Successor Liability Actions as a Collection Tool

Nicholas D. Krawec, Esq.

Very little can be as frustrating to a creditor than the situation where a debtor from which you have been trying to collect, supposedly “closes down” but then re-appears as a new company. Think about it. You have probably encountered this situation. You have a claim or a judgment against a commercial debtor, which is purportedly out of business. However, at the same address of your debtor is a (supposedly) new corporation, with the same ownership, the same management, the same employees, engaged in the same line of business. You call the debtor business and the phone answers with the new company’s name. You ask what happened to your debtor company and you are told by the phone receptionist that “we bought them out,” or perhaps “it’s under new management” or “we changed our name” or “that used to be us.” Whatever the purported excuse, you are being stonewalled, and led to believe that your debtor is out of business. Do you have any remedies?

Successor Liability Action
As a general rule, the purchaser of the assets of a corporation ordinarily is not liable for the debts of that corporation. Under this traditional rule, the court will look at the nature of the purchase and sale transaction between predecessor and successor corporations. If the acquisition of the predecessor corporation is accomplished by merger, with shares of the stock in the predecessor corporation serving as consideration, the successor corporation generally assumes all its predecessor’s liabilities. However, where the acquisition is merely an asset purchase (which is what, supposedly occurs in the scenario described above), accomplished by an exchange of cash for assets, the successor is not liable for the predecessor corporation’s liabilities unless one of the following five narrow exceptions applies.

Exceptions to the general rule: The above general rule can be overcome if any of five exceptions to that rule can be established:

1. The purchaser expressly or implicitly agreed to assume liability (which is rare in a collection setting);
2. The “purchase and sale” transaction amounted to a consolidation, or a de facto merger, of the seller corporation and the buyer corporation;
3. The purchasing corporation was merely a continuation of the selling corporation;
4. The transaction was fraudulently entered into to escape liability; OR
5. The transfer was without adequate consideration and no provisions were made for creditors of the selling corporation (in other words, a fraudulent transfer).

The de facto merger doctrine, as an exception to the general rule against liability of the successor corporation, may be applied if there is:

1. Continuity of ownership between the seller and buyer corporations;
2. Cessation of the ordinary business by, and dissolution of, the predecessor/seller corporation as soon as practicable;
3. Assumption by the successor/buyer of liabilities ordinarily necessary for uninterrupted continuation of the business; AND
4. Continuity of the management, personnel, physical location and the general business operation.

The mere continuation doctrine may be applicable if:

1. The purchasing corporation has essentially the same officers and directors as the selling corporation;
2. The purchasing corporation produced and sold the same or similar product or service as the selling corporation;
3. The purchasing corporation used the same facility as the selling corporation;
4. The purchasing corporation hired all individuals previously employed by the selling corporation; AND
5. The selling corporation was dissolved.

In one example of Bernstein-Burkley, P.C. successfully handling a successor liability action, the creditor held a confessed judgment against the “seller corporation” for approximately $1.7 million. The information needed to support successor liability allegations was obtained by depositions of “former” employees of the seller corporation (who also worked for the buyer corporation) and the subpoena of records of a bank whose loan was allegedly assumed by the “buyer corporation” (which disclosed that bank had no records of any such assumption). Sufficient additional pressure was exerted to lead to a $300,000 settlement from daughter of one of the guarantors of underlying debt (who were principals of the seller corporation).

So, a vigilant creditor need not be frustrated by a debtor closing its doors and “re-appearing” as a “new” company. There may be remedies available depending on the facts surrounding the “sale” of the debtor business. Dig into the details!

For more information on successor liability and fraudulent transfer remedies, click here.