Buying a Business, Not the Company: The Legal Challenges

Authors: Kurt Hyzler, Emma Marie Sammut & Pamela Dingli

A buyer can acquire a business in one of two ways: by acquiring the company that owns it, or by buying the business itself from that company.

Buying the shares is the more traditional route. By acquiring the company, the buyer takes on everything that comes with it, including its contracts, its people and its history, warts and all. Buying the business instead allows the buyer to cherry-pick the assets, customers and contracts it wishes to acquire, while leaving most of the seller’s legacy issues behind. This flexibility, however, comes with its own legal challenges.

A. Identification of the required assets

Deciding to buy the business is not enough on its own. The buyer needs a thorough understanding of the assets it must acquire from the seller in order to run the business, and must identify, at the due diligence stage, which of the seller’s assets will form part of the transaction. Unlike on the acquisition of a company, anything not included in the asset schedule stays with the seller.

At the same stage, the buyer should confirm that the seller owns the identified assets, that they are freely transferable and that they are free from encumbrances. Encumbrances securing liabilities of the seller that are not being transferred should be released, and their release made a condition to completion.

Many assets, however, are of little value unless they are underpinned by agreements, such as the premises lease, software licences, supplier and customer contracts and regulatory permits. So, while identifying the assets needed to operate the business is crucial, determining which agreements must be transferred alongside them, and whether they can be, is equally important.

These agreements do not always transfer freely, whether because of their own terms or because of the law governing them. While the benefit of a contract can generally be assigned, its obligations cannot be transferred without the counterparty’s consent, and many contracts require consent for any assignment. The counterparty may use this opportunity to renegotiate the contract’s terms. In other cases, the contract or the law itself may prohibit assignment outright, particularly where the rights concerned are personal to the original contracting party, having been granted in consideration of that party’s identity. Licences, particularly regulatory licences, are a common example: they are often personal to the holder and cannot be transferred at all, in which case the buyer may need to apply for its own licence, with a possible impact on the deal timetable.

B. Identification of the required services

The buyer should also determine which services the business needs in order to operate independently of the seller and its group, such as IT, payroll, finance, HR and shared supplier arrangements. Once these services are identified, the buyer can decide, for each one, whether:

1. the buyer or its group can provide the service from completion, in which case the seller’s existing arrangements for that service can be terminated;
2. a transitional services agreement (TSA) is needed, under which the seller continues to provide the service for a limited period until the buyer has its own arrangements in place; or
3. a third-party provider should be appointed.

C. Liabilities

In a share acquisition, the buyer acquires the company together with all of its assets and liabilities, whether known or not. In a business acquisition, by contrast, the buyer acquires only the business, together with the assets and agreements it needs to operate it.

The same selectivity applies to liabilities. Liabilities relating to the business are traditionally taken on by the buyer, but there is no strict requirement for this, save for obligations under the employment contracts of the transferring employees, which pass to the buyer by operation of law (see Section D). The parties are therefore free to agree which liabilities the buyer assumes and which remain with the seller. The asset purchase agreement should set this out clearly in lists of assumed and excluded liabilities, supported by an indemnity from the seller for the excluded liabilities.

Before completion, the buyer should carry out financial, tax and legal due diligence to determine which liabilities actually relate to the business, so that it does not assume debts unconnected with it, such as debts incurred by the seller in relation to another business.

D. Employees: no picking and choosing

While a buyer of a business can choose which assets to acquire, it cannot necessarily do the same with employees. In practice, the outcome is similar whichever route is taken.

On a share acquisition, the employer does not change. The employees stay employed by the same company, and their employment continues on the same terms, with their seniority and their protection under the general rules on unfair dismissal and redundancy intact. A change in the company’s shareholders, even a change of control, is not a transfer of an undertaking, because the employer’s legal personality remains the same.

On a business acquisition, much the same result is reached by operation of law. Council Directive 2001/23/EC (the “Directive”), implemented in Malta by the Transfer of Business (Protection of Employment) Regulations (S.L. 452.85), protects employees’ rights whenever an undertaking, business or part of one is transferred to another employer. In other words, it applies wherever the person responsible for running the business, and who owes the obligations of an employer to its staff, changes.

When is there a transfer?

The test is whether an economic entity, meaning an organised grouping of resources pursuing an economic activity, is transferred and retains its identity. A transfer may take place through more than one transaction, and whether or not any property passes from transferor to transferee. What matters is whether the identity is maintained.

The courts assess this by weighing all the circumstances. In Spijkers (Case 24/85), the Court of Justice of the European Union (“CJEU”) listed the relevant factors: the type of business, whether tangible assets are transferred, the value of any intangible assets, whether the majority of employees are taken over, whether customers are transferred, how similar the activities are before and after the transfer, and how long, if at all, they were suspended. No factor is decisive on its own, and the type of business determines how much weight the others carry.

The CJEU distinguishes between activities based essentially on manpower, such as cleaning or security, and those based essentially on assets. In Süzen (Case C-13/95), it held that losing a service contract to a competitor is not, on its own, a transfer. In a labour-intensive business, however, the entity may retain its identity where the new employer takes over a major part of the workforce, in terms of both numbers and skills. In Klarenberg (Case C-466/07), the CJEU added that the transferred part does not need to remain a separate unit within the buyer’s business. It is enough that the functional link between the transferred resources is preserved and allows the buyer to pursue the same or a similar activity. Any other approach would let buyers avoid the Directive simply by integrating what they acquire.

Maltese courts follow the CJEU’s approach. In Maria Norma Abela vs Pater Holding Company Limited et (App. 32/2007), the Court of Appeal identified three elements of a transfer: the activity continues as an economic entity, a new person replaces the one previously running it, and the activity is retained. In Antoinette Farrugia vs Optical (CCSG) Co. Ltd and Classic Group (App. 16/2018), the Court held that a transfer had taken place even though the new operator had taken a fresh lease directly from the landlord and shared no directors with the outgoing one. The new operator carried on the same activity, the sale of eyewear, from the same premises, took over part of the stock and furniture, and benefited from the goodwill its predecessor had built up.

In short, the question is whether what the buyer ends up with is recognisably the same business, still running in the same way, under a new owner.

What happens if there is a transfer?

The employees assigned to the business move across automatically to the buyer on their existing terms and conditions, with their continuity of service preserved. Each contract of employment takes effect as if it had originally been made with the buyer, and the seller’s rights and obligations under those contracts pass to the buyer. The seller does not walk away entirely, however. It remains responsible for settling whatever is due to the employees up to the date of the transfer. Article 3(1) of the Directive allows Member States to make the transferor and transferee jointly liable for obligations that arose before the transfer, but the Maltese legislator has not taken up that option. Any dismissal by reason of the transfer is unlawful unless it is justified by an economic, technical or organisational reason entailing changes in the workforce. Changes to terms of employment made because of the transfer are equally open to challenge.

This makes employee due diligence essential. The buyer will need to establish:

1. Which employees transfer. These are all the employees assigned to the business, or part of the business, being transferred. Ultimately, whether a transfer has taken place, and therefore whether their employment continues with the buyer, is for the courts to decide.
2. What the buyer is taking on in resprect of those employees, namely:
   • any dues owed to them up to the date of transfer, which the seller must settle by the next pay date following the transfer. Although Maltese law does not make the buyer jointly liable for these, the buyer is still exposed in practice. Accrued entitlements, such as leave and length of service, travel with the employees. A dispute that was already pending may well be pursued against the buyer as the new employer. The buyer should therefore identify any such claims during due diligence and protect itself with a specific indemnity from the seller, backed where appropriate by a retention from the purchase price; and
   • their terms and conditions of employment and accrued entitlements. The seller must provide this information to the buyer within five working days of the buyer being identified, or by the date of transfer if earlier.

Finally, both parties must inform and consult the employees’ representatives before completion. Where the seller has more than twenty employees, the seller and the buyer must deliver a written statement to the representatives of their respective affected employees. It must set out the date and reasons for the transfer, its legal, economic and social implications, and any measures envisaged in relation to the employees. The statement must be delivered at least fifteen working days before the transfer, or before the employees are directly affected if earlier, and a copy must be sent to the Director of Industrial and Employment Relations on the same day. Where the transfer affects the employees’ conditions of employment, consultation must begin within seven working days of the representatives being notified.

E. Intellectual property

On a share acquisition, the company’s intellectual property (IP) generally stays where it is: the company continues to own its trade marks, software, know-how and data, so nothing needs to be transferred. The exceptions are IP used by the business but held by another company in the seller’s group outside the transaction perimeter, which will need to be transferred or licensed, and IP licensed to the company, which may be subject to change-of-control clauses.

On a business acquisition, by contrast, each item of IP must be identified and transferred individually. Anything left out of the transfer documents stays with the seller.

The buyer should check that the seller actually owns the IP it is selling (work by contractors, unlike most employee work, may never have been assigned to it) and that registered rights are assigned in writing and the change of ownership recorded.

Where the assets being acquired include customer databases, the transfer is likely to involve the processing of personal data. It must therefore comply with the GDPR, and the buyer must be able to use the data lawfully after completion.

F. Tax treatment

As with any transaction, the parties will want to ensure that their tax position is properly structured. Here too, the choice between buying the company and buying the business makes a real difference. A share acquisition involves a single taxable event: the transfer of the shares. A business acquisition, by contrast, is a series of transfers, and each class of asset carries its own tax treatment. The tax analysis must therefore follow the asset schedule, asset by asset.

Transfer of shares in a Maltese company

Gains on the transfer of shares in a Maltese company are, in principle, subject to income tax in Malta, whether the seller is resident in Malta or not. Maltese resident companies are taxed at 35% on their worldwide income, subject to any available exemptions. The most relevant of these is the participation exemption, under which a Maltese resident company may elect to exempt gains on the sale of qualifying shareholdings. Non-resident sellers may also be exempt from tax on such gains in certain cases.

A share transfer falls outside the scope of VAT. The buyer, however, will generally pay stamp duty at 2% or 5%, depending on whether immovable property is involved, on the higher of the price and the market value of the shares. No duty is payable where one of the parties qualifies for a stamp duty exemption determination.

Transfer of a business

On a business acquisition, the tax position depends on what is being transferred. Two classes of asset illustrate the point.

Intellectual property. A gain on the transfer of IP is a capital gain and is subject to income tax in Malta. Transfers within a group, that is, between Maltese group companies or companies directly or indirectly owned by the same shareholders, may be exempt in certain cases. A transfer of IP does not attract stamp duty, but VAT may apply. It is generally treated as a supply of services between taxable persons and is, in principle, subject to Maltese VAT at 18%. Where the buyer intends to carry on the same line of business as the seller, however, the transfer may qualify as a transfer of a going concern (“TOGC”) and fall outside the scope of Maltese VAT. Whether it qualifies depends on several factors, so the point should be confirmed early.

Immovable property. Real estate attracts both income tax and stamp duty. The seller is generally subject to property transfers tax (“PTT”), a final withholding tax charged on the transfer value rather than on the profit. The standard rate is 8%, although in some cases the rate ranges from 5% to 10%. A non-resident seller that proves it is tax resident in another country may fall outside the PTT system, in which case the ordinary rules on capital gains apply instead. Intra-group transfers may also be exempt if the relevant conditions are met. The exemption, however, is a deferral rather than a waiver: the tax becomes due if the property is later transferred out of the group. The buyer, for its part, generally pays stamp duty of 5% on the higher of the price and the market value of the property.

Finally, because each asset is taxed separately, the asset purchase agreement should allocate the purchase price across the assets being transferred. That allocation drives each tax computation, and the parties’ interests in it will not always coincide.

G. Hardening period

Under article 303 of the Companies Act (Cap. 386), any transfer or other disposal of property made by a company within six months before its dissolution is deemed to be a fraudulent preference against its creditors if it constitutes a transaction at an undervalue or gives a preference. This applies whether the transfer was gratuitous or onerous, unless the buyer proves that it did not know, and had no reason to believe, that the seller was likely to be dissolved by reason of insolvency. If the seller is then dissolved by reason of insolvency, the transfer is void.

It is therefore important to ensure, and to be able to show, that:

1. the seller can continue to operate, or at least meet its obligations, without the business;
2. the consideration paid is at least equal to market value, ideally supported by an independent valuation; and
3. the liabilities remaining with the seller do not leave it de facto insolvent.

To mitigate these risks, the asset purchase agreement should contain adequate warranties and indemnities, covering in particular the seller’s solvency. Since the seller may be left with few assets once the business is sold, or may even be dissolved, the buyer could consider obtaining a guarantee from the seller’s shareholder covering the seller’s obligations under the agreement, including repayment of the purchase price should the transfer be declared void. Alternatively, or in addition, part of the purchase price could be held in escrow or retained for an agreed period as further security. Finally, as part of its financial due diligence, the buyer should seek comfort on the seller’s forecast financial position after completion.

H. Other considerations

As with share acquisitions, buyers should also consider merger control and foreign direct investment (FDI) screening before acquiring a business. Both may need to be built into the transaction timetable and the conditions to completion in the asset purchase agreement.

Conclusion

Buying a business rather than a company gives the buyer a degree of flexibility over what it acquires, but this flexibility comes at a price. A business that once existed within a single legal person is removed from its ecosystem and placed in another. It is therefore incumbent on the buyer, for the continued success of the business, to ensure that all the connecting parts fit into their new environment.

Those connecting parts are the issues discussed above: the assets and the agreements that make them work, the employees who run the business, the IP and data it relies on, and the group services that kept it running. Each must be identified and then transferred or replaced. Just as important is what the buyer leaves behind. Liabilities and encumbrances that do not belong to the business must stay with the seller, and the seller must remain solvent enough for the transfer to withstand scrutiny during the hardening period.

None of this can be left to the negotiating table. The connecting parts are best identified and mapped at the due diligence stage, and the findings reflected in a carefully drafted asset purchase agreement and supporting documents. Done properly, this allows the buyer to secure the business it wants, with everything it needs to operate, while leaving behind the legacy issues it set out to avoid.

This article is for general information only and does not constitute legal advice.