Hybrid
Equity/Asset
Transactions

SUMMARY

Transactions can be structured as part equity, part asset.

In hybrid transactions, the equity portions will generally be treated as equity transactions and the asset portions will generally be treated as asset transactions.

Contract provisions can be used to modify default rules around who bears the financial burden of liabilities (like for taxes and third-party claims), but they cannot alter legal duties.

DEFAULT LIABILITY ALLOCATION

In an equity transaction, a buyer is generally responsible for all pre-closing liabilities of a target. In contrast, in an asset transaction, a seller is generally responsible for all pre-closing liabilities of a target.

RESPONSIBILITY FOR LEGAL DUTIES

A buyer inherits the legal duties of a target company in an equity transaction. These include defending against third-party claims, filing taxes, and paying taxes, in each case relating to the pre-closing or post-closing ownership periods.

In an asset transaction, legal duties like these for the pre-closing period are largely left behind with the seller. The buyer is only responsible for them post-closing.

SYNTHETIC PROVISIONS

Contract provisions can be used to synthetically allocate liabilities (like for tax obligations and lawsuit claims) in equity transactions as if they were asset transactions.

In such cases, a seller would agree to broadly indemnify a buyer for all pre-closing liabilities of a target business.

From a risk allocation perspective, this places the buyer in the same financial position as if the equity transaction were an asset transaction. (Assuming the seller is creditworthy.)

However, legal duties follow the default rules.

In any equity transaction the buyer will be responsible for actually filing tax returns, paying taxes, and defending against third-party claims, regardless of whether the seller is ultimately responsible for the financial burden of all three.

In a traditional asset transaction, the buyer would not need to take any of these actions.

ILLUSTRATIVE EXAMPLE

A buyer purchases the assets of a target company from a seller. As part of the transaction, the buyer also purchases the equity of one of the target’s subsidiaries. (The subsidiary holds material permits that could not be transferred in an asset sale without triggering a lengthy re-licensure process.) Accordingly, the transaction is hybrid.

In the purchase agreement, the parties agree to allocate the liabilities of the subsidiary along the lines of the larger deal (i.e., as an asset sale).

Following closing, a former employee of the subsidiary—whose employment with the subsidiary ended years before closing—sues.

The buyer is responsible for defending the lawsuit, even though the seller will be responsible for the financial outcome.

If the subsidiary’s assets had been purchased instead of its equity, the buyer would not typically be required to defend against the lawsuit.