What if a carve-out leaves the seller’s company unable to pay its debts?

A carve-out is when a seller separates the business or assets you are buying from the rest of its company. If the company is left holding its debts but not the assets that would have paid them, its creditors have a reason to look hard at the sale. The buyer is not automatically liable, but a transfer that leaves the seller unable to pay what it owes is the kind that gets challenged.

How insolvency law can reach the buyer

If the seller later becomes bankrupt, its trustee can apply to a court about a transfer at undervalue, meaning a disposition for which nothing, or conspicuously less than fair market value, was received. The court may declare the transfer void as against the trustee, or order a party to it to pay the estate the difference. Whether the price was close to market value is therefore the first question.

The reach is longer for connected parties

The Act applies different look-back periods depending on whether the parties dealt at arm’s length, with a longer reach where they did not. For an arm’s-length party, the transfer must fall within the shorter period and the seller must have been insolvent at the time or made insolvent by the transfer and also have meant to defraud, defeat or delay a creditor. For a party not at arm’s length, a transfer within the shorter period is enough on its own, and in the longer period either insolvency or that intent will do. Related persons are deemed not to deal at arm’s length, so a buyer related to the seller faces the longer reach.

Tax debts can follow the property

The Income Tax Act also has a rule on tax liability for property transferred not at arm’s length, under which the transferee and transferor can be jointly liable for an amount tied to the transfer. A buyer related to the seller should ask an accountant whether it applies.

What a buyer can ask before closing

• What security interests are registered against the assets? Provinces run personal property registries, and Alberta’s explains how to search one.
• What debts will the seller’s company still owe after closing, and what will be left to pay them?
• What supports the price other than the seller’s own say-so?