Risk of liability for satisfaction of buyer in asset acquisition

In an asset acquisition, it is almost inevitable that the seller of the assets owes debts to third parties at the time of the asset sale. One of the risks that the buyer needs to consider is whether, after completion of the acquisition, it will be required to assume liability for satisfaction to the extent of the assets it acquires, or, in other words, whether the seller’s creditors have the right to claim that the buyer bear toward it liability for satisfaction to the extent of the assets acquired by the buyer. An analysis of this issue requires attention to the following dimensions.

SPC regulations

Pursuant to the Several Provisions of the Supreme People’s Court on Several Issues Concerning the Trial of Civil Disputes Relating to Enterprise Reorganization, if a debtor transfers property, the transferee may under certain circumstances be liable for satisfaction to the extent of the acquired assets.

Article 6. Where an enterprise uses a portion of its property and the accompanying debts to form a new company with a third party, the newly formed company shall bear civil liability for the debts transferred if approved by the creditors. If the creditors are not notified of the transfer of the debts, or if they are so notified but refuse to accord their approval, civil liability shall be borne by the original enterprise. If the original enterprise is insolvent, and the creditors assert their claims against the new company in this respect, the new company shall bear joint and several civil liability with the original enterprise to the extent of the property received by the new company.

Article 7. Where an enterprise uses high-quality assets to form a new company with a third party, the debts are left in the original enterprise, and a creditor institutes a legal action naming the new company and the original enterprise as co-defendants, to assert its claim the new company shall bear joint and several civil liability with the original enterprise to the extent of the property received by the new company.

Article 11. Where an enterprise, when undergoing a reorganization into a joint-stock co-operative enterprise, notifies its creditors by announcement with reference to relevant provisions of the Company Law, and after such reorganization a creditor institutes a legal action against the joint-stock co-operative enterprise in respect of a debt concealed or omitted by the asset manager (investors) of the original enterprise, if the creditor declared its claim during the announcement period the joint-stock co-operative enterprise may, after bearing civil liability, seek recovery against the asset manager (investors) of the original enterprise.

If the creditor failed to declare its claim during the announcement period, the joint-stock co-operative enterprise shall not bear civil liability, and the People’s Court may inform the creditor to institute a legal action against the asset manager (investors) of the original enterprise.

Article 24. If the buyer, after the sale of an enterprise, incorporates the assets of the acquired enterprise into the enterprise in question, or transforms the acquired enterprise into an affiliated (sub-)branch, the debts of the acquired enterprise shall be assumed by the buyer unless otherwise provided by the buyer and seller and approved by the creditors.

From the above-mentioned it can be seen that when an enterprise uses its property to form a new company with a third party, or undergoes a reorganization into a joint-stock co-operative enterprise, the buyer may be required to bear liability for satisfaction to the extent of the acquired assets, and a buyer may be required to assume the debts of a small state-owned enterprise that it purchases.

Local higher court opinions

The Liaoning Provincial Higher People’s Court points out in the Guiding Opinions of the Liaoning Provincial Higher People’s Court on Several Issues Concerning the Application of the Law in Current Commercial Adjudication that: “Where an enterprise purchases assets of another enterprise by paying reasonable consideration therefore, then pursuant to the Replies to Questions Concerning the Validity of Contracts for the Sale of Enterprise Assets and the Bearing of Civil Liability of the Research Office of the Supreme People’s Court, if the buyer has paid reasonable consideration and none of the circumstances set out in article 52 of the Contract Law apply to it, the contract shall be found valid, the provisions shall not apply to the act in question and, after the asset sale, the enterprise shall itself bear the debts it originally owed to third parties.”

Case breakthrough

Various cases indicate that although the courts found that an asset acquisition does not constitute an enterprise restructuring, they nevertheless applied the provisions on the grounds of the “principle that an enterprise’s debts change with its assets”.

Taking Civil Ruling (2019) Zui Gao Fa Min Shen No. 2330 of the Supreme People’s Court as an example, the court held that: “Xinji de facto transferred a portion of its business assets to Risheng Bearing, and Risheng Bearing, with the exception of accepting a portion of the debts, did not pay reasonable consideration for accepting the above-mentioned assets,” and, “although this case does not involve the reorganization of an enterprise, the principle that an enterprise’s debts change with its assets is a principle that began in the division of companies … Accordingly, regardless of whether looked at from the principle of the division of companies, or analyzed from the perspective of the rules for the reorganization of enterprises, Risheng Bearing should, after receiving the high-quality assets from Xinji, bear joint and several liability for the related debts of Xinji … The grounds for the application put forward by Risheng Bearing that the above-mentioned legal provisions are not applicable because its receiving of the relevant assets of Xinji is not an enterprise reorganization is not tenable, and this court rejects such grounds.”

In this case, the buyer failed to pay reasonable consideration for the assets it received, resulting in the court holding that, by the new company taking away only the high-quality property and discarding the enterprise debt that it should bear, and the original enterprise fundamentally losing the property liability capacity of an enterprise because its high-quality property was transferred while leaving the debts, the principle that an enterprise’s debts change with its assets was violated.

This case reminds a buyer that where the seller of assets owes debts to third parties it should pay reasonable consideration when acquiring the assets, otherwise it may not be able to avoid the liability for repaying, and the obligation to repay, the creditors.

Huang Ling is a salaried partner and Du Kaiyan is an associate at Grandway Law Offices