Business & civil litigation / bulk sales

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THE BULK SALES LAW

 Johnnie Cochran has been dead for years, yet his name is still being used to attract clients nationwide.  The Cochran firm's website states specifically: "When Johnnie Cochran founded The Cochran Firm, he set out with one goal in mind: To provide exceptional representation to victims of all types of injustice. Now, over 40 years later, The Cochran Firm has established itself as one of the premier plaintiffs' litigation and criminal defense law firms in the United States.  With offices throughout the United States, The Cochran Firm has brought together some of the most highly-respected and experienced men and women in the legal field."  The name has value - this is what we call branding and if you are buying a brand, you want to make sure that you get what you pay for.  If you are buying a business and a portion of the business contains "Branded products" you need these brands to retain existing customers.  Branding is and always has been an important aspect of purchasing any retail or wholesale business, even if the brand is not been registered under the federal or state trademark laws. 

The State of California has what is referred to as the "Bulk Sales" law.  It is designed to prevent merchants from making surreptitious sales or encumbrances of their stock-in-trade that are not in the ordinary course of business and that in effect defraud or defeat the financial claims of their creditors. It allows creditors an opportunity to satisfy their claims before the sellers can sell off their assets and vanish with the proceeds of those sales.

Commercial lenders normally file what is commonly referred to as a "UCC1", which is simple form, but which incorporates the terms of a security agreement.  The security agreement can be long, complicated and far reaching. Its purpose is to identify all of the collateral in which the secured party (The finance company) wants to secure a loan - and these days, they usually want everything - including all intellectual property rights.  Hmmmm - intellectual property?  You guessed it.  They want common law as well as statutory trademarks and trade names… the BRANDS NAMES!!

The first thing to understand is that personal property comes in many forms.  Automobiles, computers, televisions, machinery and other types of assets can be specifically identified.  There is other property however that can be difficult to identify, such as bulk foods, agricultural products, cases of liquid beverages, water, thumb tacks, lumber, a bag of nails . . . the list can go on and on and often include both common law and statutory intellectual property as well as trade names.  These are all legitimate subjects of security agreements and can be the subject of fraud occasioned by a fraudulent seller.  Property that cannot be physically segregated is also property that a finance company has difficulty monitoring.  A finance company can do a monthly inventory of personal property which has serial numbers but they cannot identify one almond from another or one bottle of soda from another… so a question like: "what is status of your intellectual property today?" is - well - stupid. 

A buyer entering into a transaction to purchase a large chunk of a seller's inventory, that includes the brand names under which it is sold, should carefully consider whether to insist upon compliance with the Bulk Sales law.  Under that law, the buyer must give notice of the proposed sale because it is he who is liable to the seller's creditors if notice is not given.

         
A bulk sale means either:

  • A sale by auction or a sale or series of sales conducted by a liquidator on the seller's behalf.
  • A sale or series of sales not in the ordinary course of the seller's business of more than half of the seller's inventory and equipment, as measured by a value on the date of the bulk-sale agreement.

 

A sale consists in the passing of title from the seller to the buyer for a price. Goods are classified as inventory if they are held by a person who holds them for sale or lease or to be furnished under contracts of service, or if he or she has so leased or furnished them, or if they are raw materials, work in process, or materials used or consumed in a business. Inventory of a person is not to be classified as his or her equipment. Goods are classified as equipment if they are used or bought for use primarily in business (including farming or a profession) or by a debtor who is a nonprofit organization or a governmental subdivision or agency or if the goods are not included in the definition of inventory, farm products, or consumer goods. A sale is in the ordinary course of the seller's business if the sale comports with usual or customary practices in the kind of business in which the seller is engaged or with the seller's own usual or customary practices.

If the terms of the sale specify the buyer to pay $2 million or less and is substantially all cash or an obligation of the buyer to pay cash in the future, additional announcements are required in the notice of sale. On every bulk sale subject to The Bulk Sale Law, except one made by sale at auction or a sale or series of sales conducted by a liquidator on the seller's behalf, it is the duty of the buyer or, if the transaction is handled through an escrow, the escrow agent, to apply the cash paid by the buyer so far as necessary to pay those debts of the seller for which claims are due and payable on or before the date of the bulk sale and are received in writing on or prior to the date specified as the last date to file claims with the person designated in the notice to receive claims. This duty of the buyer or escrow agent runs to each claimant timely filing the claim. If a seller disputes whether a claim is due and payable on the date of the bulk sale or the amount of any claim, the buyer or escrow agent must withhold from distribution an amount equal to (1) 125 percent of the first $7,500 of the claim, and (2) an amount equal to that portion of the claim in excess of the first $7,500.  The Buyer or the escrow holder must also send a written notice to the claimant filing the claim on or before two business days after the distribution, stating that the amount will be paid to the seller, or to the other claimants, as the case may be, unless attached within 25 days from the mailing of the notice.

Any portion of the amount withheld that is not attached by the claimant within a certain time is paid by the buyer or escrow agent to the seller, or to the other claimants in accordance with if they have not been paid in full.  A critical situation where a person with a claim against the seller can get legally complicated and should consider involving counsel.  

If the cash consideration payable is not sufficient to pay all of the claims received in full, and no escrow has been established, the buyer must follow the procedures specified in the Commercial Code, which are complicated.  If the buyer slips up, then the immunity established by the Commercial Code does not apply to protect the buyer.

So what happens if the transaction is not considered a "Bulk sale" and the buyer insists on an escrow which follows the Bulk Sales law?  Nothing.  If a buyer insists on an escrow and refuses to follow the Bulk Sales law, most lawyers should be suspicious and increase their due diligence. 

Conclusion

Many lawyers choose to avoid using escrow companies to handle business transactions where sellers are selling a portion of their company's assets outside of the ordinary course of the seller's business.  This means using their trust accounts and withholding documents involved in the transaction until all the terms of the transaction by both parties are satisfied.  This presents a tricky predicament for attorneys because of potential conflict of interest problems and placing themselves in a position of holding the documents and money in trust - if the deal comes apart, the lawyer will be in the middle of a range war where anything goes.   Yuck! 

While escrow companies can be a real pain in the derriere but they do serve an alternative purpose of keeping the attorney out of trouble as a trustee or fiduciary.  The escrow company who handles business transactions is well equipped to process the documents of the transaction including the details of the Bulk Sales Law, leaving the attorney alone to be able to do what he or she is supposed to do - protect the client's interest.  Insisting on following the Bulk Sales Law is a great way to determine whether there are hidden Skeletons behind the deal. 

 

Charles M. Farano has been in practice since 1979 and is a business and commercial litigator who also handles small business transactions.  He has been chosen as one of "Southern California's Super Lawyers" every year since 2009. 

 

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