What Is the Bulk Sales Law?
The general bulk sales law was enacted in California to protect the rights of creditors. It was adopted in 1933 as a part of the Uniform Commercial Code into California law. Its purpose is to prevent an insolvent debtor from defrauding creditors by creating a sale of assets that looks like an arm’s length transaction, but is really a wind down of the business among friends and family, prior to its filing for bankruptcy.
When a business sells a major portion of its assets within a limited period of time while it continues in business, the general bulk sales law provides a mechanism for creditors whose debts might not be satisfied because the assets were misappropriated from the debtor in a manner that would give those unsecured creditors a priority over the transferees of those assets. Having this protection in place encourages both buyers and sellers of assets to be aware of potential problems arising when they conduct these sales , and to seek ways to protect themselves and their creditors.
Assets such as: machinery, equipment, leases, fixtures, goodwill, supplies, raw materials, or a going concern operation are all defined broadly as business assets to which the general bulk sales law applies. Excluded from its application, however, is real property, which is covered separately under the Bulk Sale Law. California Civil Code Section 672 declares that its purpose is threefold: The member countries of the United Nations adopted the Convention on International Factoring in 1988, which covered cross border factoring. This treaty also incorporated the bulk sale law as a part of the convention’s standard terms. Like other treaties, the language of the convention can be found within the Uniform Commercial Code as adopted by California.
A Look at the California Uniform Commercial Code
The California Uniform Commercial Code (the "UCC") was created to make the process of facilitating commercial transactions easier, more efficient and clearer for buyers, sellers and creditors. The UCC was adopted in California in 1964. The warranty of good title is granted under § 2-312 of the UCC, which says: "(1) Subject to subsection (a) of Section 2-316, a seller who is a merchant regularly dealing in goods of the kind warrants that the title conveyed to the buyer is good, and its transfer is rightful and its claiming any interest therein rightful."
If a seller of items, as additional consideration, warrants that the effect of his transaction is to confer on the "buyer" an interest in the tangible chattels which is superior to that of the "seller’s" creditor, such "sales" would not be governed by the UCC. See Bolton’s, Inc. v. Landsdale Farmers Mut. Fire Ins. Co., 251 A.2d 554 at 558 (Pa. 1969)).
In addition, the UCC makes the distinction between a transfer of the business assets and those of some one or more of the business’s owners. See Waller v. Baetz, 271 N.W.2d 192 (Ct. App. Iowa 1978).
There are certain exemptions, however, to the application of the UCC to bulk sales transactions. One such exemption is for transfers of goods in the ordinary course of business (which includes sales). Another exemption is for transfers to lien creditors. See C.C. § 1021 & § 1025.
Nothing contained in this division shall apply to: (1) A transfer made as security or pursuant to a preferential agreement; (2) A transfer of collateral in a transaction secured by a security interest, or in which a security interest attaches, or the satisfaction of any liability secured thereby; (3) A transfer to the state of California or any officer or agency thereof; (4) A transfer to an (A) Affiliate of the corporation; (B) Subsidiary of the corporation; or (C) Partnership in which the corporation is a partner; (5) A transfer to the United States or any department of agency thereof; (6) A transfer from a decedent to his personal representative under Chapter 3.1, relating to the transfer of a decedent’s trust property, or in the case of property in which his ownership was limited as provided in § 19004(b), to the person or persons under whose management the property is or was held. See C.C. § 1021.
A transfer of property under this division is perfected only by compliance with § 2301. The rights, duties, and remedies of applicants and holders of security interests in transferred property are governed by §§ 9101-9278. However, neither the UCC provisions for regarding bulk sales are intended to interfere with remedies provided by other divisions of this code. See C.C. § 9201.
When Do the Bulk Sales Laws Apply?
It is important to note that the California bulk sales laws apply when the bulk of a business or its assets is sold. A California court has explained that sales of less than the entire stock or assets of a business do fall within the bulk sales laws if the sale is in substance the sale of the bulk. Conversely, when the property sold does not constitute the bulk of the business, the bulk sales laws do not apply.
The bulk sales laws apply when three conditions are met: (1) the seller is a natural person or other legal entity; (2) the property sold is the entire business or the bulk of it; and (3) there is a sale of goods, wares, or merchandise held for sale by the seller. The bulk sales laws apply to the sale or transfer of farm produce only when it is the entire farm or the bulk of it, owned by a farmer. The bulk sales laws do not apply to either the sale of a single parcel or single item of property or to the sale of all the property owned by a single person or entity.
For the bulk sales laws to apply, the bulk or the majority of the value of the business must be transferred. The courts have looked to four factors when determining whether all or a majority of the taxable value of the business has been transferred: (1) the proportion each item bore in relation to the total taxable value of the property; (2) the proportion each item bore to the total value of the consideration given; (3) whether the property was essential to the continuance of the business as a going concern; and (4) whether the property was used in conducting the business.
How to Give Notice to Creditors
The seller must identify and provide written notice to the known creditors of the business, and other creditors need not be notified. The notice is to inform creditors that they have the right to collect any claim, and that if not between formally presented, any amount may be lost and the buyer will be under no obligation to pay anything to the creditor, even if that amount is subsequently claimed to be due.
Notice must be given to all known creditors of the seller, and must be provided at least ten days prior to the date of sale even if the seller believes an offer to purchase the assets may not be accepted until after the ten-day period. If the notice is not given, the buyer is not obligated to assume the debts, and the trustee or receiver may bring an action against the seller or buyer to recover the amount unreasonably withheld as a pledge that the sale is not good and to recover any money received from the sale. An individual’s or business’ failure to comply with the notice requirements may subject them to liability for punitive damages, consequential damages, and attorney’s fees.
The notice must contain both general and specific information regarding the matter. Prior to the sale, a notice statement must be executed and incorporate the following information. It should:
A fictious business name statement must also be filed with the County Clerk.
What Happens If You Don’t Comply with the Bulk Sales Laws?
Failure to comply with California bulk sales laws can lead to a wide variety of legal complications for the parties involved. Such consequences present potential financial risks for both buyers and sellers, as the rejected sale may leave the businesses without sufficient resources to pay creditors.
At its most basic level, buyers do not want to purchase a struggling business under a cloud of potential liability and payments to creditors. In addition to litigation over the validity of the sale, they do not want to get stuck with an unexpected additional tax bill for unpaid sales tax. To avoid these risks, a buyer may withhold payment to the seller until a seller pays the sales tax or provides a waiver or assignment of claims from the state and other grievors. A buyer may buy the business on the spot or contract for "deferred terms , " whereby a buyer agrees with the seller to buy on credit—sometimes with the allowance of an installment payment plan.
The failure of the deal will impact both parties’ relationships with their vendors and creditors of the seller’s pre-sale debts. Many suppliers may key their payment terms based on the relationship with the seller and its ability to pay, not on the financial information from the seller.
Failure by the seller to comply with the bulk sales law can, in addition, lead to civil and criminal liability for the seller, the president, officers and directors, agents and employees of the corporation or other entity, and any other person who knowingly participated in the prohibited sale, including the buyer. While the list of people liable seems quite broad, the buyer is nonetheless at significant risk because it can never know in advance the risk.
What to Do to Comply with California Bulk Sales Laws
To ensure compliance with the California bulk sales laws, buyers should consider the following best practices: Ascertain whether the seller has assets that are the subject of a bulk sale or a sale in the ordinary course of business. Bulk sales generally arise when the seller possesses primarily noninventory type assets, while sales in the ordinary course of business generally arise when the seller possesses primarily inventory-type assets. If bulk sales are the subject of the transaction, the buyer must require from the seller a list of the seller’s creditors and the amount of indebtedness owed to each, including both secured and unsecured creditors and all persons providing assistance in connection with the seller’s business. Evaluate the seller’s notice and publication obligations under the bulk sales laws, and identify which specific notices must be delivered prior to consummating the transaction. Prepare an affidavit or certificate evidencing the seller’s compliance with all bulk sales notice and publication obligations, and require the seller to execute it. Request that the seller provide a copy of the newspaper(s) wherein the bulk sale notice has been published, and confirm that the notice has been filed with the seller’s local tax collector or other governmental office charged with the duty of receiving property taxes. Determine whether the seller has any contingencies to closing the proposed bulk sale transaction. Consult with counsel as necessary to satisfy compliance with the bulk sales laws. Add the bulk sales compliance affidavits to the transaction’s closing documents and require that they be executed prior to closing and/or as a condition to closing the transaction. Record all bulk sales compliance affidavits in the appropriate government offices for the geographical jurisdiction where the seller’s business was located at the time of the sale, and where the assets sold in bulk sales are transferred to the buyer.
Recent Developments and Trends
Recent changes and trends in California bulk sales laws are reflective of a growing trend to hold owners and operators of companies responsible for the debts of those companies. For example, on July 1, 2016, the Department of Business Oversight ("DBO") officially removed the minimum number of days that a notice of bulk sale transaction must be published in a newspaper with general circulation, making it within the DBO’s discretion. Although the statutory requirement is now gone, the DBO has instructed buyers to continue its long-standing practice of maintaining a 10- to 15-day period between publication of notice in a DBO-approved trade journal and completion of the sale.
As of July 1, 2016, the law requires that bulk sale notices must be sent to certain state and county agencies, the Franchise Tax Board, the Employment Development Department, the Division of Labor Standards Enforcement, the State Board of Equalization, the Secretary of State and county tax collector. While the law originally required a 10-day notice period, it has been amended to state that only a "reasonable time" is required.
Since assembly bills 1447 and 1448 went into effect on January 1, 2017, California has redefined the term "bulk transfer" to mean a transfer that is not in the course of the seller’s ordinary business conducted by the seller. Under the statute, "the sale of inventory in bulk to an individual or group of individuals in a single transaction or multiple related transactions" is no longer within the "ordinary course of business," and therefore, is considered a bulk transfer. This legislative change means that all sales of inventory must follow bulk sale procedures.
Conveniently, AB 1448 also eliminates requirements that sellers maintain a file of published and sent notices for up to four years after completion of a bulk sale . This eliminates some of the administrative burden bulk sales places on sellers. But it also may be a harbinger of the belief that bulk sales notifications will no longer be required for property transferred in the ordinary course of a seller’s business.
Finally, there have been several efforts by members of the California Legislature to limit damages for bulk sales buyers who are injured by bulk sales of tainted property. In addition to AB-349, (detailed below), AB 743 and SB 176 seek to limit liability for bulk sales sellers, trustees and assignees to the sale price of the transferred property, or the value assigned to the property by a fact finder in a lawsuit.
Recently, Assembly Bill 349 sought to clarify that a court "shall limit the amount awarded to the sum paid to the seller, not the amount the buyer may ultimately recoup." This statute was introduced to "provide certainty to buyers of businesses, and to create uniformity of the law regarding business purchases under the bulk sales law." The statute was based on the opinion of the California court in FSG Bank v. Digimarc Corp. (2013) 215 Cal. App. 4th 480, 486, a case in which the Court held "The plain language of section 6109 does not support the conclusion that the damages recoverable by a buyer from a bulk sales seller for the seller’s failure to comply with the bulk sales law is the price the buyer paid, plus costs incurred, plus any consequential damages resulting from the untimely payment, but only the price the buyer paid."
The statue’s sponsors were surprised by the widespread opposition to AB 349. Several public interest groups led an extensive campaign against the bill, which resulted in the bill being "shelved" in the Senate Judiciary Committee. California bulk sale law likely will continue to see more case law applications and legislative development.