Asset Purchase Agreement (APA)

An asset purchase agreement is the definitive contract for buying a business by buying what it owns, rather than the corporation that owns it. The seller is the operating entity, usually a corporation, and its shareholders often join as principals to give representations, a non-compete and sometimes a guarantee of the seller's indemnity. The buyer is frequently a new corporation set up for the purchase.

The buyer chooses what it takes. Each category of purchased assets is described in a schedule, and everything else stays with the seller, including the corporate entity, its tax history and every liability the buyer does not expressly assume. That selectivity is why buyers favour asset deals, and why an APA has drafting tasks a share purchase agreement does not: transferring contracts one by one, dealing with each employee, handling HST and allocating the price among the assets. Our free asset vs. share sale checker compares the two structures, and our guide to letters of intent, term sheets and purchase agreements shows where the APA fits in the deal timeline.

Where an Ontario corporation sells all or substantially all of its property other than in the ordinary course of business, subsection 184(3) of the Business Corporations Act requires shareholder approval by special resolution, and dissenting shareholders can be entitled to be paid fair value for their shares. The APA makes that approval a condition. Our article on shareholder approval for an asset sale explains when it applies.

The asset schedules are the heart of the APA. A typical sale of an operating business lists:

• equipment, vehicles, furniture and leasehold improvements, usually by serial number;
• inventory, counted on the closing date with the price adjusted to the count;
• the customer, supplier and other contracts being assigned;
• intellectual property, including trademarks, domain names, software, websites and social media accounts;
• transferable permits and licences;
• books, records, customer lists and telephone numbers; and
• goodwill, including the right to carry on the business under its name.

Excluded assets are listed just as carefully: cash, accounts receivable if the seller keeps them, tax refunds, the corporate minute book, insurance policies and any personal assets of the owners.

The second essential schedule lists the liabilities the buyer assumes. In a well-drafted APA the list is short and specific: obligations under the assigned contracts arising after closing, customer deposits for which the buyer receives a price credit, and perhaps accrued vacation pay for employees the buyer hires. Everything else is an excluded liability, including taxes for periods before closing, debts, litigation, claims about goods or services supplied before closing and the seller's obligations to employees the buyer does not hire. The seller indemnifies the buyer if anyone asserts an excluded liability against it.

Leaving a liability behind in the contract does not always stop it following the business. Two examples matter in most Ontario deals:

• Employee service. Under section 9 of the Employment Standards Act, 2000, if the buyer employs a seller's employee, the employee's service with the seller counts as service with the buyer for the Act's purposes, unless the buyer hires the employee more than 13 weeks after the earlier of the employee's last day with the seller and the day of the sale.
• Security interests. Under Ontario's Personal Property Security Act (PPSA), a security interest generally continues in collateral that is sold unless the secured party authorized the sale free of it, and only a buyer in the seller's ordinary course of business takes goods free of it. A buyer of a whole business is not one, so an undischarged registration follows the assets. The APA therefore requires each creditor shown on a PPSA search to discharge its registration or release the purchased assets at closing, usually paid from the proceeds.

Ontario repealed its Bulk Sales Act on March 22, 2017, so no statutory bulk sales procedure protects the buyer against the seller's creditors. The protection is due diligence, searches and discharges, pricing and an indemnity backed by a holdback, not the excluded liabilities clause on its own.

Contracts do not transfer automatically. The benefit of a contract can usually be assigned unless the contract prohibits assignment or requires consent, and many commercial contracts do. The burden cannot be transferred at all without the other party's agreement, so where the seller's obligations must move to the buyer, the parties need a novation, a three-party agreement substituting the buyer for the seller. Consents from key customers and suppliers are usually closing conditions, and the APA says what happens to a contract whose consent does not arrive: the price may be reduced, or the seller may hold the contract for the buyer's benefit until consent is given.

The premises lease is often the most important consent. Most commercial leases require the landlord's consent to an assignment, and landlords commonly ask for financial information about the buyer and a guarantee from its principals; see lease assignment vs. sublease.

Employees are the other major difference from a share deal. The buyer decides whom to offer employment and on what terms, and the seller remains responsible for those not hired, including their entitlements under the Employment Standards Act, 2000 and any greater common law entitlement. Offers to hired employees usually recognize prior service, since section 9 already counts it for statutory purposes. The successor employer entry covers these rules.

An asset sale is a taxable supply for HST purposes unless an election applies. Under the section 167 election in the Excise Tax Act, the seller and buyer can jointly elect that no GST/HST is payable where the buyer acquires all or substantially all of the property needed to carry on the business, which the CRA generally reads as 90% or more. The election is not available if the seller is a registrant and the buyer is not. A registrant buyer files Form GST44, or uses the CRA's online election service, with its GST/HST return for the reporting period in which the acquisition occurred.

The APA also allocates the price among the assets. Section 68 of the Income Tax Act lets the CRA substitute a reasonable allocation if the parties' figures are not reasonable, so both sides should fix the allocation in the APA and report it consistently. Their interests pull in opposite directions: the seller generally prefers more of the price allocated to goodwill, which is generally taxed as a capital gain, and less to depreciable equipment, where proceeds above the undepreciated capital cost, up to the original cost, are recaptured as income; the buyer prefers inventory and equipment, which it can deduct faster. The purchase price allocation entry explains the mechanics. If owned real property is included, land transfer tax also applies.

Sofia Marchetti owns all the shares of Marchetti Landscape Services Ltd., an Oakville company with 16 employees and three municipal maintenance contracts. Kwame Mensah incorporates a new company to buy the business for $1.6 million under an APA, allocated $540,000 to equipment and vehicles, $45,000 to inventory and $1,015,000 to goodwill and customer contracts.

The APA excludes the company's cash and $210,000 of receivables, which Sofia's company collects itself, and a dispute with a former customer stays with the seller as an excluded liability. A PPSA search shows the bank's general security agreement, which is discharged at closing from the proceeds. As sole shareholder, Sofia signs a special resolution approving the sale.

Two of the three municipal contracts are assigned with consent before closing. The third, worth about $90,000 a year, is not, and under an agreed mechanism the price drops by $75,000 to $1,525,000, taken off the goodwill and customer contracts allocation. Kwame's company offers jobs to 14 of the 16 employees on terms that recognize their prior service, and Sofia's company pays the other two their termination entitlements. Both companies are HST registrants and the buyer takes everything needed to run the business, so they make the section 167 election and the buyer files it with its return for the period. That spares the buyer from paying about $198,000 of HST at closing and waiting to recover it as an input tax credit. Sofia's company then pays tax on the sale and distributes the after-tax proceeds to her.