Successor Liability – Could You Be Held Liable After Buying a Business?

Successor Liability – Could You Be Held Liable After Buying a Business?

Under New York law, the general rule is that a corporation that acquires the assets of another is not liable for the claims of its predecessor...

Under New York law, the general rule is that a corporation that acquires the assets of another is not liable for the claims of its predecessor. However, there are some exceptions to the rule that can result in successor liability. Accordingly, it is important for businesses contemplating a merger or acquisition to understand their potential liability risks.

Successor Liability Under New York Law

For businesses buying another business, the good news is that you will typically only assume those obligations and liabilities expressly agreed to in the asset purchase agreement. However, there are some situations where courts can impose liability.  In Schumacher v. Richards Shear 59 N.Y.2d 239, 244 (N.Y. 1983), the court held that a corporation may be held liable for the torts of its predecessor if:

• It expressly or impliedly assumed the predecessor’s tort liability;
• There was a consolidation or merger of seller and purchaser;
• The purchasing corporation was a mere continuation of the selling corporation; or
• The transaction is entered into fraudulently to escape such obligations.

Notably, the traditional rule of corporate successor liability and the exceptions to the rule are generally applied regardless of whether the predecessor or successor organization was a corporation or some other form of business organization.

Assumption of Liability

The most straightforward case of successor liability is when the agreement between the seller and the buyer provides that the seller will assume certain liabilities. To avoid any potential confusion, agreements should expressly state what liabilities the successor entity assumes and/or the circumstances under which such assumption must occur. Conversely, buyers seeking to avoid any future liability should ensure that the agreement states that the buyer will not be responsible for the seller’s liabilities, and require that the seller indemnifies the buyer for any pre-closing liabilities.

With regard to implied liability, courts have held that the conduct or representations relied upon by the party asserting liability must indicate an “intention on the part of the buyer to pay the debts of the seller.” MBIA Ins. Corp. v Countrywide Home Loans. Inc, 105 A.D.3d 412 (N.Y. App. Div. 2013). However, “where evidence is  introduced demonstrating an intent by the asset buyer to pay the debts of the seller, express disclaimers do not preclude a finding of implied assumption of liabilities.” Under New York case law, “[a] finding of an implied assumption is more likely where the asset seller becomes a mere shell as a result of the sale, creating the real possibility that creditors are left without a remedy.”

De Facto Merger Exception

The “de facto merger” exception is most frequently cited in successor liability claims Under existing New York precedent, “the de facto merger doctrine creates successor liability when the transaction between the purchasing and selling companies is in substance, if not in form, a merger.” As set forth in Martin Hilti Family Trust v. Knoedler Gallery, LLC, 2015 WL 5773895, 17 (S.D.N.Y. 2015), the hallmarks of a de facto merger include:

• Continuity of ownership;
• A cessation of ordinary business and dissolution of the acquired corporation as soon as possible;
• Assumption by the successor of the liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation; and
• A continuity of management, personnel, physical location, assets, and general business operation.

New York courts have clarified that the first criterion, continuity of ownership, exists where the shareholders of the predecessor corporation become direct or indirect shareholders of the successor corporation as the result of the successor’s purchase of the predecessor’s assets, as occurs in a stock-for-assets transaction.

“Mere Continuation” Exception

Another one of the most frequent litigation exceptions to the general rule regarding successor liability is the “mere continuation” exception. Under this exception, the acquirer may be found to be a mere continuation of the seller’s business and, therefore, deemed to have assumed the seller’s liabilities. Factors New York courts will consider when determining whether a corporation is a “mere continuation” of its predecessor include:

• All or substantially all assets are transferred to the successor corporation;
• Only one corporation exists after the transfer;
• Assumption of an identical or nearly identical name;
• Retention of the same corporation officers or directors; and
• Continuation of the same business.

Fraudulent Attempt to Evade Creditors

The Court will also find successor liability if they find a transfer was a fraudulent attempt to evade creditors. In determining whether a fraudulent conveyance occurred, courts look to what has been termed “badges of fraud,” which are, among other factors:

• A close relationship among the parties to the transaction;
• A secret and hasty transfer not in the usual course of business;
• Inadequacy of consideration;
• The transferor’s knowledge of the creditor’s claim and the transferor’s inability to pay it;
• The use of dummies or fictitious parties; and
• Retention of control of the property by the transferor after the conveyance.

Consult Your Lawyer Before You Dissolve Your Corporation

If it appears that your corporation is going to lose a lawsuit, know this before dissolving the corporation.  I sued a corporation that, when the owners decided it was going to lose the case, they dissolved the corporation. I sued them personally and collected. Their mistake: when a corporation is dissolved, it may leave the controlling shareholders of a closely held company open to being sued personally. Dissolving the entity can cause the loss of the protective corporate shield from personal liability.

Key Takeaway

While not the general rule, the purchase of another business can sometimes lead to costly successor liability. Because each case involves unique facts and circumstances, it is imperative to work with an experienced New York business attorney.

If you have questions, please contact us

If you have questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.