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Overview of Asset Purchase Agreement

An agreement between a seller and a buyer for the purchase of an asset or any portion of such an asset is called the Asset Purchase Agreement. Under this agreement, the buyer is under a contractual obligation to pay a consideration amount to the seller for the purchase of an asset. After the consideration amount has been paid or promised to be paid, the seller transfers the ownership of the asset to the purchaser.

A common asset purchase agreement includes the transfer of:

  • Plant and machinery,
  • Goodwill,
  • Stock,
  • Premises, etc.

Advantages of the asset purchase agreement

There are several advantages of an asset purchase agreement which are as follows:

  • An agreement provides a right to purchase an asset to the buyer which he/she is willing to buy.
  • It also provides a right to choose the fair value of the asset to the seller.

Disadvantages of the asset purchase agreement

  • The amount of tax charged to the seller for selling the asset is high. Thus, the seller is forced to charge a higher price for the asset while selling it.
  • If the seller sells the asset, he/she needs to renegotiate the employment agreement with the key employees.

Essentials of an Asset purchase agreement

There are certain essential elements of an asset purchase agreement. These are as follows:

Sale and transfer of specified assets

Under this clause, the seller states that he/she is authorized and agrees to sell, transfer and assign the particular asset to the purchaser. He/she also informs the buyer that the asset is free from any lien or liability at the time of selling. If the buyer is willing to buy an asset as per the terms where the asset is not free then obligations and liabilities attached to asset will be borne by the purchaser. The seller needs to mention that the ownership and risk of the asset will be transferred to the purchaser. If there is involvement of any intellectual property then the owner is also entitled to receive a royalty fee. Information about the intellectual property will also be defined in the license agreement.

Purchase price

Under this clause, the seller will mention the lump-sum amount to be paid and the mode of payment. The mode of payment which has been mutually decided by parties must be mentioned 5 days from closing the agreement. If there is any previous financial agreement between parties, the said amount can be deducted or set off. No price such as taxes, charges, etc shall be paid by the purchaser except the price for the purchase of an asset. After the sale has been made, the purchaser will be responsible for the payment of taxes.

Representation and Warranties

It is the responsibility of the seller to clearly specify that the details provided by the seller in the agreement are true and will remain true till the closing date of the agreement. the same responsibility of mentioning true details is also applicable to the buyer.

Condition Precedent

The purchaser will be under an obligation to comply with the schedule mentioned in the asset purchase agreement. The condition mentioned in the schedule is open for negotiation as per the need of the parties.

Conduct before the closing of the agreement

The seller is duty bound to carry on its business in the same way as he/she was conducting the business before entering into the agreement and pay all the debts and taxes as required from the date on which the transaction took place to the date of closing of the agreement.

Closing

The closing of the agreement must be made as per the terms and conditions specified in the agreement. The seller must provide each notice and Document related to the asset to the purchaser before closing. The parties must perform due diligence very carefully and not hasten in closing of the agreement to avoid any future problems. The seller is also responsible for providing the certificate and other supporting instruments to the purchaser at the time of closing of the agreement. 

Post-closing obligations

After the closing of the agreement, the seller is responsible to deliver all the related notice and other information related to the business that he receives.

The seller under the asset purchase agreement promises the buyer not to directly or indirectly engage in the activities such as:

  • The business in which the purchaser is involved.
  • Use of any confidential information or intellectual property.
  • Solicit or hamper the relationship of the buyer with its customer.

As per the terms of the contract, the purchaser is also required to make a promise that he/she will not directly or indirectly involve himself/herself in activities such as:

  • The business in which the seller is involved.
  • Use of any confidential information or intellectual property.

Indemnification

There must be a clause related to indemnification wherein the seller promises to indemnify the purchaser for any losses, suits or penalties, etc.

Terms and termination

The agreement of purchase of assets must be executed on the date on which both parties signed the agreement as per the mutually agreed terms. Such an agreement can be terminated:

  • With mutual consent of both parties (seller and buyer)
  • By the buyer, only after the seller has been provided with a written notice stating that there has been a violation of the terms of the warranty.
  • By the purchaser when the seller has become bankrupt or insolvent.

Miscellaneous

Under this clause, all other information which has not been separately mentioned in the agreement needs to be mentioned here. There should be a statement mentioning that the seller will not be allowed to assign the agreement to any of his family members or relatives without the prior consent of the purchaser. The purchaser also has the right to assign the agreement to any of his family members or relatives only after giving notice to the seller.

The agreement must contain a provision specifying the law which will govern the agreement and the competent court having jurisdiction. There must be a pre-defined mode of dispute resolution which must be mutually agreed upon by both parties. The dispute can be resolved by way of arbitration or court.

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Documents required for an Asset purchase agreement

The Documents which parties are required to have while forming an asset purchase agreement are as follows:

  • Passport-size photograph of both parties.
  • Identity proof – Aadhar and PAN Card of both parties.
  • A utility bill
  • Address proof – Aadhar card of both parties
  • Other Documents depending on each case
  • All the accepted terms and conditions.

Common mistakes in the asset purchase agreement

There are some common mistakes which parties make while drafting an asset purchase agreement. It might negatively affect the rights and duties of the seller and the buyer. Thus, it is important that the agreement must be drafted carefully. Some common mistakes which parties do and should avoid are as follows:

Entering into an agreement with the wrong person

When either party to the agreement is found to be a fraudulent person and incompetent from entering into legal contracts, the well-structured asset purchase agreement will be considered a waste. Thus, it is very important to verify the credibility of a person before entering into a contract with him/her. A task of due diligence must be performed including activities such as:

  • Inspection of books of accounts for a minimum time period of the past five years.
  • Asking general questions from the customers and partners.
  • To ensure that there is no litigation case pending against the seller or if there was a previous litigation case in which the seller was convicted.
  • Check the payment system along with unsecured and secured debt.

These details provide information about the financial status and reliability of a seller.

Essential parties are not part of the asset purchase agreement

Sometimes, the owners of a company purchase the asset by themselves but buy it in the name of some other company and use the same asset for their company. This has been mostly seen during the formation of asset purchase agreements. Thus, it is important to mention the name of essential parties in the agreement.

Failure to identify and address the essential conditions of the deal

It is important to identify the important and essential terms and conditions of an asset purchase agreement that have been mutually agreed upon by the parties. Any confusion related to any terms or conditions must be resolved by the parties before entering into the agreement. The important conditions vary in each agreement depending on the facts of the case. Thus, both parties (the buyer and the seller) need to make sure that all the essential conditions are mentioned in the agreement and that the agreement also contains certain important approvals such as:

  • Approval from the bank.
  • Approval from the authorities.
  • Approvals from the third-party, etc.

Failure to specify a “long stop date” in the agreement

There should be a termination date or a date on which the parties will perform their part of the obligation that is arising out of the contract. Thus, if any party delays his/her part of the performance, the other party has the right to terminate the agreement on the long stop date which has been mentioned in the agreement.

Failure to agree on the necessary financial adjustment

In order to protect the interest of buyers, some buyers prefer to add a clause related to post-acquisition adjustments with regard to the price of the asset. After both parties have decided on the terms and conditions of the agreement and performed their part of obligations, the buyer’s accountant checks the net asset value of the organization to verify whether the price paid for the purchase of the asset has been favourable to the organization or not. If it has been found that the price has been paid more than the market value, the buyer can use the clause and get a chance to reconcile the deal.

Failure to specify closing requirements

Sometimes, parties forget to mention the essential closing requirements of an agreement. Such an asset purchase agreement must contain detailed information about the actions to be taken and the submission of Documents after the closing of the agreement.

Failure to protect against competition from the seller

To protect the interest of the buyer, the buyer should insist on adding a non-compete clause in the agreement. A non-compete clause states that the seller will not become a competitor with the buyer in the future.

No effective dispute resolution system

There should be a well-defined dispute resolution mechanism mentioned in the asset purchase agreement. Whenever parties have any arguments related to the agreement, they can use the dispute resolution system to solve the matter between them. The parties can either approach the courts or appoint an arbitrator to resolve the dispute between them. An expert of law will help the parties to resolve their matter effectively without terminating the agreement.

Not hiring lawyers for review, negotiation and drafting of the asset purchase agreements

Drafting a well-structured asset purchase agreement is very important. Thus, parties who are willing to enter into an asset purchase agreement must hire a lawyer to draft, review or negotiate the terms and conditions of an agreement. Hiring a lawyer having expertise and knowledge about relevant laws will help parties cover each and every aspect of the agreement. People who do not hire lawyers for agreement drafting or reviewing regret later if they forget to cover an important aspect of the agreement and which can create a dispute between parties.

Frequently Asked Questions

An event where one party called the seller sells the ownership of an asset to another person called the buyer is called an asset transfer. Here, the buyer can be an individual person or company.

When acquiring an asset, the buyer purchases a defined asset along with the liabilities attached. In the case of purchasing a stock, the buyer buys the whole company along with all the assets and liabilities of the organization.

As the asset transfer agreement is a written and legal agreement, it is binding on both parties to the agreement. Parties are bound to follow all the agreed terms and conditions mentioned in the agreement.

While recording the purchase of an asset, the fixed asset account will be debited for the price at which the asset has been purchased and the cash/loan account will be credited with the same price.

The essential clauses of an asset purchase agreement include the price on which the asset will be purchased, the payment plan along with interest, the right to lien, conditions precedent for the closing, and dispute resolution mechanism, etc.

Most of the parties try to perform their part of performance within 2-3 weeks depending on the type of asset and terms and conditions that have been agreed by the parties.

An income statement contains information about the expenses and revenue of an organization. The asset which has been purchased is of a fixed nature, it does not affect the income statement of an organization.

Earn out clause is beneficial for the seller to avail of benefits even after the asset has been sold. This clause states that if the buyer’s business earns a specific amount of profit, the seller is entitled to get additional payment from the profit earned for selling the asset.

An agreement between the seller and the buyer wherein the sellers transfers the ownership of the asset to the buyer is called Asset Purchase Agreement.

A person is required to use an asset purchase agreement for different purposes. Usually, it is used when parties to the agreement are willing to seek flexibility while entering into a transaction. This agreement is used when parties enter into a joint venture or sale of the business.

Goodwill is an intangible asset and is a premium which is paid over the value of the asset during an asset purchase agreement. It is attached to the company and cannot be sold/brought independently. Other assets such as licenses, copyright, patents, etc can be sold or purchased separately.

The assets that can be transferred in an asset purchase agreement are as follows:

  • Plant and machinery
  • Stock
  • Contracts
  • Premises
  • Know-how
  • Goodwill

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