Successor Liability

When one business closes, and another takes over.

Owed money by a business, only to have it shut down and reopen with a different name or owners?  It’s time to have a clear understanding of Successor Liability, as what you are owed does not immediately convey to the new company.

The general rule is that a successor entity (or person) is not liable for the debts (or acts or liabilities or obligations of its predecessor. Fortunately, there are exceptions to protect creditors when the business sale is fraudulent and was made for for the purpose of avoiding paying debts.

If there is a pre-existing lien on the assets of a business, such as in a tax lien or UCC filing, a “purchase agreement” won’t take priority over those previous liens. If such a lien exists, you could still have rights to those assets as a creditor.

Or, if the circumstances of their asset purchase can be shown to meet certain exceptions to the general rule, it is still possible that the creditor can recover their debts through successor liability even if what is owed you exceeds the value of the very assets that were sold. In this scenario, a buyer’s potential liability could be infinite. In many states (including Florida), the purchaser is not liable for the liabilities of the seller, except:

1. where the purchaser expressly (or impliedly) agrees to assume such debts/liabilities;
2. where the transaction is really a consolidation or a merger (i.e. the “de facto merger exception”);
3. when the purchasing corporation is merely a continuation of the selling corporation;
4. or where the transaction was fraudulently made in order to escape liability for such debts.

The Agreement Exception

If a Purchase Agreement does not affirmatively state that the purchaser is not assuming any acts, debts, liabilities or obligations, they can be potentially presumed or at least the subject of costly litigation. To prevent this exception from being triggered, the Purchase Agreement should clearly state which, if any, specific liabilities are being assumed. If none, the Purchase Agreement should specifically say this.

The De Facto Merger Exception

The de facto merger exception will trigger if three or more of the following four factors exist for a particular transaction:

1. Is there a continuation of the enterprise?
2. Is there a continuity of shareholders?
3. Has the selling company ceased its ordinary business operations?
4. Has the purchasing company assumed the seller’s obligations?

The de facto merger exception is a common trigger that allows debt collection attorneys to proceed with successor liability cases.

A de facto merger will not necessarily exist, when only two of the four factors exists, especially if it can be shown the purchaser paid fair market value for the assets of the business.

• A “continuation of the enterprise” may be shown if the physical location, assets, operations, management, employees, branding and/or clients are the same (or substantially similar) between the seller and the purchaser.
• A “continuity of shareholders” means substantially the same (or similar) ownership between between the seller and the purchaser. Minor similarities in ownership may not necessarily trigger this factor, but including the seller as a major partner in the new establishment could.
• A “cessation of operations” looks at whether the selling company continued to exist and/or its operations post-sale. If the seller winds up its operations or dissolves shortly after a sale of substantially all its assets, it will trigger this factor.
• Finally, an “assumption of obligations” looks at the obligations necessary for the ordinary course of business. This could include customers, contractors, vendor agreements, leases, specific assets that were acquired, phone numbers, websites and domain names, intellectual property, and so on. If the Purchase Agreement isn’t crystal clear on what obligations are and are not assumed by the purchaser, the purchaser may become liable for all of the seller’s obligations.

The Mere Continuation Exception

The mere continuation exception could be met if

1. only one company remains after the transfer of assets, and
2. there is an identity of stocks, stockholders and directors between the two companies.

This will generally occur when the owners of the selling company maintain a significant ownership stake in the purchasing company.

The Fraudulent Transaction Exception

The purchaser of a company can be liable for the debts and obligations of the selling company, if it’s determined the asset sale was made in an attempt to escape such debts and obligations. This can arise, when ownership in the purchasing company is awarded to the seller’s owners, as payment (or consideration) for the assets. To avoid this exception, stock in the purchasing company can be awarded to the seller itself, not the individual owners, which will help to keep the selling company solvent for the benefit of outstanding debtors and creditors.

How a Purchaser Becomes Liable for a Seller’s Obligations

Purchasers can be liable for old debts and obligations of the selling company in several ways.

Outstanding Liens. In particular, liens (UCC and tax liens) on assets the purchaser thinks it acquired will have superior rights over the purchaser, if the purchaser acquired those assets after the liens have been properly perfected (i.e. filed).

Triggering an Exception to Successor Liability. If the facts and circumstances meet one of the exceptions (as discussed above), the debts, liabilities and/or obligations of the selling company can come back to haunt the purchaser. This is often the case with unpaid state sales and gross receipts taxes.