Don't Bet the Business

Business is nothing if not fluid.  Corporate structures and identities can change likes days on a calendar.  Most often these changes take place for strategic reasons and are benign. 

Sometimes, however, corporations change, through sales or mergers, to avoid future liabilities or obligations. The prosecution or defense of lawsuits involving sales of assets often invite questions over “successor liability.”

Corporations are recognized as separate entities with their own legal identities. Because of this, a corporation is liable for its own debts and no others. However, when corporations are bought and sold, the liability distinction between the buyer and seller can get blurry.

The theory of holding a transferee/ buyer liable for the transferor/seller’s debts is referred to in the law as “successor liability.”  A litigator’s analysis of successor liability begins by examining the nature of the transaction between the transferor/seller (predecessor) and the transferee/buyer (successor). 

If the successor’s acquisition is the result of a corporate merger, with shares of stock exchanged as a result, the successor will generally be deemed to have assumed its predecessor’s debts and liabilities. If, however, a buyer/successor purchases the seller/predecessor’s assets for cash, the successor will not, in most cases, be liable for the predecessor’s debts and liabilities. Exceptions do, however, exist.

Specifically, after an asset sale which normally does not expose the buyer to successor liability, Michigan law recognizes five narrow exceptions:

(1) where there is an express or implied assumption of liabilities;

(2) where the transaction is not labeled as such, but amounts to a consolidation or merger;

(3) where the transaction was fraudulent;

(4) where some part of the transaction lacked good faith, or where the transfer lacked consideration to avoid creditors; or

(5) where the successor was a mere continuation or reincarnation of predecessor.

In very general terms, exceptions one and two often are planned for as part of the underlying transaction. Exceptions three and four typically arise when there is some suggestion or concern that the transfer improperly occurred as a means of avoiding legitimate creditors’ claims. 

It bears noting that this is often a confused area because transfers to avoid potential personal liability are not, of themselves, wrongful.  Indeed, avoiding personal liability is precisely why individuals and entities form corporations or limited liability companies in the first place.

Exception five is the one that is often the most fertile ground for litigation as it typically is latent. Court’s love lists of factors and elements, and the “mere continuity” exception to successor liability is no different. As a plaintiff, to establish a plausible mere continuity claim, the courts will examine to see if:

(1) there is continuation of the seller corporation through a continuity of management, personnel, physical location, assets and general business operations;

(2) the predecessor corporation ceased its ordinary business operations, liquidated and dissolved as soon as legally and practically possible; and

(3) the purchaser assumed the seller’s liabilities and obligations deemed necessary for the uninterrupted continuation of normal operations.

These elements can seem intuitive, but from experience I can confidently declare that these are some of the most contested concepts and set the high-water mark for factual disputes.

Issues surrounding successor liability are typically considered in any asset sale, or at least they should be. However, even after the most careful planning by acquisition experts, successor liability claims can arise; they may even be inevitable.