Expert Advice

By Joseph N. Demko
     
      Commercial Law
      Avoiding Surprises of Successor Liability
      When one business purchases all or most of the assets of another business in California, the buyer is generally not liable for claims against the seller.
      However, there are a few exceptions. Under the doctrine of successor liability, a buyer may be liable for claims based on a seller's actions even though the basis for the claims arose prior to the sale.
      The doctrine is an equitable one, generally decided by a court instead of a jury, although questions may arise if a claim is joined with other actions, such as fraudulent transfer, that may entitle the complaining party to a jury trial. (See, Wisden v. Superior Court, 124 Cal. App. 4th 750 (2004).)
      Express or implied assumption. Successor liability may be imposed when the buyer expressly or impliedly assumes some of the seller's liabilities. Generally, the courts look to the language or absence of language in the purchase agreement to determine this.
      An implied assumption may exist, for example, if there has been express exclusion of some liabilities but not all of them?and there is no disclaimer in the purchase agreement of the assumption of any liability that is not assumed. There is not a great deal of case law on what constitutes an implied assumption. Therefore, great care is needed to explicitly provide for assuming only those liabilities that the buyer intends to assume?along with an express provision disclaiming the assumption of all liabilities, claims, debts, or obligations other than those expressly assumed. Otherwise, the new owner may end up inadvertently taking on liabilities that he or she never intended to assume.
      Consolidation or merger. Successor liability may also be imposed when a transaction amounts to a de facto consolidation or merger of the two companies. Such a merger occurs when one corporation takes all of the other corporation's assets without providing adequate consideration, or when the consideration provided consists wholly of shares of the buyer's stock, which then get distributed to the seller's shareholders in connection with the seller's liquidation.
      In determining whether a de facto merger has occurred, a court will look to a number of factors, including whether: the consideration paid for the assets was solely the stock of the purchasing company; the purchaser continues to operate the same type of business after the sale; the shareholders of the seller become shareholders of the buyer; the seller liquidated after the sale; and the buyer assumed only the liabilities necessary to carry on the seller's prior business.
      Mere continuation. A third exception?when the purchasing corporation is a mere continuation of the seller?focuses on the buyer's acquisition of the assets and the makeup of the companies. (Ray v. Alad, 19 Cal. 3d 22 (1977).)
      For mere continuation to exist, a court looks at whether one or more people were officers, directors, or shareholders of both the purchasing and the selling corporations. In addition, a court will look to whether: the principal assets were acquired, there was a direct sale of the assets, there was an overlap of employees, or the buyer held itself out to customers as a continuation of the seller.
      What appears to distinguish the two exceptions mentioned above is that in the de facto merger situation, there need be no overlap of the buyer's and seller's officers, directors, or stockholders.
      The Ninth Circuit recently held that one factor must always be present for the de facto merger or mere continuation exceptions to apply: the payment of inadequate consideration. (Katzir's Floor & Home Design v. M-MLS.com, 394 F.3d 1143, 115051 (2004).) It therefore appears unlikely that a mere showing of any overlap of business, officers, directors, or shareholders?without a showing of inadequate consideration?will be sufficient in itself to sustain a finding of successor liability based on either the mere continuation or de facto merger exceptions.
      The question of "adequate" consideration can also be problematic. The language in some cases implies, although none of them hold, that cash consideration is required, or that whatever consideration is given must be made available to meet the claims of creditors. (Beatrice Co. v. State Bd. of Equalization, 6 Cal. 4th 767 (1993); Franklin v. USX Corp., 87 Cal. App. 4th 615 (2001).)
      Fraudulent purpose. Finally, successor liability may also apply if the transfer of assets is for the fraudulent purpose of escaping the seller's debts. No recent California cases address this exception. Generally, however, if assets are transferred with the actual intent to hinder, delay, or defraud any creditor?or, if the debtor was insolvent, without receiving reasonably equivalent value?then there can be a finding that a fraudulent transfer took place. (See Cal. Civ. Code § 3439.04.)
     
      Joseph N. Demko (jnd@jmbm.com) is a partner in the San Francisco office of Jeffer, Mangels, Butler & Marmaro, where he focuses primarily on complex commercial litigation.
     

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