Hidden Restaurant Liabilities That Can Bite Long After You Buy

As a prospective restaurant buyer who has spent weeks poring over lease documents, crunching cash flow numbers, and attempting to quantify the value of each brick, mortar joint, and square inch of stainless steel that comprises the business you're buying, you may be tempted to breathe a sigh of relief that the most frustrating work is behind you. Don't let your guard down just yet, though. A few of the fatal traps that often snare would-be restaurant buyers are all but invisible going into the deal. Let's go over a few common liabilities that can potentially rear their ugly heads and bite you long after the deal has closed.

Liability #1: Health Code Violations

The item on this list that will garner the greatest attention if left unchecked is an outstanding heath code violation. If your restaurant incurred an infraction that was left uncorrected while it was under previous ownership or if any undiscovered infraction exists when you close the deal, you as the new owner are fully responsible for correcting it. Any restaurateur worth his salt will want to make sure that the restaurant he's taking over is up to code before he signs the deal.

Many states keep a searchable database of restaurant health scores.¹ Some of those databases even allow you to see specific violations and when they occurred. Scoping out the history of the restaurant you're buying will let you know about recent infractions so you can ensure they've been corrected. Observing patterns of recurring issues can help you better understand your new restaurant's unique challenges and which areas you should focus on when you train staff.

Health departments may see the sale of the business as a good time to require the facilities be brought up to code. Those improvements can vary dramatically in cost, ranging from the purchase of a new ice scoop to installing an up-to-date kitchen hood. Speak with a contractor or inspector before you sign the purchase agreement to find out if anything may need to be updated and consider negotiating with the seller to see if they'll deduct all or part of the cost of those updates from the contract.

Liability #2: Unpaid Overtime

Under the Fair Labor Standards Act, hourly employees are entitled to be compensated for 1.5 times their normal wages² for any hours they work past 40 in a single week. Fleeced employees can file a complaint under the FLSA for unpaid wages earned as far back as two years ago. If employees should make such a claim, even for hours worked before you owned the business, the responsibility to get the issue sorted out will fall on you.

To protect yourself against inheriting a liability for unpaid wages, verify that the previous owner has kept thorough and accurate payroll records for at least the previous two years and that you have access to those records. Having them will help shield you from liability in the event that a claim for unpaid overtime is ever brought against your business.

In addition to workers filing claims for unpaid wages, every business is subject to audits by the U.S. Department of Labor. The federal agency generally focuses on businesses in industries with high employee turnover and lower wages, so virtually any restaurant is a prime target. The first thing the auditors will ask for when they begin an audit is payroll records, giving you an even greater reason to keep those up to date, organized, and accessible.

Liability #3: Unpaid Sales Tax

As with payroll records, keeping up with your tax bookkeeping is key to keeping your business on the right side of the law. It can be difficult to know if the owner of the business you're buying was diligent in keeping sales tax records and passing them on to the IRS, but one thing is critical: If your business owes any unpaid taxes under the previous owner, you may not be off the hook for those when the business becomes yours.

One especially critical thing to root out is whether the IRS or state tax authority has filed a lien³ on the business you're buying. These come from legal action brought against the business for unpaid federal or state taxes. The tax-collecting entity legally owns part or all of a business that has a tax lien against it, and that lien stays when the business changes owners.

In some states, you may request a tax status letter for the business signifying that there are no unpaid taxes. Be aware that obtaining such a letter may require a tax audit, which can extend the time it takes it takes to close your deal, but it may be worth the hassle if it protects you from potential tax liability.

The Solution: An Assets-Only Purchase

The solution to some of these traps may be very simple: buy the assets of the business only. In most cases, when you purchase an entire company outright, you're essentially buying a basket of assets and liabilities, including the many potential liabilities you can't see. By negotiating a contract that leaves you with only the assets of the company, you leave behind many of the liabilities for the previous owner to handle as he dissolves the business.

There are caveats that prevent an assets-only purchase from being a legal cure-all. First, you will need to arrive at a contract that both you and the buyer agree on. A long list of clauses that heap liabilities on the seller may turn him off to the deal, especially if there's a line of other potential buyers behind you with fewer demands.

Be warned that an assets-only purchase won't free you from all the liabilities we mentioned above. For example, if there are any tax or mortgage liens tied to the physical or monetary assets of the company, those will follow the business into your ownership. Make sure those are paid off or settled in a way that's satisfactory to both you and the seller before you close the deal.

Specific laws governing the sale of businesses vary from state to state and each individual deal is unique. If you don't already have a lawyer, now is a good time to find one who can help you polish off the finer points of your business deal to ensure you assume as few risks as possible.

Resources

1. Restaurant Inspections In Your Area. Food Safety News. Accessed January 2022.
2. Wages and the Fair Labor Standards Act. US Department of Labor. Accessed January 2022.
3. How to Buy a Business With IRS Liens. Houston Chronicle. Accessed January 2022.