Basics of Liens and Security Interests in M&A Transactions

By: John Hinders
 
Though the sources and types of debt vary significantly between industries and from one company to another, identifying indebtedness and navigating removal of related liens is a key part of due diligence in almost any M&A transaction and will often be one of the first third-party matters addressed by the parties.

Part of the reason for this focus on debt is self-evident: buyers want to understand what financial obligations burden their purchase. The other significant consideration is liens. Liens encumber the target company’s real or personal property to secure payment of some obligation and can arise from many circumstances, including:

• Liens securing long term debt extended by banks or other financial institutions.
• Liens securing revolving lines of credit, often used to support a business’s working capital needs on an ongoing basis.
• Purchase money liens, which encumber only the specific personal property purchased with the loaned funds.
• Liens asserted by a target’s suppliers, usually intended to secure payment for inventory provided to the target on credit.
• Judgment or tax liens, which may attach to a target’s property as a result of unpaid judgments or taxes, respectively.

Identifying and addressing liens is critical because, if the obligation secured by a lien is not satisfied, the lienholder will generally be permitted to foreclose on the collateral, selling the encumbered property and applying the proceeds to the unpaid amounts. The risks of unresolved liens are all the more acute in asset transactions, where the seller’s failure to satisfy its financial obligations may result in the foreclosure of the buyer’s newly acquired assets. Further, the seller’s sale of the encumbered assets is itself likely to be a violation of the lienholder’s rights, permitting foreclosure of the assets.

Practically speaking, a seller should assume that a buyer will require any long-term debts that remain as of the closing to be satisfied directly out of the purchase price that would otherwise be payable to the seller. Short-term debts and current obligations such as trade payables may or may not be required to be paid at closing depending on the transaction structure and treatment of the target’s net working capital in the purchase agreement.

Similarly, a seller will be expected to coordinate the release of most liens at or before closing, usually by acquiring a “payoff letter” from the lienholder. The payoff letter is a simple document delivered by the lienholder whereby the creditor commits to releasing its lien if it receives an identified “payoff” amount by a date certain. There are exceptions, however. If, for example, the target has a favorable contract with an inventory supplier that the buyer intends to continue on the same terms following the closing, there will often be no reason to require termination of the related lien because that lien is itself a requirement of the contract with the supplier.

Ultimately, all parties are best served by identifying liens asserted on a target’s assets early in the diligence and drafting process so that treatment of the liens can be agreed and payoff letters obtained as needed well in advance of closing.

To learn more, connect with John Hinders, JD, for legal guidance on business transactions and corporate governance matters. A shareholder in the corporate and transactions group at Brown & Fortunato, John represents clients in the purchase and sale of pharmacies, DME suppliers, and home health agencies, as well as non-healthcare businesses. Reach out at (806) 345-6305 or jhinders@bf-law.com to learn how he can help support your business.

This article is for informational purposes only and does not constitute legal advice or establish an attorney-client relationship. This article was prepared on a specific date, and the law may have changed since it was written. You should contact your attorney to obtain advice with respect to your specific legal issue and needs.

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