjustment under Section 481(a) of the Code by reason of a change in accounting method or otherwise, except for adjustments under Section 481(a) which have been fully recognized on or before the Closing Date.

4.18 Insurance. Schedule 4.18 contains a complete and accurate list of all current policies or binders of fire, product liability, automobile liability, general liability, worker’s compensation and other forms of insurance (showing as to each policy or binder the carrier, policy number, coverage limits, expiration dates, annual premiums, deductibles, whether coverage is “occurrence” or “claims made” and a general description of the type of coverage provided and policy exclusions) maintained by Seller and relating to Seller’s properties and assets or personnel (collectively, the “Insurance”). The Insurance is in full force and effect and sufficient for compliance in all material respects with all requirements of applicable law and of all contracts to which Seller is a party. Seller is not in default in any material respect under any of the Insurance, and Seller has not failed to give any notice or to present any claim under any of the Insurance in a due and timely manner. No notice of cancellation, termination, reduction in coverage or increase in premium (other than reductions in coverage or increases in premiums in the ordinary course) has been received with respect to any of the Insurance, and all premiums with respect to any of the Insurance have been timely paid. Seller has not experienced claims in excess of current Insurance coverage. Except as disclosed on Schedule 4.18, there will be no retrospective insurance premiums or charges on or with respect to any of the Insurance for any period or occurrence through the Closing Date.

4.19 Inventory. Except as set forth on Schedule 4.19, (i) the Purchased Inventory is in good and merchantable condition and consists only of items of a quality and quantity commercially usable and salable in the ordinary course of the Business, (ii) the Purchased Inventory is not damaged, obsolete or excess and is reasonably related to the normal demands of the Business, (iii) all of the Purchased Inventory is owned by Seller free and clear of any Encumbrance and is located at the Current Real Property, (iv) none of the Purchased Inventory is on consignment, (v) the Inventory as reflected in the Financial Statements and Interim Financial Statements has been valued at the lower of average cost basis or fair market value, net of reserves, in a manner consistent with past practices and procedures (including, without limitation, the method of computing overhead and other indirect expenses to be applied to inventory) and (vi) all inventory located at the Current Real Property is owned by Seller and is not held by Seller (on consignment or otherwise) for or on behalf of any other Person.

4.20 Purchased Accounts Receivable. All of the Purchased Accounts Receivable of Seller are bona fide receivables, are reflected on the books and records of Seller, arose in the ordinary course of the Business and will be collected at their full face amount, net of reserves. Except as set forth on Schedule 4.20, there are no Encumbrances on the Purchased Accounts Receivable, there is no right of offset against any of the Purchased Accounts

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Receivable, and no agreement for deduction or discount has been made with respect to any of the Purchased Accounts Receivable.

4.21 Contracts. Schedule 4.21 contains a true and correct list of the Contracts. True and correct copies of the Contracts have been delivered to Buyer. Each of the Contracts is valid and binding on all parties thereto and is enforceable by Seller in accordance with its terms (subject to bankruptcy and similar laws affecting creditors’ rights and principles of equity). Each of the Contracts was entered into in the ordinary course of business and is not subject to termination except in accordance with its terms or except as provided by applicable law. Except as set forth on Schedule 4.21, each of the Contracts is in full force and effect, all fees, rents, royalties and other payments due thereunder are current, neither Seller nor any other party is in material default thereunder or in material breach thereof, and Seller has not, during the past five years, obtained or granted any waiver of or under any provision of any Contract (including, without limitation, any waiver from any lender or other creditor of any term, condition or default under any Contract), except for routine waivers granted or sought in the ordinary course of the Business. To the knowledge of Seller or Shareholder, there exists no event or occurrence, condition or act which constitutes or, with the giving of notice, the lapse of time or the happening of any future event or condition, would become, a material default by Seller or any other party under any of the Contracts. Neither Seller nor Shareholder knows of a threatened default under any of the Contracts. Except as set forth in Schedule 4.21, Seller is not a party to any Contract which was not entered into in the ordinary course of business, which requires Seller to make any capital expenditure in excess of $_______, which has a term of greater than one year (other than contracts which are cancelable without penalty in sixty (60) days or less), which contains terms other than on arms-length basis or which are in excess of the normal business requirements of the Business.

4.22 Suppliers and Customers. Except as set forth on Schedule 4.22, no substantial supplier or customer (accounting for more than ____ percent (__%) of aggregate annual purchases or more than ____ percent (__%) of aggregate annual revenues, as the case may be, of Seller) has informed Seller that it intends to terminate its relationship with Seller, and neither Seller nor Shareholder is aware of any such supplier or customer that intends to terminate such relationship or of any material problem or dispute with any such supplier or customer. Seller has good business relationships with each such supplier and customer. Neither Seller nor Shareholder has any reason to believe that the consummation of a sale of the Business will or is likely to disrupt the existing relationships with any such supplier or customer.

4.23 Business Records. All material records of accounts, personnel records and other business records for the past ten years relating to Seller or the Business have not been destroyed and are available upon request, subject to applicable Governmental Requirements and/or contractual prohibitions or limitations. In addition, all such business records relating to periods prior to such ten-year period which Seller is required to maintain (including without limitation personnel records and information relevant to current or future tax filings) have not

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been destroyed and are available upon request, subject to applicable Governmental Requirements and/or contractual prohibitions or limitations.

4.24 Bank Accounts, Directors and Officers. Schedule 4.24 contains (i) a true, complete and correct list of all bank accounts and safe deposit boxes maintained by Seller and all persons entitled to draw thereon, to withdraw therefrom or with access thereto, (ii) a description of all lock box arrangements for Seller, (iii) the names of all the directors and officers of Seller and (iv) a true, complete and correct list of all powers of attorney executed by Seller.

4.25 Environmental Matters. Except as set forth on Schedule 4.25, Seller and each Predecessor, and their assets, properties and operations are now and, at all times prior to the Closing Date, have been in compliance in all material respects with all applicable Environmental Laws. Except as set forth on Schedule 4.25, there has been and is no Release or threatened Release of any Hazardous Substance at, on, under, in, to or from any of the Real Property, whether as a result of the operations and activities at the Real Property or otherwise. Except as set forth on Schedule 4.25, neither Seller, Shareholder nor any Predecessor has received any notice of alleged, actual or potential responsibility for, or any inquiry or investigation regarding, the presence, Release or threatened Release of any Hazardous Substance at any location, whether at the Real Property or otherwise, which Hazardous Substances were allegedly manufactured, used, generated, processed, treated, stored, disposed or otherwise handled at or transported from the Real Property or otherwise. Except as set forth on Schedule 4.25, neither Seller, Shareholder nor any Predecessor has received any notice of any other claim, demand or action by any Person alleging any actual or threatened injury or damage to any Person, property, natural resource or the environment arising from or relating to the presence, Release or threatened Release of any Hazardous Substances at, on, under, in, to or from the Real Property or in connection with any operations or activities thereat, or at, on, under, in, to or from any other property. Neither the Real Property nor any operations or activities thereat is or has been subject to any judicial or administrative proceeding, order, consent, agreement or any lien relating to any applicable Environmental Laws or Environmental Claims. Except as set forth on Schedule 4.25, there are no underground storage tanks presently located at the Current Real Property and there have been no releases of any Hazardous Substances from any underground storage tanks or related piping at the Current Real Property. There are no PCBs located at, on, under or in the Current Real Property. There is no asbestos or asbestos-containing material located at, on, under or in the Current Real Property.

4.26 Absence of Certain Changes. Except as set forth on Schedule 4.26, since December 31, 20____ there has not been:

(a) any material adverse change in the business, financial condition or operations of Seller;

(b) any damage, destruction or loss, whether covered by insurance or not, materially and adversely affecting the properties of Seller or the Business;

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(c) any declaration, payment or setting aside for payment of any dividend or

other distribution (whether in cash, stock or property) with respect to the capital stock of Seller, or any direct or indirect redemption, purchase or other acquisition of any shares of capital stock of Seller;

(d) any increase in the compensation of or granting of bonuses payable or to become payable by Seller to any officer or employee whose 20____ calendar-year compensation (salary plus bonus) exceeded $_______, other than annual increases or bonuses consistent with Seller’s past practices or pursuant to the terms and provisions of the Employee Contracts and not exceeding, for any such officer or employee, ____ percent (__%) of such officer’s or employee’s 20____ calendar-year compensation;

(e) any sale or transfer by Seller of any material tangible or intangible asset, any mortgage or pledge or creation of any Encumbrance relating to any such material asset, any lease of real property or equipment, or any cancellation of any debt or claim, except in the ordinary course of business;

(f) any other material transaction not in the ordinary course of business or not otherwise consistent with Seller’s past practices; or

(g) any material change in accounting methods or principles.

4.27 No Brokers. Neither Seller nor Shareholder has entered into any agreement, arrangement or understanding with any Person which will result in the obligation to pay any finder’s fee, brokerage commission or similar payment in connection with the transactions contemplated by this Agreement, other than _________________ whose fees shall be the sole responsibility of Seller and shall not be paid out of the Purchased Assets.

4.28 Absence of Certain Payments. To the knowledge of Seller or Shareholder, neither Seller nor any Affiliate, nor any of their respective officers, directors, employees or agents or other people acting on behalf of any of them, nor any Affiliate of any of the foregoing, have with respect to the Business (i) engaged in any activity prohibited by the United States Foreign Corrupt Practices Act of 1977 or any other similar law, regulation or decree, directive or order of any Governmental Authority or (ii) without limiting the generality of the preceding clause (i), used any corporate or other funds for unlawful contributions, payments, gifts or entertainment, or made any unlawful expenditures relating to political activity to officials of any Governmental Authority. To the knowledge of Seller or Shareholder, neither Seller nor any of its shareholders, directors, officers, employees or agents or other Persons acting on behalf of any of them, nor any Affiliate of any of the foregoing, has accepted or received any unlawful contributions, payments, gifts or expenditures.

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4.29 Products; Product Warranties.

(a) A form of each product warranty relating to products produced or sold by

Seller or services performed by Seller at any time during the ____-year period preceding the date of this Agreement is attached to or set forth on Schedule 4.29.

(b) Schedule 4.29 sets forth a true and complete list, of (i) all products manufactured, marketed or sold by Seller that have been recalled or withdrawn (whether voluntarily or otherwise) at any time during the past ten (10) years (for purposes of this paragraph, a product shall have been recalled or withdrawn if all or a substantial number of products in a product line were recalled or withdrawn) and (ii) all proceedings (whether completed or pending) at any time during the past ten (10) years seeking the recall, withdrawal, suspension or seizure of any product sold by Seller.

(c) Except as set forth on Schedule 4.29, neither Seller nor Shareholder is aware of any material defect in design, materials, manufacture or otherwise in any products manufactured, distributed or sold by Seller during the past ten (10) years or any defect in, or replacement of, any such products which could give rise to any material claim.

(d) Schedule 4.29 sets forth on a year-by-year basis, a true and complete list of all warranty expenses (including, parts and labor, but not overhead) and all other unreimbursed repair, maintenance and replacement expenses incurred by Seller after January 1, 1990. The reserve for warranty expenses reflected on the Financial Statements and Interim Financial Statements are adequate and consistent with past practices and procedures.

(e) Except as provided in any of the standard product warranties described in paragraph (a) of this Section and as otherwise set forth on Schedule 4.29, Seller has not sold any products or services which are subject to an extended warranty of Seller beyond 18 months and which warranty has not yet expired.

4.30 Material Misstatements or Omissions. None of the representations or warranties by Seller or Shareholder in this Agreement contains any untrue statement of a material fact, or omits to state any material fact necessary to make the statements or facts contained therein not misleading.

ARTICLE 5

REPRESENTATIONS AND WARRANTIES OF BUYER Buyer hereby represents and warrants to Seller and Shareholder as follows:

5.01 Organization and Good Standing. Buyer is a ________ corporation, duly organized, validly existing and in good standing under the laws of the state of ________. Buyer

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has full power and authority to conduct its business as presently being conducted and to own and lease its properties and assets.

5.02 Authority; Authorization; Binding Effect. Buyer has all necessary power and authority to execute and deliver this Agreement, to consummate the transactions contemplated by this Agreement and to perform its obligations under this Agreement. Copies of all resolutions of the board of directors of Buyer with respect to the transactions contemplated by this Agreement, certified by the Secretary or an Assistant Secretary of Buyer, in form reasonably satisfactory to counsel for Seller, have been delivered to Seller. This Agreement has been duly executed and delivered by Buyer and constitutes a legal, valid and binding obligation of Buyer, enforceable against Buyer in accordance with its terms (subject to bankruptcy and similar laws affecting creditors’ rights and principles of equity).

5.03 No Conflict or Violation. The execution and delivery of this Agreement, the consummation of the transactions contemplated by this Agreement and the performance by Buyer of its obligations under this Agreement, do not and will not result in or constitute (i) a violation of or a conflict with any provision of the certificate of incorporation or by-laws of Buyer, (ii) a breach of, a loss of rights under, or an event, occurrence, condition or act which is or, with the giving of notice, the lapse of time or the happening of any future event or condition, would become, a material default under, any term or provision of any contract, agreement, indebtedness, lease, commitment, license, franchise, permit, authorization or concession to which Buyer is a party or (iii) a violation by Buyer of any statute, rule, regulation, ordinance, code, order, judgment, writ, injunction, decree or award.

5.04 Consents and Approvals. Except as otherwise set forth on Schedule 5.4, no consent, approval or authorization of, or declaration, filing or registration with, any Governmental Authority or other Person is required to be made or obtained by Buyer in connection with the execution, delivery and performance of this Agreement, and the consummation of the transactions contemplated by this Agreement.

5.05 No Proceedings. There is no action, order, writ, injunction, judgment or decree outstanding or claim, suit, litigation, proceeding, arbitral action or investigation pending or threatened against, relating to or affecting in any adverse manner the transactions contemplated by this Agreement.

5.06 No Brokers. Buyer has not entered into any agreement, arrangement or understanding with any Person which will result in the obligation to pay any finder’s fee, brokerage commission or similar payment in connection with the transaction contemplated hereby.

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ARTICLE 6


THE PARTIES PRIOR TO CLOSING Seller and Shareholder jointly and severally on the one hand, and Buyer on the other hand, each covenant with the other as follows:

6.01 Investigation by Buyer. During the period beginning on the date of this Agreement and ending on the Closing Date, Buyer and each Representative of Buyer may continue to conduct a due diligence review of Seller. Buyer and each Representative of Buyer shall be granted full access to all Current Real Property in connection with such due diligence review. In connection with such due diligence review, Seller and Shareholder agree, and shall cause each Representative of Seller and Shareholder, upon reasonable prior notice, to (i) cooperate with Buyer and each Representative of Buyer, (ii) provide all information, and all documents and other data relating to such information, reasonably requested by Buyer or any Representative of Buyer, (iii) permit Buyer and each Representative of Buyer to inspect any assets of Seller and (iv) permit Buyer to have access to and to communicate with Seller’s employees, vendors, customers and other persons having dealings with Seller, provided that such access and communications shall be controlled and scheduled by Shareholder or Seller.

6.02 Notifications, Consents and Approvals. As soon as practicable, Buyer, Seller and Shareholder, as applicable, shall commence all reasonable actions to obtain all other consents, approvals, permits and agreements of, to give all notices to, and to make all filings with, any Person as may be necessary to authorize, approve or permit the full and complete sale, conveyance, assignment or transfer of the Purchased Assets free of all Encumbrances, on or before the Closing Date.

6.03 Environmental Audits. In addition to any environmental investigations and audits conducted by Buyer or its Representatives with Seller’s approval prior to the date of this Agreement, Buyer shall, at Buyer’s sole expense, be permitted to cause further environmental audits of the Real Property to be conducted assessing the presence and or disposition of Hazardous Substances and compliance with Environmental Laws; provided, however, that Buyer will not conduct or cause to be conducted any “Phase II” environmental audits or other invasive testing procedures without the prior written consent of Seller. Seller hereby grants a license to Buyer’s qualified environmental consultants to enter upon the current Real Property, upon giving Seller reasonable notice, with men and materials to conduct such environmental audits.

6.04 Conduct Pending Closing. (a) From the date of this Agreement to the Closing Date, and except as otherwise specifically provided in this Agreement or consented to or approved by Buyer in advance in writing, Seller and Shareholder shall conform to the following:

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(i) Seller shall carry on its business substantially in the same manner as heretofore conducted and shall not engage in any transaction or activity, enter into any agreement or make any commitment except in the ordinary course of business.

(ii) No change or amendment shall be made in or to the certificate or articles of incorporation or other governing or organizational charter or instruments of Seller.

(iii) Seller shall not declare, pay or set aside for payment any dividend or other distribution (whether in cash, stock or property) with respect to its capital stock, and Seller shall not directly or indirectly redeem, purchase or otherwise acquire any shares of its capital stock.

(iv) Seller shall use its best efforts to preserve its corporate existence and business organization intact and to preserve its properties, assets and relationships with its employees, suppliers, customers and others with whom it has business relations. Seller shall not dispose of any material asset included in the Purchased Assets except in the ordinary course of business.

(v) Except for contracts or commitments made in the ordinary course of business of Seller, no contracts or commitments shall be entered into by or on behalf of Seller, except contracts terminable by Seller on thirty (30) days or less notice. No amendments or changes shall be made to any of the Contracts.

(vi) Seller shall not (A) grant any increase in compensation to any employee, (B) declare or pay any bonus to Shareholder or any employee or (C) enter into, or amend in any material respect, any Employee Plan or Employee Contract.

(vii) Seller shall not create, incur, assume or guarantee or otherwise become liable with respect to any indebtedness other than in the ordinary course of business of Seller, and Seller shall not alter, amend or otherwise modify the terms or conditions of any existing indebtedness. Seller shall not grant or permit any third party to impose any Encumbrance on any of the Purchased Assets.

(viii) Seller shall (A) not grant any special conditions with respect to accounts receivable other than in the ordinary course of business (e.g., extended terms), (B) pay all accounts payable on a timely basis, (C) purchase Inventory in the ordinary course consistent with past practices and procedures, (D) not make capital expenditures in excess of $_______ for any particular item or $_______ in the aggregate and (E) not purchase Inventory in excess of supplies necessary in the ordinary course of business and consistent with past practices (and in no event exceeding, for any particular item, a ____–month supply).

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(ix) Neither Seller nor Shareholder shall take any action which would cause, or fail to take any action the failure of which would cause, any representation or warranty of Seller or Shareholder in this Agreement to be breached or to be or become untrue in any material respect.

(b) In addition to the foregoing, Seller and Shareholder shall at all times prior to Closing keep Buyer regularly informed of employment matters relating to Seller, including without limitation:

(i) any negotiations and arrangements with unions representing employees;

(ii) any proposed changes in the rates of renumeration or other terms and conditions of employment of employees;

(iii) any proposed or actual increase or reduction in the number of employees;

(iv) the departure or recruitment or expected or proposed departure or recruitment of any key employee; and

(v) any strikes by or disputes with any of the employees.

(c) From the date of this Agreement to the Closing Date, and except as otherwise specifically provided in this Agreement or consented to or approved by Seller or Shareholder in advance in writing, Buyer shall not take any action which would cause, or fail to take any action the failure of which would cause, any representation or warranty of Buyer in this Agreement to be breached or to be or become untrue in any material respect.

6.05 Notification of Certain Matters. Seller and Shareholder shall give prompt notice to Buyer of (i) any fact or circumstance, or any occurrence or failure to occur of any event, which fact, circumstance, occurrence or failure would be likely to cause any representation or warranty by Seller or Shareholder contained in this Agreement to be breached or to be or become untrue or inaccurate in any material respect any time from the date of this Agreement to the Closing Date and (ii) any failure of Seller or Shareholder to comply with or satisfy any covenant, condition or agreement to be complied with or satisfied by Seller or Shareholder under this Agreement. Buyer shall give prompt notice to Seller and Shareholder of (i) any fact or circumstance, or any occurrence or failure to occur of any event, which fact, circumstance or failure would be likely to cause any representation or warranty by Buyer contained in this Agreement to be breached or to be or become untrue or inaccurate in any material respect any time from the date of this Agreement to the Closing Date and (ii) any failure of Buyer to comply with or satisfy any covenant, condition or agreement to be complied with or satisfied by Buyer under this Agreement. Seller and Shareholder on the one hand, and Buyer on

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the other hand, shall notify the other of any representation or warranty by the other party which the notifying party knows to be untrue.

6.06 Delivery of Interim Financial Statements. Within fifteen (15) days after the end of each month after the execution of this Agreement and prior to the Closing Date, Seller shall deliver or cause to be delivered to Buyer monthly and year-to-date interim financial statements of Seller. Upon delivery, such year-to-date interim financial statements shall automatically become and be deemed to be Interim Financial Statements for purposes of this Agreement.

6.07 Non-Competition Agreement. On the Closing Date, Seller, Shareholder and certain key management employees identified on Schedule 6.7 shall enter into Non-Competition Agreements with Buyer substantially in the form of Exhibit 6.7 (the “Non-Competition Agreement”).

6.08 Waiver of Bulk Sales Laws. The parties hereto waive compliance with the bulk transfer provisions of the Uniform Commercial Code as adopted in Washington and any other state which has applicability to the transactions contemplated by this Agreement.

6.09 Insurance Coverage. Seller shall be responsible and liable for all Insured Claims. To the extent any policy of Insurance is “claims made” insurance, Seller shall purchase “tail” coverage with respect to such policy, on the same or comparable terms as the existing coverage, from the insurance company which issued such policy or from another insurance company reasonably satisfactory to Buyer, and shall take all other actions necessary to extend the coverage under such “claims made” insurance policy to cover all occurrences through the Closing Date. On or prior to the Closing Date, Seller shall provide to Buyer an original certificate of insurance and a copy of each insurance policy and other document or instrument relating to such extended coverage, together with evidence satisfactory to Buyer that such extended coverage shall remain in effect for a period of five (5) years after the Closing Date and that all premiums relating thereto have been fully paid. Each policy of extended coverage provided by Seller under this Section shall name Buyer as an additional insured and shall require the applicable insurance company to give Buyer thirty (30) days written notice of any change to or termination of such policy. To the extent any extended coverage obtained by Seller hereunder is subject to a deductible or a coverage limit, Seller shall pay the amount of such deductible and all amounts in excess of such coverage limit.

6.10 Offer of Employment to Seller’s Employees. On the Closing Date, Buyer shall offer employment to all of Seller’s employees upon substantially comparable terms and conditions to those which such employees presently receive from Seller; except that, among other things, Buyer intends to honor Seller’s bonus plan obligations through the Closing Date and to replace such bonus plan from and after the Closing Date with Buyer’s bonus plan. Notwithstanding the foregoing, nothing herein shall require Buyer to retain any such employee for any period of time or otherwise restrict or limit Buyer’s right to terminate or otherwise alter

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the terms of employment of any such employee, each of whom shall be considered an employee “at will.”

ARTICLE 7

CONDITIONS TO SELLER’S AND SHAREHOLDER’S OBLIGATIONS The obligation of Seller and Shareholder to consummate the transactions contemplated by this Agreement is subject, in the discretion of Seller and Shareholder, to the satisfaction, on or prior to the Closing Date, of each of the following conditions (any of which, in Seller’s and Shareholder’s absolute and sole discretion, may be waived in whole or in part without impairing or affecting any right of indemnification or other right or remedy hereunder):

7.01 Representations, Warranties and Covenants. All representations and warranties of Buyer contained in this Agreement shall be true and correct in all material respects at and as of the Closing Date, except as and to the extent that the facts and conditions upon which such representations and warranties are based are expressly required or permitted to be changed by the terms of this Agreement, and Buyer shall have performed all agreements and covenants required by this Agreement to be performed by it prior to or at the Closing Date.

7.02 Consents, Approvals and Filings. All consents, authorizations and approvals from, and all declarations, filings and registrations with, any Person required to consummate the transactions contemplated by this Agreement shall have been obtained or made.

7.03 No Proceedings. No action, order, writ, injunction, judgment or decree shall be outstanding, and no claim, suit, litigation, proceeding, arbitral action or investigation shall be pending, threatened or anticipated against Buyer, Seller or Shareholder seeking to enjoin, or materially adversely affecting, the consummation of the transactions contemplated by this Agreement.

7.04 Closing Certificate. Buyer shall have furnished Seller with a certificate of an officer of Buyer, in form and substance satisfactory to Seller, to evidence compliance with the conditions set forth in this Article 7.

ARTICLE 8

CONDITIONS TO BUYER’S OBLIGATIONS The obligation of Buyer to consummate the transactions contemplated by this Agreement, is subject, in the discretion of Buyer, to the satisfaction, on or prior to the Closing Date, of each of the following conditions (any of which, in Buyer’s absolute and sole discretion, may be waived in whole or in part without impairing or affecting any right of indemnification or other right or remedy hereunder):

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8.01 Representations, Warranties and Covenants. All representations and warranties of Seller and Shareholder contained in this Agreement shall be true and correct in all material respects at and as of the Closing Date, except as and to the extent that the facts and conditions upon which such representations and warranties are based are expressly required or permitted to be changed by the terms of this Agreement and each of Seller and Shareholder shall have performed or caused to be performed all agreements and covenants required by this Agreement to be performed or caused to be performed by it or him prior to or at the Closing Date.

8.02 Consents, Approvals and Filings. All consents, authorizations and approvals from, and all declarations, filings and registrations with, any Person required to consummate the transactions contemplated by this Agreement shall have been obtained or made.

8.03 No Proceedings. No action, order, writ, injunction, judgment or decree shall be outstanding, and no claim, suit, litigation, proceeding, arbitral action or investigation shall be pending, threatened or anticipated against Buyer, Seller or Shareholder, seeking to enjoin, or materially adversely affecting, the transactions contemplated by this Agreement.

8.04 No Interruption or Adverse Change. (i) No interruption or suspension of the Business as now conducted shall have occurred or, to the knowledge of Seller or Shareholder, been threatened and (ii) no material adverse change in the business, prospects, assets or financial condition of Seller shall have occurred, as determined in the sole discretion of Buyer, or, to the knowledge of Seller or Shareholder, been threatened.

8.05 Closing Certificate. Seller and Shareholder shall each have furnished Buyer with a certificate or certificates in form satisfactory to Buyer to evidence compliance with the conditions set forth in this Article 8.

8.06 [Intentionally Deleted] 8.07 No Casualty. There shall have occurred no Casualty for which Buyer has

elected to terminate this Agreement in accordance with Section 10.2.

8.08 Agreements with ______________. Buyer shall have entered into agreements with _________________ in form and content satisfactory to Buyer.

8.09 Lease. Buyer shall have entered into a lease agreement with Shareholder for Seller’s facility in the form of Exhibit 8.9.

8.10 Non-Competition Agreements. Buyer shall have entered into Non-Competition Agreements with Seller, Shareholder and the key management employees listed on Schedule 6.7.

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8.11 Sales Tax Returns. Seller shall have provided to Buyer evidence satisfactory to Buyer of the payment of, or provisions for payment of, and the filing of all applicable sales tax returns with respect to, all state sales taxes owing by Seller with respect to the operation of the Business through the Closing Date.

8.12 Satisfactory Due Diligence. Buyer and its Representatives shall have completed their environmental, tax, accounting, legal and other due diligence review of Seller and the Purchased Assets and Buyer shall be satisfied in its sole discretion with the results of such due diligence review.

ARTICLE 9


THE PARTIES AFTER CLOSING

9.01 Survival and Indemnifications.

(a) Survival of Representations, Warranties, Covenants and Agreements.

(i) All representations and warranties made by Seller and Shareholder contained in this Agreement shall survive the Closing Date for the duration of the Claims Period; except that (A) all representations and warranties contained in Section 4.17 (Tax Matters) shall survive the Closing Date until the expiration of all applicable statutes of limitations and (B) all representations and warranties contained in Section 4.2 (Power and Authority; Authorization; Binding Effect), clause (iii) of Section 4.9 (Real Property), the third sentence of Section 4.10 (Tangible Personal Property) and subsection (i) of the second sentence of Section 4.11 (Intangible Property) shall survive the Closing Date indefinitely. Any claim initiated by Buyer with respect to such representations and warranties must be made during the Claims Period, except for claims relating to the representations and warranties described in clauses (A) and (B) of the preceding sentence, as to which claims must be made within the period indicated. All of said representations and warranties shall in no respect be limited or diminished by any past or future inspection, investigation, examination or possession (whether before or after the Closing) on the part of Buyer or its Representatives. All covenants and agreements made by Seller and Shareholder contained in this Agreement (including, without limitation, the indemnification obligations set forth in this Section) shall survive the Closing Date until fully performed or discharged.

(ii) All representations and warranties made by Buyer contained in this Agreement shall survive the Closing Date for the duration of the Claims Period; except that all representations and warranties contained in Section 5.2 (Authority; Authorization; Binding Effect) shall survive the Closing Date indefinitely. Any claim made by Seller or Shareholder with respect to such representations and warranties (other than those contained in Section 5.2) must be made during the Claims Period. All covenants and agreements made by Buyer

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contained in this Agreement (including without limitation the indemnification obligations set forth in this Section) shall survive the Closing Date until fully performed or discharged.

(b) Indemnification by Seller and Shareholder. Seller and Shareholder jointly and severally agree to defend, indemnify and hold harmless Buyer, its Affiliates, successors and assigns and their respective officers, directors, employees, agents and Representatives (collectively, “Buyer Parties”) (before and after the Closing), from, against and in respect of the following:

(i) any and all claims, losses, liabilities, proceedings, demands, Encumbrances, assessments, judgments, deficiencies, damages, cost and expenses (including without limitation reasonable legal and accounting fees and expenses incurred in the investigation or defense of the foregoing) (collectively, “Losses”) suffered or incurred by Buyer Parties by reason of a breach of any representation or warranty by Seller or Shareholder contained in this Agreement; provided, however, that Seller and Shareholder shall have no obligation to indemnify Buyer Parties with respect to the foregoing unless and until the Losses incurred by Buyer Parties exceed in the aggregate $_______, and then only to the extent such Losses exceed such amount.

(ii) any and all Losses suffered or incurred by Buyer Parties by reason of the nonfulfillment of any covenant or agreement by Seller or Shareholder contained in this Agreement (including without limitation the payment or performance by Seller of any liability which is an Excluded Liability);

(iii) any and all Losses suffered or incurred by Buyer Parties attributable to the operation of the Business on or prior to the Closing Date (except to the extent that any of such Losses constitutes an Assumed Liability); and

(iv) any and all Losses suffered or incurred by Buyer Parties resulting from the failure of Seller, Shareholder or Buyer to give any notice or take any other action under the bulk transfer or bulk sales provisions of the State of _________ or any other applicable State in connection with the sale of the Purchased Assets pursuant to this Agreement.

(c) Indemnification by Buyer. Buyer agrees to defend, indemnify and hold harmless Seller and Shareholder, their Affiliates, successors and assigns and their respective officers, directors, employees, agents and Representatives (collectively, “Seller Parties”) (before and after the Closing) from, against, and in respect of:

(i) any and all Losses suffered or incurred by Seller Parties resulting from a breach of any representation or warranty by Buyer contained in this Agreement; provided, however, that Buyer shall have no obligation to indemnify Seller Parties with respect to the foregoing unless and until the Losses incurred by Seller Parties exceed in the aggregate $_______, and then only to the extent such Losses exceed such amount.

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(ii) any and all Losses suffered or incurred by Seller Parties resulting

from the nonfulfillment of any covenant or agreement by Buyer contained in this Agreement (including without limitation the payment or performance by Buyer of the Assumed Liabilities);

(iii) any and all Losses suffered or incurred by Seller Parties attributable to the operation of the Business after the Closing Date; and

(d) Notification and Defense of Claims or Actions.

(i) As used in this Section, any party seeking indemnification pursuant to this Section is referred to as an “indemnified party” and any party from whom indemnification is sought pursuant to this Section is referred to as an “indemnifying party.” An indemnified party which proposes to assert the right to be indemnified under this Section shall submit a written demand for indemnification setting forth in summary form the facts as then known which form the basis for the claim for indemnification. With respect to claims based on actions by third parties, an indemnified party shall, within twenty (20) days after the receipt of notice of the commencement of any claim, action, suit or proceeding against it in respect of which a claim for indemnification is to be made against an indemnifying party, notify the indemnifying party in writing of the commencement of such claim, action, suit or proceeding, enclosing a copy of all papers served; provided, however, that the failure to so notify the indemnifying party of any such claim, action, suit or proceeding shall not relieve the indemnifying party from any liability which it may have to the indemnified party, except to the extent that the indemnifying party is prejudiced by the failure to be so notified. Thereafter, the indemnified party shall deliver to the indemnifying party, within twenty (20) days after receipt by the indemnified party, copies of all further notices relating to such claim.

(ii) If a third-party claim is made for which an indemnified party is entitled to indemnification pursuant to this Section, the indemnifying party will be entitled to participate in the defense of such claim and, if he or it so chooses, and provided that he or it acknowledges his or its obligation to indemnify the indemnified party, to assume primary responsibility for the defense of such claim with counsel selected by the indemnifying party and not reasonably objected to by the indemnified party. Should the indemnifying party assume the defense of such claim, the indemnifying party will not be liable to the indemnified party for any legal expenses subsequently incurred by the indemnified party in connection with the defense of such claim.

(iii) If the indemnifying party assumes the defense of a third-party claim as set forth in paragraph (ii) of this Section, then (A) in no event will an indemnified party admit any liability with respect to, or settle, compromise or discharge, any such claim without the indemnifying party’s prior written consent and (B) each indemnified party shall be entitled to participate in, but not control, the defense of such claim with its own counsel at its own expense. If the indemnifying party does not assume the defense of any such claim, an indemnified party

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may defend such claim in a manner as it may deem appropriate (including without limitation settling such claim, after giving twenty (20) days prior written notice of such settlement to the indemnifying party, on such terms as the indemnified party may deem appropriate).

(iv) In the event that any claim for indemnification is made with respect to any third-party claim pursuant to this Section, (A) the party assuming primary responsibility for the defense of such claim shall at all times keep the other party informed as to the status of such claim and (B) the party not primarily responsible for the defense of such claim shall cooperate fully with the other party in connection with such defense.

9.02 Application of Retained Amount for Indemnification. In the event that Buyer is entitled to indemnification from Seller or Shareholder pursuant to this Article 9, Buyer shall first apply the Retained Amount toward satisfaction of any such indemnification amount in accordance with the provisions of Section 2.6. However, nothing in this Section 9.2 shall be construed or implied to limit Seller’s and Shareholder’s indemnification obligation pursuant to this Article 9 to the Retained Amount.

9.03 Use of Corporate Name or Trade Name. After the Closing, except as required by law in connection with the liquidation and winding up of Seller or in connection with services to be performed for Buyer, neither Seller nor either Shareholder, nor any Affiliate of Seller or Shareholder, will use or refer to the name “_____________” or any trade name included within the Intangible Property being conveyed to Buyer, or any derivative or variation thereof or any name similar thereto.

9.04 Continuation Health Care Coverage. On and after the Closing, Buyer shall make available to all Qualified Individuals (as hereafter defined) continuation health coverage under the terms and conditions as would be required of Seller by COBRA if such obligations of Seller were not being assumed by Buyer hereunder. Buyer also shall notify, in accordance with the requirements of COBRA, any such Qualified Individual of his or her right to obtain continuation health coverage from Buyer. For purposes of this Section, “Qualified Individual” means any employee or qualified beneficiary of Seller who, prior to the date of Closing or as a result of the transactions contemplated under this Agreement, has or had incurred a Qualifying Event (as defined by COBRA) and who has elected, or may elect to have, health care continuation coverage under the requirements of COBRA.

9.05 Access to Records and Personnel.

(a) For a period of six (6) years after the Closing Date, Seller and Shareholder, and their respective Representatives, shall have reasonable access to all books and records of Seller transferred to Buyer hereunder, and to all former employees of Seller having knowledge with respect thereto, to the extent that such access may reasonably be required in connection with matters relating to (i) the Excluded Liabilities, (ii) all matters as to which Seller and Shareholder are required to provide indemnification under this Agreement or (iii) the

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preparation of any tax returns required to be filed by Seller or Shareholder with respect to any periods prior to the Closing. Such access shall be afforded by Buyer upon receipt of reasonable advance notice and during normal business hours, provided such access does not unduly disrupt Buyer’s normal business operations. Seller and Shareholder shall be solely responsible for any costs or expenses incurred by it or him pursuant to this Section 9.5. If Buyer shall desire to dispose of any of such books and records prior to the expiration of such six-year period, Buyer shall, prior to such disposition, give the Seller and Shareholder a reasonable opportunity, at their expense, to segregate and remove such books and records as they, or any of them, may select.

(b) For a period of six years after the Closing Date, Buyer and its representatives shall have reasonable access to all of the books and records relating to the Business which Seller or Shareholder, or any of their respective Representatives, may retain after the Closing Date. Such access shall be afforded by Seller and Shareholder and their respective Representatives upon receipt of reasonable advance notice and during normal business hours. Buyer shall be solely responsible for any costs and expenses incurred by it pursuant to this Section 9.5. If Seller or Shareholder shall desire to dispose of any of such books and records prior to the expiration of such six-year period, Seller or Shareholder shall, prior to such disposition, give Buyer a reasonable opportunity, at Buyer’s expense, to segregate and remove such books and records as Buyer may select.

9.06 Assets Retained by Seller. It is understood that certain Purchased Assets may not be immediately transferrable to Buyer, and Buyer may in its sole discretion allow Seller to retain certain of such assets after the Closing Date (the “Retained Assets”), and this Agreement shall not constitute an assignment of any such Retained Assets. In such event, (a) Seller shall grant to Buyer full use and benefit of its interest in the Retained Assets, it being the intent of the parties that Buyer shall have the benefit of the Retained Assets as though it were the sole owner thereof, (b) Seller and Shareholder shall take all actions necessary to preserve the value of the Retained Assets, (c) Seller shall not transfer or assign the Retained Assets to any Person other than Buyer or Buyer’s assigns, (d) Seller shall transfer or assign the Retained Assets to Buyer at the earliest date on which such transfer or assignment can be effected and (e) Buyer shall be responsible for obligations relating to such Retained Assets as if they had been transferred or assigned to Buyer in accordance with the terms of this Agreement.

9.07 Collection of Purchased Accounts Receivable and Retained Accounts Receivable.

(a) On or as soon as reasonably possible after the Closing Date, Seller shall deliver to Buyer an aging report of the Purchased Accounts Receivable. Seller agrees that, on and after the Closing Date, Buyer shall have the right and authority to collect for Buyer’s account the Purchased Accounts Receivable and to endorse with the name of “___________” or any other tradename of Seller or otherwise, as appropriate, any documents or checks received on account of or otherwise relating to the Purchased Accounts Receivable. Seller agrees to execute and deliver to Buyer, upon its request, one or more powers of attorney in form and substance

E-41


reasonably satisfactory to Buyer as evidence of the foregoing agreement. Seller agrees that it will forthwith transfer or deliver, or will cause any lender with which Seller has lockbox arrangements, to transfer or deliver to Buyer any cash or other property that Seller or any lender may receive after the Closing Date in respect of the Purchased Accounts Receivable or any other items constituting a part of the Purchased Assets.

(b) Seller guarantees the payment of the face amount of the Purchased Accounts Receivable without reduction for any reserves. For a period of six (6) months following the Closing Date, Buyer shall use its reasonable efforts (not to include bringing or threatening to bring any legal action) to collect the Purchased Accounts Receivable. After the expiration of the six-month period following the Closing Date, Buyer may assign to Seller, without recourse, all Purchased Accounts Receivable which remain uncollected other than those which Buyer elects, in its discretion, not to assign to Seller. So long as Buyer has not given any release impairing the right to collect any such uncollected Purchased Account Receivable, Seller shall thereupon pay to Buyer within five (5) business days the full amount thereof remaining uncollected without reduction for any reserves. After such payment has been made by Seller, Seller may, at its option, pursue collection of such uncollected Purchased Accounts Receivable for its own account. If and to the extent that Buyer elects not to assign any uncollected Purchased Account Receivable to Seller after the expiration of the six-month period, Buyer shall be deemed to have waived its right to receive the full amount of such uncollected Purchased Account Receivable from Seller and Seller shall have no further obligation under this Section with respect to such uncollected Purchased Account Receivable. Any amounts collected by Buyer on Purchased Accounts Receivable shall be applied in the manner directed by the account debtor or, in the absence of any direction, shall be applied first to the oldest invoice of the account debtor.

(c) Any amount collected by Buyer at any time after the Closing Date in respect of (i) any Retained Account Receivable or (ii) any uncollected Purchased Account Receivable which has been assigned to and repurchased by Seller shall promptly be remitted to Seller by Buyer.

ARTICLE 10

MISCELLANEOUS

10.01 Further Assurances. Both before and after the Closing Date, each party

will cooperate in good faith with each other party and will take all appropriate action and execute any agreement, instrument or other writing of any kind which may be reasonably necessary or advisable to carry out and confirm the transactions contemplated by this Agreement (including, but not limited to, obtaining consents or approvals from any Person for the transfer of the Purchased Assets that are transferred subject to consents or approvals being obtained).

10.02 Risk of Loss. Risk of loss with respect to any of the property or assets of Seller shall be borne by Seller at all times prior to the Closing and shall pass to Buyer only upon

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transfer to Buyer at Closing of title to the Purchased Assets. If any of the Current Real Property or the Tangible Personal Property is lost, damaged or destroyed by fire, theft, casualty or any other cause or causes prior to the Closing (a “Casualty”), Seller shall promptly notify Buyer in writing of such Casualty and the details thereof and shall answer promptly any reasonable requests from Buyer for details or information. Buyer shall thereafter proceed with the Closing, except that in the event of a Casualty to the Current Real Property or the Tangible Personal Property, the Purchase Price shall be reduced by the dollar amount (based upon replacement value as mutually agreed by Buyer and Seller) of the Casualty loss (and any insurance proceeds received or receivable as a result of such Casualty shall be payable to Seller); provided, however, that if such Casualty(ies) is in an aggregate amount in excess of [$_________] from the date hereof through the Closing Date or materially interferes, in Buyer’s sole discretion, with the operation of the Business, Buyer may terminate this Agreement by written notice to Seller.

10.03 Termination. This Agreement may be terminated at any time prior to the Closing Date as follows:

(a) By written agreement of Buyer and Seller;

(b) By Buyer or Seller by written notice to the other in the event that the Closing Date has not occurred for any reason on or prior to [___________ ____, _______ ], but only if the terminating party is not in breach of, or default under, any provision of any of this Agreement; or

(c) By Buyer by written notice to Seller of its election to terminate this Agreement pursuant to Section 10.2. In the event of the termination of this Agreement by any party as provided in the preceding sentence, no party shall have any liability hereunder of any nature whatsoever, other than for indemnification pursuant to Article 9. In the event that a condition precedent to its obligations is not satisfied, nothing contained in this Agreement shall be deemed to require any party to terminate this Agreement, rather than to waive such condition precedent and proceed with the Closing, which waiver shall not impair or affect any right of indemnification or other right or remedy hereunder.

10.04 Notices. Unless otherwise provided in this Agreement, any notice, request, instruction or other communication to be given hereunder by any party to the other shall be in writing and (a) delivered personally, (b) mailed by first-class mail, postage prepaid, (such mailed notice to be effective four days after the date it is mailed) or (c) sent by facsimile transmission, with a confirmation sent by way of one of the above methods, as follows:

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If to Seller or Shareholder, addressed to: ______________________________ ______________________________ ______________________________ Attn: _________________________ Telephone: ____________________ E-mail: _______________________ With a copy to: ______________________________ ______________________________ ______________________________ Attn: _________________________ Telephone: ____________________ E-mail: _______________________ If to Buyer, addressed to: _____________________________ _____________________________ _____________________________ Attn: _________________________ Telephone: ____________________ E-mail: _______________________ With a copy to: _____________________________ _____________________________ _____________________________ Attn: _________________________ Telephone: ____________________ E-mail: _______________________ Any party may designate in a writing to any other party any other address or telecopier number to which, and any other Person to whom or which, a copy of any such notice, request, instruction or other communication should be sent.

10.05 Public Statements. Seller, Shareholder and Buyer agree to cooperate, both prior to and after the Closing, in issuing any press releases or otherwise making public

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statements with respect to the transactions contemplated by this Agreement, and, except as Buyer’s counsel may advise is otherwise required by law as applicable to Buyer, no press release or other public statements shall be issued without the joint consent of Buyer, Seller and Shareholder.

10.06 Choice of Law. This Agreement shall be construed, interpreted and the rights of the parties determined in accordance with the laws of the State of New York without regard to principles of conflicts of law, except that, with respect to matters of law concerning the internal corporate affairs of any corporate entity which is a party to or the subject of this Agreement, the law of the jurisdiction under which the respective entity was organized shall govern.

10.07 Expenses. Except as otherwise provided in this Agreement, Seller and Shareholder shall pay all legal, accounting and other expenses of Seller and Shareholder (including without limitation any fee owing to _____________________) incident to this Agreement, and Buyer shall pay all legal, accounting and other expenses of Buyer incident to this Agreement. Nothing contained in this Agreement shall be interpreted or construed to require Buyer to directly or indirectly pay, assume or be liable for any of the foregoing expenses of Seller or Shareholder. Without limiting the foregoing, to the extent any such expenses of Seller or Shareholder have been or are paid by Seller prior to Closing, such expenses shall be paid to Buyer out of the Closing Date proceeds or deducted from the amount to be paid by Buyer to Seller pursuant to Section 2.5(a).

10.08 Titles. The headings of the articles and sections of this Agreement are inserted for convenience of reference only and shall not affect the meaning or interpretation of this Agreement.

10.09 Waiver. No failure of Seller, Shareholder or Buyer to require, and no delay by Seller, Shareholder or Buyer in requiring, the other to comply with any provision of this Agreement shall constitute a waiver of the right to require such compliance. No failure of the Seller, Shareholder or Buyer to exercise, and no delay by the Seller, Shareholder or Buyer in exercising, any right or remedy under this Agreement shall constitute a waiver of such right or remedy. No waiver by the Seller, Shareholder or Buyer of any right or remedy under this Agreement shall be effective unless made in writing. Any waiver by the Seller, Shareholder or Buyer of any right or remedy under this Agreement shall be limited to the specific instance and shall not constitute a waiver of such right or remedy in the future.

10.10 Effective; Binding. This Agreement shall be effective upon the due execution hereof by Seller, Shareholder and Buyer. Upon it becoming effective, this Agreement shall be binding upon Seller, Shareholder and Buyer and upon each successor and assignee of Seller, Shareholder and Buyer and shall inure to the benefit of, and be enforceable by, Seller, Shareholder and Buyer and each successor and assignee of Seller, Shareholder and Buyer; provided, however, that, except as provided for in the following sentence, neither Seller,

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Shareholder nor Buyer shall assign any right or obligation arising pursuant to this Agreement without first obtaining the written consent of the other party. Buyer may assign all or a portion of its rights and obligations under this Agreement to one or more Affiliates of Buyer, provided that Buyer shall remain liable hereunder notwithstanding any such assignment.

10.11 Entire Agreement. This Agreement, together with the Confidentiality Agreement, dated ___________, _______, between Buyer and Seller, contains the entire agreement between Seller, Shareholder and Buyer with respect to the subject of this Agreement, and supersedes each course of conduct previously pursued, accepted or acquiesced in, and each written and oral agreement and representation previously made, by Seller, Shareholder or Buyer with respect thereto.

10.12 Modification. No course of performance or other conduct hereafter pursued, accepted or acquiesced in, and no oral agreement or representation made in the future, by Seller, Shareholder or Buyer, whether or not relied or acted upon, and no usage of trade, whether or not relied or acted upon, shall modify or terminate this Agreement, impair or otherwise affect any obligation of Seller, Shareholder or Buyer pursuant to this Agreement or otherwise operate as a waiver of any such right or remedy. No modification of this Agreement or waiver of any such right or remedy shall be effective unless made in writing duly executed by Seller, Shareholder and Buyer.

10.13 Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original and all of which taken together shall constitute one and the same instrument. Any party may execute this Agreement by facsimile signature and the other party shall be entitled to rely on such facsimile signature as evidence that this Agreement has been duly executed by such party. Any party executing this Agreement by facsimile signature shall immediately forward to the other party an original signature page by overnight mail.

10.14 Consent to Jurisdiction. Buyer, Shareholder and Seller each hereby (i) consents to the jurisdiction of the United States District Court for the Western District of New York or, if such court does not have jurisdiction over such matter, the applicable state court in the State of New York, County of Erie, and (ii) irrevocably agrees that all actions or proceedings arising out of or relating to this Agreement shall be litigated in such court. Each of Shareholder, Buyer and Seller accepts for himself or itself and in connection with his or its properties, generally and unconditionally, the exclusive jurisdiction and venue of the aforesaid courts and waives any defense of forum nonconveniens or any similar defense, and irrevocably agrees to be bound by any non-appealable judgment rendered thereby in connection with this Agreement.

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IN WITNESS WHEREOF, Buyer has caused to be executed by an officer of Buyer, Seller has caused to be executed by an officer of Seller, and Shareholder has executed, this Agreement on the day and year indicated at the beginning of this Agreement. BUYER: ____________________________________ By_______________________________________ SELLER: ____________________________________ By_______________________________________ SHAREHOLDER: ___________________________________

F-1 © 2017 Hodgson Russ LLP

EXHIBIT F

SAMPLE ESCROW AGREEMENT

THIS ESCROW AGREEMENT, made and entered into this ______ day of ____________, 20____, by and among ______________________________ (“___________”), _________________________________ (“_____________”) and together with _______________________________, (the “Sellers”), ________________________, Inc., a Delaware corporation (the “Purchaser”), and _______________________ (the “Escrow Agent”).

RECITALS

WHEREAS, the Sellers and the Purchaser are parties to that certain Stock Purchase Agreement, dated as of _____________ _____, 20____ (the “Purchase Agreement;” all capitalized terms used but not defined herein shall have the respective meanings attributed to them in the Purchase Agreement); and

WHEREAS, the Purchase Agreement provides that at the Closing the Purchaser shall deposit with the Escrow Agent the amount of _________________ Thousand Dollars ($_________) (the “Escrow Deposit”), to secure ________ obligations under the _____________ ______________ Agreement.

NOW THEREFORE, for and in consideration of the mutual promises and the mutual benefits to be derived therefrom, the parties to this Escrow Agreement agree as follows:

1. The Purchaser hereby delivers to the Escrow Agent the amount of ________________ Thousand Dollars ($_________) to be held in an interest-bearing escrow account with ____________________ and reasonably acceptable to the Purchaser and the Sellers. The Escrow Agent hereby acknowledges the delivery and receipt of such funds.

2. The Escrow Agent shall act hereunder as a depository only and is not a party to or bound by the Purchase Agreement or any other agreement, document or understanding to which the Purchaser and the Sellers are parties (other than this Escrow Agreement) and is not responsible or liable in any manner for the sufficiency, correctness, genuineness or validity of any of the other agreements or documents existing between the Purchaser and the Sellers. The Escrow Agent undertakes no responsibility or liability for the form and execution of such other agreements and documents or the identity, authority, title or rights of any person executing any such other agreements and documents.

3. The Escrow Deposit is to be held by the Escrow Agent until it receives notice from both the Purchaser and the Sellers that:

(a) the Escrow Agent should deliver the Escrow Deposit, and all interest accrued thereon, to the Purchaser because _____________________________, or


(b) the Escrow Agent should deliver the Escrow Deposit, and all interest accrued thereon, to Seller because _____________________________________.

4. The Escrow Agent shall receive no fee for its services in connection with this Escrow Agreement. Any expenses reasonably incurred by the Escrow Agent hereunder shall be paid one-half by the Purchaser and one-half by the Sellers.

5. The Escrow Agent shall not be liable for any action which it may in good faith take or refrain from taking in connection herewith, believed by it to be authorized or within the rights and powers conferred upon it by this Escrow Agreement, and may consult with counsel of its own choice and shall have full and complete authorization and protection for any action taken or suffered by them hereunder in good faith and in accordance with the opinion of such counsel.

6. The Escrow Agent is undertaking and will perform its duties pursuant to this Agreement at the request and for the convenience of the Sellers and the Purchaser. The Purchaser acknowledges that (a) the Escrow Agent is and will continue to be the legal counsel for the Sellers in connection with the consummation of the transactions contemplated by the Purchase Agreement and for other matters and (b) a conflict of interest exists or might be claimed to exist as between the obligations of the Escrow Agent in its capacity as escrow agent pursuant to this Agreement and in its capacity as counsel for the Sellers. The Escrow Agent would be unwilling to undertake any duties pursuant to this Agreement unless it could do so without being disqualified from continuing to act as counsel for the Sellers in any circumstance when the Sellers desire to continue to use the legal services of the Escrow Agent. The Sellers would similarly be unwilling to have the Escrow Agent perform such duties if the result would be the Escrow Agent’s disqualification from representing the Sellers in connection with the consummation of the transactions contemplated by the Purchase Agreement or any other matter that might arise after the date of this Agreement. Accordingly, in order to induce the Escrow Agent to accept and perform its duties pursuant to this Agreement, the Purchaser knowingly waives any such conflict of interest and the Sellers shall be permitted, at their sole discretion, to continue using the legal services of the Escrow Agent to the same extent as if the Escrow Agent had not undertaken to perform any duties pursuant to this Agreement.

7. The Escrow Agent is authorized to act upon any document, request or notice which is believed by it in good faith to be genuine and signed or presented by the proper party or parties, and shall be protected in so acting.

8. All notices to the Escrow Agent as required or provided for herein shall be made in writing and served on the Escrow Agent at _____________________________________, or at such other address as the Escrow Agent may subsequently designate by written notice to each other party hereto, and shall be sent by guaranteed overnight delivery service. The Purchaser and the Sellers shall serve a copy of any and all notices given by any of them to the Escrow Agent simultaneously upon each other party hereto at the address shown for each in the Purchase Agreement, such notices to be sent by guaranteed overnight delivery service.


9. In the event conflicting demands are made or conflicting notices are served upon the Escrow Agent growing out of or directly related to its duties under this Agreement, the parties hereto expressly agree that the Escrow Agent shall either await final resolution of the dispute between the parties (pursuant to the mutual agreement of the parties or pursuant to a final and non-appealable judgment of a court of competent jurisdiction) or deposit the Escrow Deposit with a court of competent jurisdiction by the filing of an interpleader action. The Purchaser and the Sellers agree each to pay one-half of the Escrow Agent’s costs, including reasonable attorney’s fees, which the Escrow Agent may expend or incur in any such interpleader suit, the amount of such costs to be fixed and judgment therefore to be rendered by the court in such suit. Upon the filing of the interpleader action and the payment of the Escrow Deposit into the registry of the court, the Escrow Agent shall be fully released and discharged from all obligations imposed on it in this Escrow Agreement.

10. Construction of this Escrow Agreement and the rights, remedies and obligations arising hereunder shall be governed by the laws of the State of New York, without regard to conflicts of laws, and all disputes shall be adjudicated in any federal or state court located in the State of New York.

11. The Purchaser and the Sellers hereby agree that the duties of the Escrow Agent are purely ministerial in nature and shall be expressly limited to the safekeeping of the Escrow Deposit and the disposition of the same in accordance with the terms of this Agreement. The Escrow Deposit shall be held by the Escrow Agent in an account at ____________________________________. The Escrow Agent shall have no liability to any party on account of any depositing of funds in accordance with this Agreement or on account of any failure to invest any funds. The Purchaser and the Sellers hereby agree, jointly and severally, (a) to indemnify the Escrow Agent and hold it harmless from and against any and all claims, liabilities, damages, costs, penalties, losses, actions, suits or proceedings at law or in equity, or any other expenses, fees or charges of any character or nature, which the Escrow Agent may incur or with which it may be threatened, directly or indirectly, arising from or in any way connected with this Agreement or which may result from the Escrow Agent’s following of instructions from the Purchaser and the Sellers in accordance with this Agreement, and in connection therewith, and (b) to indemnify the Escrow Agent against any and all expenses, including attorneys’ fees and the cost of defending any action, suit or proceeding or resisting any claim, whether or not litigation is instituted, arising from or in any way connected with this Agreement but nothing herein shall be construed to so indemnify the Escrow Agent to the extent that it is determined that the Escrow Agent has acted in a fraudulent, grossly negligent or intentionally wrongful manner. The provisions of this Section shall survive the termination of this Agreement.

12. This Escrow Agreement may be executed in separate counterparts which, together, shall constitute a fully executed Escrow Agreement. The parties hereto may rely upon telecopies (faxes) of signed counterparts of this Escrow Agreement or signature pages from such telecopied (faxed) counterparts that are attached to a single copy of this Escrow Agreement, or any photocopies thereof, and the parties signing and transmitting the same shall be bound hereby as fully as if their original signature pages were attached hereto.


13. This Escrow Agreement supersedes all prior agreements and constitutes the entire agreement with respect to the escrow under this Escrow Agreement. It may not be altered or modified without the written consent of all parties.

IN WITNESS WHEREOF, the parties hereto have caused this Escrow Agreement to be duly executed on the day and year first written above.

_________________________________ _________________________________

[Name] _____________________________, INC. By: ______________________________

Name: Title:

__________________________________ By: ______________________________

Name: Title:

Reprinted with Permission from Practical Law

EXHIBIT G

ASSET ACQUISITIONS: TAX OVERVIEW

© 2017 Thomson Reuters. All rights reserved.

Search the Resource ID numbers in blue on Westlaw for more.

Resource ID: 6-383-6235

PRACTICAL LAW CORPORATE & SECURITIES

Asset Acquisitions: Tax Overview

An overview of the tax considerations involved when buying or selling the assets of a business.

This Note focuses on the tax aspects of an asset acquisition. For a discussion of other considerations involved when buying or selling the assets of a business, see Practice Note, Asset Acquisitions: Overview (6-380-7695).

Unless otherwise indicated, this Note addresses only US federal income tax considerations and assumes that:

�� The asset acquisition is structured as a taxable transaction.

�� The asset acquisition is not structured as a merger.

�� The purchase price is paid in full at closing.

�� The buyer is a private US corporation that is a C-corporation.

�� The target company is a solvent, private US corporation that is a C-corporation.

�� The target company has only US stockholders.

�� The target company is not a member of a consolidated group for tax purposes.

�� The buyer and target company are not related parties.

For a discussion of the tax issues when the target company is taxed as a pass-through entity, see Practice Note, Taxation of Pass-through Entities (2-503-9591). For a discussion of the tax issues when the target company is taxed as an S-corporation, see Practice Note, Acquisitions of a C-corporation versus S-corporation: Tax Consequences (8-522-9041). For a discussion of common tax issues that arise for buyers and sellers in acquisitions of financially distressed targets, see Practice Note, Tax Traps in an Acquisition of a Financially Distressed Target (2-503-3971).

ASSET ACQUISITIONS VERSUS STOCK ACQUISITIONS

In an asset acquisition, the buyer acquires only the assets and liabilities it identifies and agrees to acquire and assume. This is fundamentally different from a stock acquisition of all of the outstanding stock of the target company where the buyer acquires all the assets, rights and liabilities (including unknown or undisclosed liabilities) of the target company as a matter of law. The buyer and

seller must consider both tax and nontax factors when deciding between an asset and stock acquisition. As a general matter, buyers prefer to buy assets and sellers prefer to sell stock.

BUYERS GENERALLY PREFER TO BUY ASSETS

For nontax factors, buyers generally prefer to buy assets because the ability to pick and choose specific assets and liabilities provides the buyer with flexibility. The buyer does not waste money on unwanted assets and there is less risk of it assuming unknown or undisclosed liabilities. For further discussion of nontax factors, see Practice Notes, Asset Acquisitions: Overview and Private Acquisition Structures (6-380-7695).

In an asset acquisition, the buyer receives a cost basis in the acquired assets. This means the buyer acquires a basis in the acquired assets equal to the purchase price paid plus assumed liabilities and certain other items. In a stock acquisition, the target company’s basis in its assets generally remains unchanged.

For tax purposes, a buyer generally prefers to receive a cost basis in the acquired assets. A cost basis often is higher than the basis that the target company had in those assets (referred to as a stepped-up basis). Basis is used, among other things, to calculate depreciation and amortization deductions, as well as income, gain or loss on the sale or other disposition of the assets. A stepped-up basis benefits the buyer by enabling it to take greater depreciation and amortization deductions on those assets and by reducing the amount of taxable income or gain (or increasing the amount of loss) on a later sale or other disposition of the assets.

IN AN ECONOMIC DOWNTURN, BUYERS MAY PREFER TO BUY STOCK

For tax purposes, the buyer’s basis in the acquired assets cannot exceed the fair market value of the acquired assets. Therefore, if the buyer is purchasing assets from a target company whose asset values have gone down (in other words, the target company’s basis in its assets exceeds their fair market value), the asset purchase results in a “step-down” in the basis of the acquired assets. This may happen more often in an economic downturn. A buyer generally prefers to structure a transaction as a stock acquisition if there would be a step-down in the basis of the acquired assets.

© 2017 Thomson Reuters. All rights reserved. 2


SELLERS GENERALLY PREFER TO SELL STOCK

For nontax factors, sellers generally prefer to sell stock because the buyer assumes all liabilities of the target company as a matter of law in a stock acquisition (whereas sellers are left with known and unknown liabilities of the target company not assumed by the buyer in an asset acquisition). In addition, asset acquisitions often are more complicated and time consuming than stock acquisitions. For further discussion of nontax factors, see Practice Notes, Asset Acquisitions: Overview (6-380-7695), Stock Acquisitions: Overview (4-380-7696) and Private Acquisition Structures (6-380-9171).

The tax treatment of a stock acquisition generally is more favorable for the sellers because it often results in a single level of taxation (at the stockholder level) as opposed to potential double taxation (at the entity and stockholder level) in an asset acquisition (see Tax Consequences to the Target Company, Tax Consequences to the Target Company Stockholders, and Practice Note: Stock Acquisitions: Tax Overview (9-383-6719)).

STRUCTURE OF A TAXABLE ASSET ACQUISITION

A taxable asset acquisition can be structured as:

�� A direct acquisition of the target company assets.

�� A merger treated as an asset acquisition for tax purposes.

The buyer generally acquires the target company’s assets (either by direct acquisition or merger) with cash or notes (or some combination of the two), but other consideration such as the buyer’s or its affiliate’s stock can also be used.

In a direct acquisition of the target company assets, the buyer generally acquires either:

�� Specific assets and liabilities of the target company (for example, a division of the target). After the acquisition, the target company continues to operate.

�� “Substantially all” of the assets of the target company (and some or all of the liabilities of the target company). After the acquisition, the target company liquidates.

Alternatively, a taxable asset acquisition can be structured as a merger. Two types of mergers generally are treated as asset acquisitions for tax purposes:

�� A forward merger. This is a state law merger of the target company with and into the buyer in which the buyer assumes all of the target company’s assets, rights and liabilities by operation of law. After the merger, the target company ceases to exist as a separate entity.

�� A forward triangular merger. This is a state law merger of the target company with and into a newly formed or existing subsidiary of the buyer (a merger subsidiary) in which the merger subsidiary assumes all of the target company’s assets, rights and liabilities by operation of law. After the merger, the target company ceases to exist as a separate entity.

Reverse triangular mergers generally are treated as stock acquisitions for tax purposes. A reverse triangular merger is a state law merger of a buyer’s merger subsidiary with and into the target company. After the merger, the target company survives and becomes the buyer’s subsidiary. A transaction can also be structured as a reverse merger (which is treated as a stock acquisition for tax purposes) but this is not commonly used.

For a further discussion of acquisitions that are structured as mergers, see Practice Notes, Private Acquisition Structures (6-380-9171), Private Mergers: Overview (0-380-9145), Public Mergers: Overview (4-382-2164), and Mergers: Tax Overview (0-383-674).

TAX CONSEQUENCES TO THE TARGET COMPANY

The target company generally recognizes taxable income, gain or loss on the sale of its assets equal to the difference between the “amount realized” on the sale and the target company’s basis in the assets.

The amount and character (ordinary or capital) of the income, gain or loss from the asset sale is determined asset by asset. The asset purchase agreement generally specifies how the purchase price is allocated among the assets for tax purposes. This provision is included so that the target company and the buyer use the same allocation to determine the target company’s income, gain or loss on the transfer of each asset and the buyer’s basis in each acquired asset. The parties may have conflicting interests when it comes to the allocation (see The Purchase Price Allocation. For more information, see Practice Note, Asset Purchase Agreement Commentary (4-381-0590).

THE AMOUNT REALIZED BY THE TARGET COMPANY

The amount realized on the asset sale includes more than the cash consideration received by the target company. It includes among other things:

�� The fair market value of any stock (or other property) received by the target company.

�� The amount of any buyer or third party notes received by the target company.

�� Liabilities assumed by or transferred to the buyer.

The Amount Realized Includes the Fair Market Value of any Property

In calculating the target company’s amount realized when stock (or other property) is used as consideration, the property generally is treated like a cash payment equal to the fair market value of the property. For example, if the buyer bought a target company’s assets with a cash payment of $100,000 and stock with a fair market value of $50,000, the amount realized by the target company on the asset sale is $150,000.

IF STOCK IS USED AS CONSIDERATION, THE ASSET ACQUISITION MAY QUALIFY AS A TAX-FREE TRANSACTION

If stock of the buyer or its affiliate is used as consideration, it may be possible to structure an asset acquisition as a tax-free reorganization. Private company asset acquisitions generally are structured as taxable transactions for business reasons, unless the buyer or its affiliate is a public company. One business reason is that there generally is no market for the stock of a private company so sellers are often not willing to accept it as consideration. In addition, a seller that would recognize a loss in an asset acquisition prefers to structure the transaction as a taxable transaction. This is because a seller is unable to recognize a loss in a tax-free transaction. For more information about tax-free reorganizations, see Practice Notes, Tax-Free Reorganizations: Acquisitive Reorganizations (0-386-4212) and What’s Market: Tax-free Transactions (5-386-103).

3© 2017 Thomson Reuters. All rights reserved.


The Amount Realized Includes the Amount of any Buyer or Third Party Notes

If the consideration includes buyer or third party notes, the target company’s amount realized on the asset sale includes the amount of any buyer or third party note. For example, if the buyer bought a target company’s assets with a cash payment of $100,000 and a $50,000 buyer note, the amount realized by the target company on the asset sale is $150,000. If buyer notes are used as consideration, the target company may be able to defer certain gain recognition until the buyer notes are paid (or disposed of) under Section 453 of the Internal Revenue Code (IRC) (see The Timing of Gain Recognition and the Form of Consideration and Potential Entity Level Gain if the Target Company Liquidates).

The Amount Realized Includes Liabilities Assumed by or Transferred to the Buyer

The target company’s amount realized on the asset sale includes liabilities assumed by the buyer and liabilities transferred to the buyer. For example, if a buyer purchases a target company’s assets for a cash purchase price of $100,000 and one of the assets transferred is a building subject to a $25,000 mortgage. The $25,000 mortgage assumed by the buyer is then treated as additional consideration paid to the target company for its assets, so the amount realized on the asset sale is $125,000.

THE ENTITY LEVEL TAX AND THE TARGET COMPANY’S TAX ATTRIBUTES

Before an acquisition, the target company may have valuable tax attributes that can be used to offset its taxable income and a buyer may want to obtain access to those pre-acquisition tax attributes. One example of a valuable tax attribute is net operating losses (NOLs). A taxpayer has a NOL when its allowable deductions exceed its gross income in a specific taxable year. NOLs generally can be carried back two years and carried forward up to 20 years to offset taxable income (IRC § 172).

The buyer in a taxable asset acquisition generally does not obtain access to a target company’s tax attributes. Instead, the target company retains its tax attributes and can use its NOLs and other tax attributes to both:

�� Reduce or eliminate the entity level gain recognized on the asset sale.

�� Offset any future taxable income of the target company.

In a stock acquisition, the buyer (indirectly through stock ownership of the target company) generally obtains access to pre-acquisition tax attributes (for example, NOLs) of the target company. These tax attributes generally are used by the target company to offset future taxable income, subject to limitations in the IRC. If the target company is later liquidated tax-free into the buyer, the target company’s tax attributes generally carry over and can be directly used by the buyer, subject to limitations in the IRC. For more information, see Practice Note, Stock Acquisitions: Tax Overview (9-383-6719).

THE ENTITY LEVEL TAX AND THE TAX CLASSIFICATION OF THE TARGET COMPANY

The target company may not be subject to an entity level tax if the target company is any one of the following:

�� Partnership.

�� Limited liability company (LLC) (that is taxed as a “pass-through” entity (which is an entity that does not pay entity level taxes)).

�� S-corporation (if the S-corporation is not subject to the built-in gains tax (in IRC Section 1374) applicable to certain S-corporations that were previously C-corporations).

If the target company is a partnership, LLC or S-corporation, the target company generally does not pay an entity level tax on the sale of assets. Instead, any taxable income, gain or loss from the sale of the assets generally “passes-through” to (that is, taxed directly to) the target company’s partners, members or stockholders.

A seller is more likely to agree to structure a transaction as an asset acquisition if the target company is a partnership, LLC or S-corporation. This is because the asset acquisition results in only a single level of taxation (at the stockholder level) as opposed to potential double taxation (at the entity and stockholder level) if the target company is a C-corporation.

For a discussion of the tax issues that arise when the target company is US partnership, LLC or S-corporation, see Practice Notes, Taxation of Pass-through Entities (2-503-9591) and Acquisitions of a C-corporation versus S-corporation: Tax Consequences (8-522-9041). For more information on the US federal income tax classification rules that apply to US corporations, partnerships and LLCs, see Practice Note, Choice of Entity: Tax Issues (1-382-9949).

THE TIMING OF GAIN RECOGNITION AND THE FORM OF CONSIDERATION

If the purchase price is paid in cash or stock (or some combination of the two) at closing, the target company generally recognizes the full amount of any gain or loss immediately.

If the consideration includes buyer notes, the target company’s amount realized on the asset sale includes the amount of any buyer notes. In this case, the target company may be able to use the installment method to defer the recognition of a certain amount of gain until the note is paid (or disposed of) if all of the following:

�� At least one payment is received in a tax year after the year of sale (in other words, the sale provides for deferred payments and meets the definition of an “installment sale” in IRC Section 453(b)).

�� The notes are issued by the buyer (generally not a third party) and are not payable on demand or readily tradeable (IRC § 453(f)(4-5)).

Under the installment method, the total recognized gain from the sale generally is prorated and reported by the target company over several years as payments of purchase price are received. The installment method does not apply when a loss is recognized on the sale; the full amount of any loss is recognized immediately.

For example, assume on January 1, 2010, the target company sold an asset for both a:

�� $40,000 cash payment.

�� $60,000 buyer note which bears adequate interest and is payable in two equal installments on January 1, 2011 and 2012 (so both payments on the notes occur after the year of sale).

If the target company has a $50,000 basis in the asset, the target company’s total gain recognized on the sale is $50,000 (amount realized of $100,000 minus basis of $50,000). Assuming that the



sale qualifies for the installment method, the target company is taxed on the asset sale as follows:

�� Year one. 40% of the gain ($20,000) (because the target company received $40,000, or 40% of the total amount realized in year one) plus any interest received on the buyer note is recognized.

�� Year two. 30% of the gain ($15,000) (because the target company received $30,000, or 30% of the total amount realized in year two) plus interest received on the buyer note is recognized.

�� Year three. 30% of the gain ($15,000) (because the target company received $30,000, or 30% of the total amount realized in year three) plus interest received on the buyer note is recognized.

If the buyer note does not provide for adequate interest, interest generally is imputed to the target company (IRC §§ 483 and 1274).

The benefit of the installment method is decreased in large asset sales because IRC Section 453A generally imposes an annual interest charge on the target company’s deferred tax liability in any year that the aggregate face amount of buyer notes (arising from all sales by the target company with a sales price exceeding $150,000) exceeds $5 million.

The pledge of a buyer note (arising from a sale with a sales price exceeding $150,000) as security for a borrowing by the target company generally accelerates the recognition of the entity level gain that was deferred by the installment method (IRC § 453A(d)). For example, assume the same facts as the above example on the installment method, except that the target company pledges the $60,000 buyer note as security for a $30,000 borrowing. The target company immediately recognizes 50% ($30,000 divided by $60,000) of the gain that was deferred by the installment method.

If a transaction meets the requirements for an installment sale, the installment method must be used unless the taxpayer formally elects not to have it apply (IRC § 453(d)). However, if the target company elects not to use the installment method, the full amount of gain is recognized in the year of the sale even though some payments of purchase price are deferred and paid after the year of sale. Therefore, a target company with expiring NOLs (or other tax attributes) may want to elect not to use the installment method.

GAIN RECOGNITION MAY BE DEFERRED IN ASSET SALES WITH ESCROWS AND EARN-OUTS

The installment method may also be available to the target company if a portion of the purchase price is held in escrow (or there is an earn-out) and all or a portion of the escrow (or earn-out) is released (or paid) to the target company in a tax year after the sale. For more information on escrows and earn-outs, see Practice Notes, Earn-outs (0-500-1650), Accounting for Transaction Costs and Earn-outs in M&A (4-504-4662) and Asset Purchase Agreement Commentary (4-381-0590).

POTENTIAL ENTITY LEVEL GAIN IF THE TARGET COMPANY LIQUIDATES

A target company generally liquidates after an asset sale if it sells “substantially all” of its assets because it is essentially a shell (a company with few, if any, assets) after the transaction.

If the target company liquidates after the asset sale, it generally recognizes gain or loss on the liquidating distribution of any non-cash assets (basically unwanted assets that the buyer did not purchase in the sale) to the target company stockholders (IRC § 336). If a target company stockholder is a corporation that owns at least 80% of the target company (an 80% corporate stockholder), the target company generally does not recognize taxable gain or loss on a liquidating distribution to an 80% corporate stockholder (IRC § 337).

In addition, if the target company used the installment method to report gain recognized on the sale of its assets, a liquidating distribution of the buyer notes to the target company stockholders causes the target company to recognize the entity level gain that was deferred by the installment method unless either:

�� The buyer notes are distributed to an 80% corporate stockholder (IRC § 453B(d)).

�� In certain circumstances, the target company is an S-corporation (IRC § 453B(h)).

SALES, USE AND OTHER TRANSFER TAXES UNDER STATE LAW

In addition to potential double taxation, many asset sales are subject to sales, use and other transfer taxes under state law. The target company generally is responsible for these taxes as a matter of law, but they can be shifted to the buyer by contract. Stock sales generally do not result in sales, use or other transfer taxes (however, a few states impose a stock transfer tax and a few states impose a real estate transfer tax on the sale of a controlling interest in a real property entity). It is advisable to consult with a state law tax specialist when structuring an acquisition.

TAX CONSEQUENCES TO THE TARGET COMPANY STOCKHOLDERS

A target company stockholder generally recognizes a taxable income, gain or loss on the distribution of any proceeds from the sale. The target company generally distributes any sale proceeds either as a non-liquidating distribution or a liquidating distribution. This potentially results in double taxation (at the entity and stockholder level) as opposed to a single level of taxation (at the stockholder level) in a stock acquisition. For more information on stock acquisitions, see Practice Notes, Stock Acquisitions: Overview (4-380-7696) and Stock Acquisitions: Tax Overview (9-383-6719).

NON-LIQUIDATING DISTRIBUTIONS OF SALE PROCEEDS

Under IRC Section 301, non-liquidating distributions of sale proceeds generally are treated:

�� First. As a taxable dividend (defined in the IRC Section 316 as a distribution out of the target company’s current or accumulated earnings and profits).

�� Second. With respect to distributions (or portions thereof) that exceed the target company’s current and accumulated earnings and profits, as a non-taxable return of capital to the extent of the target company stockholder’s basis in its shares.

�� Third. With respect to any remaining portion of the distribution, as capital gain.

For example, if the target company has $20,000 of current and accumulated earnings and profits and a stockholder has a $10,000



basis in its stock, a non-liquidating distribution of $50,000 of sale proceeds to that stockholder generally would be treated as:

�� First. $20,000 taxable dividend (because the target company only has $20,000 of current and accumulated earnings and profits).

�� Second. $10,000 non-taxable return of capital (because the target company stockholder has a $10,000 basis in its stock).

�� Third. $20,000 of capital gain.

For tax years beginning on or after January 1, 2013, a 3.8% medicare tax may apply to dividends and gains earned by certain higher income individuals (IRC § 1411).

LIQUIDATING DISTRIBUTIONS OF SALE PROCEEDS OR BUYER NOTES

A target company generally liquidates after an asset sale if it sells “substantially all” of its assets because it is essentially a shell after the transaction.

Liquidating distributions of sale proceeds generally are treated as a sale of the target company’s stock in exchange for the sale proceeds. The target company stockholders recognize gain or loss on the liquidating distribution under IRC Section 331. For tax years beginning on or after January 1, 2013, a 3.8% medicare tax may apply to gains earned by certain higher income individuals (IRC § 1411).

However, an 80% corporate stockholder generally does not recognize gain or loss on a liquidating distribution of any sale proceeds under IRC Section 332. Therefore, if the target company is 100% owned by a corporate stockholder, an asset sale results in only a single level of tax imposed at the entity level.

A liquidating distribution of the buyer notes to the target company stockholders generally causes the target company to recognize the entity level gain that was deferred by the installment method (see Potential Entity Level Gain if the Target Company Liquidates). However, the target company stockholders who receive a timely liquidating distribution of buyer notes may be able to report the transaction under the installment method as a deemed sale of company stock in exchange for the buyer notes. This may allow the target company stockholders to defer the recognition of a certain amount of gain resulting from the liquidation until the buyer note is paid (IRC § 453(h)). If there are multiple target company stockholders, the installment method can be used by a target company stockholder even if some of the stockholders elect not to use the installment method. However, a target company stockholder cannot use the installment method if the target company stock is traded on an established securities market (IRC § 453(k)).

A liquidating distribution of buyer notes can have adverse tax consequences for the stockholders if the target corporation is an S-corporation (essentially accelerating the recognition of gain for the S-corporation stockholders if the target company liquidates), unless the target company’s only asset at the time of the liquidation is the buyer note (IRC §§453(h) and 453B(h)). If the S-corporation retains assets after the sale or desires a portion of the purchase price in cash, it may be possible to avoid accelerating gain recognition with pre-acquisition tax planning.

TAX CONSEQUENCES TO THE BUYER

The buyer receives a cost basis in the acquired assets. This cost basis is often a stepped-up basis (see Buyers Generally Prefer to

Buy Assets). However, there is a step-down in basis if the target company’s basis in its assets exceed their fair market value (see Box, In an Economic Downturn, Buyers May Prefer to Buy Stock).

In a stock acquisition, the target company’s basis in its assets remains unchanged. In certain circumstances, the parties can make an election to treat a stock acquisition as an asset acquisition for tax purposes (see Practice Note, Stock Acquisitions: Tax Overview (9-383-6719)).

FULL COST BASIS AT TIME OF SALE

The buyer generally receives a full cost basis at the time of the sale even if purchase price payments are deferred and the target company uses the installment method (see The Timing of Gain Recognition and the Form of Consideration (4-520-5216)).

TARGET COMPANY’S TAX ATTRIBUTES

The buyer in a taxable asset acquisition generally does not obtain access to the target company’s tax attributes (for example, NOLs). Instead, the target company retains its tax attributes (see The Entity Level Tax and the Target Company’s Tax Attributes).

In a stock sale, the buyer may, depending on the circumstances, be able to obtain access (generally indirectly through stock ownership of the target company) to certain pre-acquisition tax attributes (for example, NOLs) of the target company. For more information, see Practice Note, Stock Acquisitions: Tax Overview.

PRE-CLOSING INCOME TAXES OF THE TARGET COMPANY

The buyer is ordinarily not responsible for pre-closing income taxes of the target company unless those taxes are expressly assumed. However, under some state and local laws, the buyer can be responsible for certain taxes of the target company under the applicable successor liability statutes. In some states and localities, a buyer may be able to avoid this successor liability by obtaining a tax clearance certificate from the relevant taxing authority or by withholding a portion of the purchase price. It is advisable to consult with a state and local tax specialist when structuring an acquisition.

FIRPTA WITHHOLDING

A buyer generally is required to withhold a 10% tax with respect to acquisitions of US real property (including stock of a “United States real property holding corporation”) from a foreign seller. This is referred to as FIRPTA (Foreign Investment in Real Property Tax Act) withholding (IRC § 897). This 10% tax is applied to the amount realized by the foreign seller. If the buyer does not withhold the 10% tax, it may be responsible for the payment of the tax as well as tax penalties and interest. For this reason, a buyer generally requires a seller to provide a certificate of nonforeign status at or prior to closing to ensure that no FIRPTA withholding is required by the buyer. For more information about FIRPTA, see Practice Note, Investments in US Real Property by Non-US Investors: Basic FIRPTA Rules.

THE PURCHASE PRICE ALLOCATION

The asset purchase agreement provides how the purchase price is allocated among the assets for tax purposes. The amount of purchase price allocated among the assets generally is the same

6

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as the target company’s amount realized on the sale. This provision is included so that the target company and the buyer use the same allocation for purposes of determining the target company’s income, gain or loss on the transfer of each asset and the buyer’s basis in each acquired asset. For more information, see Practice Note, Asset Purchase Agreement Commentary (4-381-0590).

The parties can have conflicting interests when it comes to the allocation. Generally, the target company prefers allocations to assets that result in capital gain and a buyer generally prefers allocations to assets that generate depreciation and amortization (which generally do not generate capital gain for the target company).

However, there are fewer conflicts between the parties now than in the past because:

�� The buyer can amortize payments for covenants not to compete, goodwill and going concern value.

�� The corporate tax rates applicable to ordinary income and capital gain are currently the same.

Before the enactment of IRC Section 197 in 1993, payments for covenants not to compete were amortizable but payments for goodwill or going concern value were not. Therefore, the buyer preferred to allocate as much purchase price as possible to covenants not to compete. By contrast, the target company preferred to allocate as much purchase price as possible to goodwill and going concern value which generated capital gain and as little as possible to covenants not to compete which generated ordinary income.

The enactment of IRC Section 197 reduced the conflicts between the parties concerning the allocation because it provided that payments for covenants not to compete, goodwill, and going concern value are amortizable.

Even though allocations to covenants not to compete still generate ordinary income (and allocations to goodwill and going concern value generate capital gain), a target company that is a C-corporation generally is not as concerned about allocations that generate ordinary income. This is because the tax rates applicable to ordinary income and capital gain of a C-corporation currently are the same. However, long-term capital gains of an individual are taxed at a preferential rate (maximum rate of 20% for higher income individuals, plus a potential additional 3.8% tax for higher income individuals on “net investment income,” which includes gains). Therefore, a target company that is an S-corporation or partnership (or other pass-though entity) with individual stockholders, partners or members still has a preference for allocating purchase price to assets that generate preferentially taxed capital gain.

PURCHASE PRICE ALLOCATION WHEN THE INSTALLMENT METHOD IS USED

If the target company is using the installment method to report gain recognized on the sale of its assets, the target company usually wants to specially allocate the cash received in the transaction to the assets that are not eligible for installment sale reporting (for example, inventory) and the buyer notes to assets that are eligible for installment sale. This decreases the amount of gain recognized in the year of sale by the target company. If the parties do not agree to a special (non-pro rata) allocation of cash and buyer notes among the assets, the cash and buyer notes are allocated pro rata among the assets.

SPECIAL ALLOCATION RULES

IRC Section 1060 contains special allocation rules when the group of assets purchased in a taxable transaction constitutes a trade or business. Most asset sales (especially those of “substantially all” the assets of the target company) are subject to the special allocation rules under IRC Section 1060. IRC Section 1060 requires the parties to use the “residual method” to determine the buyer’s basis in each acquired asset and the target company’s income, gain or loss on the transfer of each asset.

The residual method requires the allocation of the purchase price to seven different classes of assets in sequence. This means that purchase price is allocated first to Class I assets, then if any purchase price is remaining, to Class II assets and so on, with any “residual” or left over amount allocated to Class VII assets. The amount allocated to any asset (other than a Class VII asset) cannot exceed its fair market value on the purchase date.

The seven classes of assets generally are defined as follows:

�� Class I. Cash and general deposit accounts (including savings and checking accounts) other than certificates of deposit.

�� Class II. Actively traded personal property (including publicly traded stock and US government securities), certificates of deposit and foreign currency.

�� Class III. Assets that a taxpayer marks-to-market at least annually for US federal income tax purposes, accounts receivables and most debt instruments.

�� Class IV. Inventory and property primarily held for sale to customers.

�� Class V. All assets other than Class I, II, III, IV, VI, and VII assets. Class V assets generally include furniture and fixtures, buildings, land, vehicles and equipment, which constitute all or part of a trade or business.

�� Class VI. All IRC Section 197 intangibles except goodwill and going concern value.

�� Class VII. Goodwill and going concern value (whether or not the goodwill or going concern value qualifies as a IRC Section 197 intangible).

If an asset sale is subject to IRC Section 1060, the parties must file IRS Form 8594 specifying the allocation of purchase price among each class of assets. The target company’s allocation must match buyer’s allocation. The parties file IRS Form 8594 by attaching it to their US federal income tax returns for the year in which the sale date occurred.

Reprinted with Permission from Practical Law

EXHIBIT H

STOCK ACQUISITIONS: TAX OVERVIEW

© 2017 Thomson Reuters. All rights reserved.

Search the Resource ID numbers in blue on Westlaw for more.

Resource ID: 9-383-6719

PRACTICAL LAW CORPORATE & SECURITIES

Stock Acquisitions: Tax Overview

An overview of the tax considerations involved when buying or selling the stock of a corporation.

This Note focuses on the tax aspects of a stock acquisition. For a discussion of other considerations involved when buying or selling the stock of a corporation, see Practice Note, Stock Acquisitions: Overview (4-380-7696).

Unless otherwise indicated, this Note addresses only US federal income tax considerations and assumes that:

�� The stock acquisition is for all of the outstanding stock of the target company.

�� The stock acquisition is structured as a taxable transaction.

�� The stock acquisition is not structured as a merger.

�� The purchase price is paid in full at closing.

�� The buyer is a private US corporation that is a C-corporation.

�� The target company is a solvent, private US corporation that is a C-corporation.

�� The target company has only US stockholders.

�� The target company is not a member of a consolidated group (either before or after the stock acquisition) for tax purposes.

�� The buyer and target company are not related parties.

For a discussion of the tax issues when the target company is taxed as a pass-through entity, see Practice Note, Taxation of Pass-through Entities (2-503-9591). For a discussion of the tax issues when the target company is taxed as an S-corporation, see Practice Note, Acquisitions of a C-corporation versus S-corporation: Tax Consequences (8-522-9041). For a discussion of common tax issues that arise for buyers and sellers in acquisitions of financially distressed targets, see Practice Note, Tax Traps in an Acquisition of a Financially Distressed Target (2-503-3971).

STOCK ACQUISITIONS VERSUS ASSET ACQUISITIONS

In a stock acquisition, the buyer acquires all of the outstanding stock of the target company. By doing so, the buyer acquires all the assets, rights and liabilities (including unknown or undisclosed liabilities) of the target company as a matter of law. This is fundamentally

different from an asset acquisition where the buyer only acquires the assets and liabilities it identifies and agrees to acquire and assume. The buyer and seller must consider both tax and nontax factors when deciding between a stock and stock acquisition. As a general matter, sellers prefer to sell stock and buyers prefer to buy assets.

SELLERS GENERALLY PREFER TO SELL STOCK

For nontax factors, sellers generally prefer to sell stock because the buyer assumes all liabilities of the target company as a matter of law in a stock acquisition (whereas sellers are left with known and unknown liabilities of the target company not assumed by the buyer in an asset acquisition). In addition, asset acquisitions are more complicated and time consuming than stock acquisitions. For further discussion of nontax factors, see Practice Notes, Asset Acquisitions: Overview (6-380-7695), Stock Acquisitions: Overview (4-380-7696) and Private Acquisition Structures (6-380-9171).

The tax treatment of a stock acquisition generally is more favorable for sellers because it often results in a single level of taxation (at the stockholder level) as opposed to potential double taxation (at the entity and stockholder level) in an asset acquisition (see Tax Consequences to a Target Company Stockholder, Tax Consequences to the Target Company and Practice Note, Asset Acquisitions: Tax Overview (6-383-6235)).

BUYERS GENERALLY PREFER TO BUY ASSETS

For nontax factors, buyers generally prefer to buy assets because the ability to pick and choose specific assets and liabilities provides the buyer with flexibility. The buyer does not waste money on unwanted assets and there is less risk of it assuming unknown or undisclosed liabilities. For further discussion of nontax factors, see Practice Notes, Asset Acquisitions: Overview (6-380-7695) and Private Acquisition Structures (6-380-9171).

In an asset acquisition, the buyer receives a cost basis in the acquired assets. This means the buyer acquires a basis in the acquired assets equal to the purchase price paid plus assumed liabilities and certain other items. In a stock acquisition, the target company’s basis in its assets generally remains unchanged (see Tax Consequences to the Target Company).

For tax purposes, a buyer generally prefers to receive a cost basis in the acquired assets. A cost basis often is higher than the basis that



the target company had in those assets (referred to as a stepped-up basis). Basis is used, among other things, to calculate depreciation and amortization deductions, as well as income, gain or loss on the sale or other disposition of the assets. A stepped-up basis benefits the buyer by enabling it to take greater depreciation and amortization deductions on such assets and by reducing the amount of taxable income or gain (or increasing the amount of loss) on a later sale or other disposition of the assets.

For a further discussion of the tax considerations involved when buying the assets of a target company, see Practice Note, Asset Acquisitions: Tax Overview (6-383-6235).

IN AN ECONOMIC DOWNTURN, BUYERS MAY PREFER TO BUY STOCK

For tax purposes, the buyer’s basis in the acquired assets cannot exceed the fair market value of the acquired assets. Therefore, if the buyer is purchasing assets from a target company whose asset values have gone down (in other words, the target company’s basis in its assets exceeds their fair market value), the asset purchase results in a “step-down” in the basis of the acquired assets. This may happen more often in an economic downturn. A buyer generally prefers to structure a transaction as a stock acquisition if there would be a step-down in the basis of the acquired assets (see Practice Note, Asset Acquisitions: Tax Overview (6-383-6235)).

STRUCTURE OF A TAXABLE STOCK ACQUISITION

A taxable stock acquisition can be structured as:

�� A direct acquisition of all of the outstanding stock of the target company.

�� A merger treated as a stock acquisition for tax purposes.

The buyer generally acquires the target company’s stock (either by direct acquisition or merger) with cash or notes (or some combination of the two), but other consideration such as the buyer’s or its affiliate’s stock can also be used.

In a direct acquisition of the target company’s stock, the buyer acquires all of the outstanding stock of the target company directly from the target company stockholders. After the transaction, the target company either maintains its corporate existence and becomes a subsidiary of the buyer or liquidates into the buyer (this liquidation is often structured as an upstream merger for corporate purposes). For more information, see Practice Note, Stock Acquisitions: Overview (4-380-7696).

Alternatively, a taxable stock acquisition can be structured as a merger. Reverse triangular mergers and reverse mergers generally are treated as stock acquisitions for tax purposes. A reverse triangular merger is a state law merger of a buyer’s newly formed or existing subsidiary (a merger subsidiary) with and into the target company. After the merger, the target company survives and becomes the buyer’s subsidiary. A transaction can also be structured as a reverse merger but this is not commonly used. Forward mergers and forward triangular mergers generally are treated as asset acquisitions for tax purposes.

For a further discussion of acquisitions that are structured as mergers, see Practice Notes, Private Acquisition Structures (6-380-9171), Private Mergers: Overview (0-380-9145), Public Mergers: Overview (4-382-2164), and Mergers: Tax Overview (0-383-6747).

TAX CONSEQUENCES TO A TARGET COMPANY STOCKHOLDER

A target company stockholder generally recognizes a taxable gain or loss on the sale of its stock equal to the difference between the “amount realized” on the sale and the target company stockholder’s basis in its stock.

THE AMOUNT REALIZED BY A TARGET COMPANY STOCKHOLDER

The amount realized on the stock sale includes more than the cash consideration received by a target company stockholder. It includes among other things:

�� The fair market value of any stock (or other property) received by a target company stockholder.

�� The amount of any buyer or third party notes received by a target company stockholder.

The Amount Realized Includes the Fair Market Value of any Property

In calculating a target company stockholder’s amount realized when stock (or other property) is used as consideration, the property generally is treated like a cash payment equal to the fair market value of the property. For example, if a buyer bought target company’s stock from a target company stockholder with a cash payment of $100,000 and stock with a fair market value of $50,000, the amount realized by the target company stockholder on the stock sale is $150,000.

IF STOCK IS USED AS CONSIDERATION, THE STOCK ACQUISITION MAY QUALIFY AS A TAX-FREE TRANSACTION

If stock of the buyer or its affiliate is used as consideration, it may be possible to structure a stock acquisition as a tax-free reorganization. Private company stock acquisitions generally are structured as taxable transactions for business reasons, unless the buyer or its affiliate is a public company. One business reason is that there generally is no market for the stock of a private company so sellers are often not willing to accept it as consideration. In addition, sellers that would recognize a loss in a stock acquisition prefer to structure the transaction as a taxable transaction. This is because sellers are unable to recognize a loss in a tax-free transaction. For more information about tax-free reorganizations, see Practice Notes, Tax-Free Reorganizations: Acquisitive Reorganizations (0-386-4212) and What’s Market: Tax-free Transactions (5-386-1032).

The Amount Realized Includes the Amount of any Buyer or Third Party Notes

If the consideration includes buyer or third party notes, the target company’s amount realized on the stock sale includes the amount of any buyer or third party note. For example, if a buyer bought target company’s stock from a target company stockholder with a cash payment of $100,000 and a $50,000 buyer note, the amount



realized by the target company stockholder on the stock sale is $150,000. If buyer notes are used as consideration, a target company stockholder may be able to defer certain gain recognition until the buyer notes are paid (or disposed of) under Section 453 of the Internal Revenue Code (IRC) (see The Timing Of Gain Recognition and the Form Of Consideration).

THE GAIN OR LOSS RECOGNIZED BY A TARGET COMPANY STOCKHOLDER

If the shares were held as capital assets for more than one year, a target company stockholder recognizes a long-term capital gain or capital loss. Long-term capital gain of an individual generally is taxed at a preferential rate (maximum tax rate of 20% for higher income individuals, plus a potential additional 3.8% tax for higher income individuals on “net investment income,” which generally includes gains on the sale of shares, see IRC §§ 1(h)(1), 1411). Corporate capital gains are not taxed at a preferential rate. This means that the tax rates applicable to ordinary income and capital gain of a corporation are currently the same (IRC §§ 11 and 1201).

THE TIMING OF GAIN RECOGNITION AND THE FORM OF CONSIDERATION

If the purchase price is paid in cash or stock (or some combination of the two) at closing, a target company stockholder generally recognizes the full amount of any gain or loss immediately.

If the consideration includes buyer notes, the target company stockholder’s amount realized on the stock sale includes the amount of any buyer notes. In this case, the target company stockholder may be able to use the installment method to defer the recognition of a certain amount of gain until the note is paid (or disposed of) if all of the following:

�� At least one payment is received in a tax year after the year of sale (in other words, the sale provides for deferred payments and meets the definition of an “installment sale” in IRC Section 453(b)).

�� The notes are issued by the buyer (generally not a third party) and are not payable on demand or readily tradeable (IRC § 453(f)(4-5)).

�� The target company stock is not traded on an established securities market (IRC § 453(k)).

Under the installment method, the total recognized gain from the sale generally is prorated and reported by a target company stockholder over several years as payments are received. The installment method does not apply when a loss is recognized on the sale; the full amount of any loss is recognized immediately.

For example, assume on January 1, 2010, a target company stockholder sold stock for both a:

�� $40,000 cash payment.

�� $60,000 buyer note which bears adequate interest and is payable in two equal installments on January 1, 2011 and 2012 (so both payments on the notes occur after the year of sale).

If the target company stockholder has a $50,000 basis in its stock, the target company stockholder’s total gain recognized on the sale is $50,000 (amount realized of $100,000 minus basis of $50,000). Assuming that the sale qualifies for the installment method, the target company stockholder is taxed on the stock sale as follows:

�� Year one. 40% of the gain ($20,000) (because the target company stockholder received $40,000, or 40% of the total amount realized in year one) plus any interest received on the buyer note is recognized.

�� Year two. 30% of the gain ($15,000) (because the target company stockholder received $30,000, or 30% of the total amount realized in year two) plus interest received on the buyer note is recognized.

�� Year three. 30% of the gain ($15,000) (because the target company stockholder received $30,000, or 30% of the total amount realized in year three) plus interest received on the buyer note is recognized.

If the buyer note does not provide for adequate interest, interest generally is imputed to the target company stockholder (IRC §§ 483 and 1274).

The benefit of the installment method is decreased in large stock sales because IRC Section 453A generally imposes an annual interest charge on the target company stockholder’s deferred tax liability in any year that the aggregate face amount of installment notes (arising from all sales by the target company stockholder with a sales price exceeding $150,000) exceeds $5 million.

The pledge of a buyer note (arising from a sale with a sales price exceeding $150,000) as security for a borrowing by the target company stockholder generally accelerates the recognition of the gain that was deferred by the installment method (IRC § 453A(d)). For example, assume the same facts as above, except that the target company stockholder pledges the $60,000 buyer note as security for a $30,000 borrowing. The target company stockholder immediately recognizes 50% ($30,000 divided by $60,000) of the gain that was deferred by the installment method.

If a transaction meets the requirements for an installment sale, the installment method must be used unless the taxpayer formally elects not to have it apply (IRC § 453(d)). If there are multiple sellers, the installment method can be used by a target company stockholder even if some of the stockholders elect not to use the installment method.

If a target company stockholder elects not to use the installment method, the full amount of gain is recognized in the year of the sale even though some payments of purchase price are deferred and paid after the year of sale. A target company stockholder with expiring net operating losses (NOLs) (or other tax attributes) may want to elect not to use the installment method (for more information on NOLs and other tax attributes, see Limitations on the Use of Tax Attributes After the Stock Acquisition).

GAIN RECOGNITION MAY BE DEFERRED IN STOCK SALES WITH ESCROWS AND EARN-OUTS

The installment method may also be available to a target company stockholder if a portion of the purchase price is held in escrow (or there is an earn-out) and all or a portion of the escrow (or earn-out) is released (or paid) to the target company stockholder in a tax year after the sale. For more information on escrows and earn-outs, see Practices Notes, Earn-outs (0-500-1650), Accounting for Transaction Costs and Earn-outs in M&A (4-504-4662) and Stock Purchase Agreement Commentary (6-381-0589).



TAX CONSEQUENCES TO THE TARGET COMPANY

The stock sale generally does not have any immediate tax consequences for the target company. The target company does not recognize gain or loss as a result of the sale and the target company’s basis in its assets remains unchanged unless an election is made to treat the stock acquisition as an asset acquisition for tax purposes (see Stock Acquisitions Treated as Asset Acquisitions). However, the use of pre-acquisition tax attributes (such as NOLs) of the target company may be limited after the sale (see Limitations on the Use of Tax Attributes After the Stock Acquisition).

After the sale, the target company either maintains its corporate existence and becomes a subsidiary of the buyer or liquidates into the buyer. If the target company liquidates into the buyer, the liquidation generally is not taxable to either the target company or the buyer (IRC §§ 332 and 337). This is because the buyer is a 100% corporate stockholder of the target company after the sale.

LIMITATIONS ON THE USE OF TAX ATTRIBUTES AFTER THE STOCK ACQUISITION

Before an acquisition, the target company may have valuable tax attributes that can be used to offset its taxable income and a buyer may want to obtain access to those pre-acquisition tax attributes. One example of a valuable tax attribute is NOLs. A taxpayer has a NOL when its allowable deductions exceed its gross income in a specific taxable year (IRC § 172).

The buyer in a stock acquisition generally obtains access (indirectly through stock ownership of the target company) to the pre-acquisition tax attributes (for example, NOLs) of the target company. These tax attributes generally are used by the target company to offset its future taxable income, subject to limitations in the IRC.

The buyer in a taxable asset acquisition generally does not obtain access to a target company’s tax attributes. Instead, the target company retains its tax attributes and may use its NOLs and other tax attributes to both:

�� Reduce or eliminate the entity level gain recognized on the asset sale.

�� Offset any future taxable income of the target company.

After a stock acquisition, several Sections of the IRC may limit the use of pre-acquisition tax attributes of the target company (IRC §§ 172, 269, 381, 382 and 384 and the Treasury regulations relating to consolidated groups). IRC Section 382 generally limits the post-acquisition use of pre-acquisition NOLs (and certain built-in losses) of the target company if there is a more than 50% ownership change in the target company’s stock ownership over a three-year period (for example, a buyer’s purchase of more than 50% of the stock of the target company). After a 50% ownership change, the target company can often use its pre-acquisition NOLs (and certain built-in losses), but that use is limited annually to an amount equal to the value of the target company’s stock at the time of the acquisition multiplied by a statutory interest rate (IRC § 382(b)(1)).

For example, assume that a buyer purchases 100% of the stock of the target corporation. At the time of the sale, the target company had a value of $100,000 and a $50,000 NOL. There has been a 50% ownership change, so the target company’s post-acquisition use of its $50,000 NOL is annually limited by IRC Section 382. If, for example,

the applicable statutory rate is 6%, the Section 382 annual limitation is $6,000 (6% of $100,000), which means that the target company’s post-acquisition use of its pre-acquisition NOL is limited to $6,000 per year (for each year that it carries over).

If the target company has $80,000 of taxable income in its first taxable year after the stock sale:

�� The target company would only be allowed to use $6,000 of its $50,000 NOL in that year, so it would have taxable income of $74,000 ($80,000 minus $6,000).

�� The remaining $44,000 of NOL generally carries forward (until it expires) and can be used to offset future taxable income subject to the IRC Section 382 limitation.

�� If the NOL expires five years after the stock sale, the target company will lose $20,000 of NOLs ($50,000 minus $6,000 multiplied by five).

In the absence of a 50% ownership change, the target company could have used the full $50,000 NOL in that year to offset its taxable income, so it would have taxable income of $30,000 ($80,000 minus $50,000).

If the target company liquidates tax-free into the buyer after the stock acquisition, the target company’s tax attributes generally carry over and can be directly used by the buyer (IRC §§ 381 and 332), subject to certain limitations in the IRC. For example, any IRC Section 382 limitation that applied to the target company because of the buyer’s stock acquisition also applies to the buyer’s use of any remaining pre-acquisition NOLs (and certain built-in losses) of the target company. For example, assuming the same facts as above, except that the target company liquidated tax-free into the buyer after the stock acquisition (IRC §§ 332 and 337), the buyer’s use of the target company’s pre-acquisition NOL is annually limited to $6,000.

TAX CONSEQUENCES TO THE BUYER

The buyer receives a cost basis in the target company’s stock. This means that the buyer acquires a basis in the acquired stock equal to the purchase price paid plus certain other items. The buyer generally receives a full cost basis at the time of the sale even if purchase price payments are deferred and the target company stockholders use the installment method (see The Timing of Gain Recognition and the Form of Consideration).

The target company’s basis in its assets remains unchanged unless an election is made to treat the stock acquisition as an asset acquisition for tax purposes (see Stock Acquisitions Treated as Asset Acquisitions).

After the sale, the target company either maintains its corporate existence and becomes a subsidiary of the buyer or liquidates into the buyer. If the target company liquidates into the buyer, the liquidation generally is not taxable to either the target company or the buyer (IRC §§ 332 and 337). This is because the buyer is a 100% corporate stockholder of the target company after the sale. The buyer takes a carryover basis in the assets of the target company after a tax-free liquidation. The buyer (indirectly through stock ownership of the target company or directly after a tax-free liquidation) also obtains access to pre-acquisition tax attributes (for example, NOLs) of the target company, which generally can be used to offset future taxable



income, subject to limitations in the IRC (see Limitations on the Use of Tax Attributes After the Stock Acquisition).

PRE-CLOSING INCOME TAXES OF THE TARGET COMPANY

In a stock acquisition of all of the outstanding stock of the target company, the buyer acquires all the assets, rights and liabilities (including pre-closing income tax liabilities) of the target company as a matter of law. However, the stock purchase agreement generally requires the seller (of a private company) to indemnify the buyer for pre-closing taxes and for certain third party taxes (such as tax liabilities of a consolidated group).

SALES, USE AND OTHER TRANSFER TAXES UNDER STATE LAW

Unlike an asset acquisition, stock acquisitions generally are not subject to sales, use or other transfer taxes. However, a few states impose a stock transfer tax, and a few states impose a real estate transfer tax on the sale of a controlling interest in a real property entity. It is advisable to consult with a state law tax specialist when structuring an acquisition.

FIRPTA WITHHOLDING

A buyer generally is required to withhold a 10% tax with respect to acquisitions of US real property (such as stock of a “United States real property holding corporation”) from a foreign seller. This is referred to as FIRPTA (Foreign Investment in Real Property Tax Act) withholding (IRC § 897). This 10% tax is applied to the amount realized by the foreign seller. If the buyer does not withhold the 10% tax, it may be responsible for the payment of the tax as well as tax penalties and interest. For this reason, a buyer generally requires a seller to provide a certificate of nonforeign status at or prior to closing to ensure that no FIRPTA withholding is required by the buyer. For more information about FIRPTA, see Practice Note, Investments in US Real Property by Non-US Investors: Basic FIRPTA Rules (4-520-5216).

STOCK ACQUISITIONS TREATED AS ASSET ACQUISITIONS

In certain circumstances, an election can be made to treat a stock acquisition as an asset acquisition for tax purposes:

�� This usually is accomplished by the buyer and seller making a joint IRC Section 338(h)(10) election.

�� The buyer can also make an election under IRC Section 338(g) (a Section 338(g) election) but this election is less common because it often results in adverse tax consequences for the seller.

�� On or after May 15, 2013, the seller and a US corporate target may be able to make an election under IRC Section 336(e) if a IRC Section 338(h)(10) or 338(g) election is unavailable (for example, if there is a non-corporate buyer or multiple buyers).

The buyer generally prefers to make an election to treat a stock acquisition as an asset acquisition for tax purposes if the buyer receives a stepped-up basis in the target company’s assets (but this may not always be the case, see Box, In an Economic Downturn, Buyers May Prefer to Buy Stock).

To make a Section 338(h)(10) election, there generally must be all of the following:

�� A taxable purchase of at least 80% of a US target corporation within a 12-month period.

�� A corporate buyer.

�� A US corporate seller that owns at least 80% of the US target corporation.

In some instances, a Section 338 (h)(10) election can be made if the target corporation is an S-corporation (Treasury Regulations § 1.338(h)(10)-1(c)).

To make a Section 338(g) election, there must be both:

�� A taxable purchase of at least 80% of a US or foreign target corporation within a 12-month period.

�� A corporate buyer.

Unless otherwise indicated, the following discussion of Section 338(h)(10) elections and Section 338(g) elections assumes that a US corporate seller owns 100% of the stock of a US target company (which is a C-corporation for tax purposes).

If a Section 338(h)(10) and 338(g) election is not available (for example, because there is a non-corporate buyer, multiple buyers or the transaction is structured as a taxable distribution rather than a sale or exchange), the seller and US corporate target may be able to make a Section 336(e) election (see Section 336(e) Election)

SECTION 338(H)(10) ELECTION

If a IRC Section 338(h)(10) election is made, the stock sale is ignored for tax purposes. Instead, the target company generally is treated as making a deemed taxable sale of its assets and then liquidating tax-free into the seller.

Because the buyer and seller must jointly make a Section 338(h)(10) election, the tax consequences to each party must be considered.

Tax Consequences to the Target Company

The tax treatment to the target company is generally the same as an actual sale of its assets followed by a tax-free liquidation into the seller:

�� The target company generally recognizes taxable income, gain or loss on the deemed sale of its assets.

�� The target company can use its NOLs and other tax attributes to reduce or eliminate the entity level gain recognized on the deemed asset sale.

�� The amount and character (ordinary or capital) of the income, gain or loss from the deemed asset sale is determined asset by asset.

�� The parties must agree to an allocation of the purchase price among the assets for tax purposes.

�� If buyer notes are used as consideration, the installment method may be available to defer the recognition of a certain amount of gain on the deemed asset sale (Treasury Regulations § 1.338(h)(10)-1(d)(8)).

�� The target company does not recognize taxable gain or loss on a liquidating distribution to the seller because the seller is a 100% corporate stockholder of the target company (IRC § 337).

For more information on the tax treatment of asset sales, see Practice Note, Asset Acquisitions: Tax Overview (6-383-6235).



Tax Consequences to the Seller

The stock sale is ignored for tax purposes. Instead, the seller is treated as receiving a tax-free liquidating distribution of the sale proceeds (IRC § 332) and generally inherits the target company’s pre-acquisition tax attributes (IRC § 381), subject to limitations in the IRC. Therefore, the acquisition of all of the outstanding stock of the target company with a IRC Section 338(h)(10) election results in a single level of tax imposed at the entity level. A stock sale also results in a single level of tax, but that tax is imposed at the stockholder level.

Because a stock sale with a Section 338(h)(10) election results in an entity level tax and a stock sale without a Section 338(h)(10) election results in a stockholder level tax, the election can have adverse tax consequences for a seller. The election can:

�� Increase the amount of any gain recognized if the seller’s basis in the target company’s stock exceeds the target company’s basis in its assets.

�� Convert a certain amount of gain to ordinary income.

�� Result in significantly higher state taxes.

For example, assume that a target company has assets with a basis of $50,000 and the target company’s sole stockholder has a basis of $80,000 in its target company stock. If the buyer purchases the target company stock from the seller for $100,000, then:

�� The stock sale without a Section 338(h)(10) election results in $20,000 of gain (amount realized of $100,000 minus stock basis of $80,000).

�� The stock sale with a Section 338(h)(10) election results in $50,000 of gain (amount realized of $100,000 minus asset basis of $50,000).

In this example, the seller generally will not want to make a Section 338(h)(10) election unless any of the following:

�� The target company has NOLs or other tax attributes that reduce the entity level gain to $20,000 or less.

�� The buyer agrees to increase the purchase price to compensate the seller for the increased tax costs of the election.

�� The buyer agrees to indemnify the seller for the increased tax costs of the election.

Tax Consequences to the Buyer

After the stock sale, the buyer owns all of the stock of the target company which is now a subsidiary of the buyer and the target company has a cost basis in its assets. In a stock sale without a IRC Section 338(h)(10) election, the target company’s basis in its assets remains unchanged (see Tax Consequences to the Target Company).

STATE TAX CONSIDERATIONS

In considering the tax consequences of a IRC Section 338(h)(10) election, the buyer and seller should determine the state law treatment of the election, and whether a separate election is required under state law.

SECTION 338(G) ELECTION

If a IRC Section 338(g) election is made, the stock sale is not ignored. Instead:

�� The target company generally recognizes taxable income, gain or loss on the deemed sale of its assets.

�� The seller generally recognizes a taxable gain or loss on the sale of its stock.

After a stock sale with a Section 338(g) election, the buyer owns all of the stock of the target company that is now a subsidiary of the buyer and the target company has a cost basis in its assets.

Because a stock sale with a Section 338(g) election potentially results in two levels of tax (at the entity and stockholder level), a seller generally would object to this election unless either:

�� The target company has NOLs or other tax attributes that eliminate the entity level gain recognized on the deemed asset sale.

�� The target company is a foreign corporation that does not have any US assets. In this case, there generally would be no US tax on the deemed asset sale.

Because the Section 338(g) election is a unilateral election made by the buyer, a seller should evaluate whether a Section 338(g) election would cause it adverse tax consequences. If it would, a seller should consider any of the following:

�� Including a provision in a stock purchase agreement that prevents a buyer from making a Section 338(g) election.

�� Requiring the buyer to increase the purchase price to compensate the seller for the increased tax costs of the election.

�� Requiring the buyer to indemnify the seller for the increased tax costs of the election.

SECTION 336(E) ELECTION

On May 10, 2013, the IRS issued final Treasury regulations under IRC Section 336(e). Under the final regulations, a US corporate target (either a C- or S-corporation) and a US corporate seller (or if the target is an S-corporation, all of the stockholders of an S-corporation, including any non-selling stockholders) can jointly agree in writing to elect to treat certain stock acquisitions (that do not qualify for a IRC Section 338(h)(10) or 338(g) election) as asset acquisitions for tax purposes. The final regulations are generally effective for “qualified stock dispositions” taking place on or after May 15, 2013.

The final regulations generally adopt a Section 338(h)(10) model. This means that the stock purchase is ignored for tax purposes. Instead, the target company generally is treated as making a deemed taxable sale of its assets and then liquidating tax-free into the seller (resulting in a single level of tax at the entity level).

A Section 336(e) election requires a qualified stock disposition (Treasury Regulations § 1.336-1(b)(6)) which generally requires:

�� A taxable sale, exchange or distribution to an unrelated party of at least 80% of the stock of a US corporate target (either a C- or S-corporation) within a 12-month period.

�� A seller that is a US corporation or S-corporation stockholder.

A Section 336(e) election generally cannot be made if a Section 338(h)(10) or Section 338(g) election could be made (Treasury Regulations § 1.336-1(b)(6)(ii)). Therefore, the Section 336(e) election expands the categories of stock transactions that can be structured

7

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as asset acquisitions for tax purposes. In particular, a Section 336(e) election can apply to:

�� Sales of US corporate target stock to non-corporate buyers (for example, individuals and/or partnerships).

�� Transactions with multiple buyers.

�� Taxable distributions of US corporate target stock to stockholders when IRC Section 355 (generally applicable to tax-free spin-offs) does not apply.

�� Distributions of US corporate target stock to stockholders when IRC Section 355 applies but the distributing corporation is subject to tax under IRC Section 355(d) or (e).

For example, a Section 336(e) election would be available (but a Section 338(h)(10) election would not) if a US corporation that owns 100% of the stock of a target corporation both:

�� Sells 50% of the target company’s stock to a non-corporate buyer on January 1.

�� Distributes 30% of the target company’s stock to unrelated target company stockholders on August 1 of the same year.

To make a Section 336(e) election, the target and a US corporate seller (or if the target is an S-corporation, all of the stockholders of an S-corporation, including any non-selling stockholders) must agree in writing to make the election (Treasury Regulations § 1.336-2(h)). The seller generally wants to make a Section 336(e) election if the target company’s aggregate basis in its assets exceeds the seller’s basis in the target company’s stock.

However, a Section 336(e) election can have adverse tax consequences for the buyer if it results in a step-down in the basis of the target company’s assets. This would happen if the target company’s basis in its assets exceeds their fair market value. For this reason, a buyer should evaluate whether a Section 336(e) election would cause it adverse tax consequences. If it would, a buyer should consider any of the following:

�� Including a provision in the stock purchase agreement that prevents the seller and target company from making a Section 336(e) election.

�� Decreasing the purchase price to compensate the buyer for the step-down in basis.

For example, assume that a non-corporate buyer purchases all of the stock of the target company for a purchase price of $125,000. At the time of the sale, the seller has a $50,000 basis in the target company stock and the target company has assets with a basis of $100,000 (and fair market value of $75,000). The tax consequences for the seller are as follows:

�� The stock sale without a Section 336(e) election results in a $75,000 gain (amount realized of $125,000 minus $50,000 stock basis).

�� The stock sale with a Section 336(e) election results in a $25,000 gain (amount realized of $125,000 minus $100,000 asset basis).

In this case the seller would want to make a Section 336(e) election. However, there are adverse tax consequences to the buyer including:

�� The stock sale without a Section 336(e) election results in a $100,000 basis in the assets (basis remains unchanged).

�� The stock sale with a Section 336(e) election results in a step-down in the basis of the assets to $75,000 (basis is limited to fair market value).

There are circumstances where the buyer would want the seller to make the Section 336(e) election. For example, if both:

�� The election results in a stepped-up basis in the target company’s assets.

�� The stock acquisition is not eligible for a Section 338(h)(10) election or 338(g) election (for example, because the buyer is not a corporation or there are multiple buyers).

In this case, the buyer should consider adding a provision to the stock purchase agreement that requires the seller and target company to make a Section 336(e) election. If the seller agrees to make a Section 336(e) election, the seller may ask the buyer to either:

�� Increase the purchase price to compensate the seller for any increased tax costs of the election.

�� Indemnify the seller for any increased tax costs of the election.

I-1 © Copyright 2017 Hodgson Russ LLP

EXHIBIT I

PERSONAL GOODWILL, NON-COMPETES & CONSULTING AGREEMENTS

Shareholder

Seller:

Closely Held C-Corp

Purchaser

Business

Assets

$$

Level 1 of tax:

Corporate gains rate

Level 2 of tax:

Capital gains rate

1) Personal goodwill • SH taxed at capital gains rates

• Purchaser (P) amortizes value over

15 years (Sec. 197)

2) Non-compete agreements • SH taxed at ordinary income rates

• P amortizes value over 15 years (Sec.

197)

3) Consulting agreements • SH taxed at ordinary income rates

• P expenses as paid

Paid directly to shareholder (SH):

Distribution

BUYING OR SELLING A SMALL BUSINESS - NYSBA

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