Successor Liability – A Primer

It is a general rule in New York, as well as most other jurisdictions, that a corporation that purchases the assets (as opposed to the stock) of another corporation does not become liable for the seller’s liabilities or contract obligations. Of course, many unscrupulous businesses view this rule as a means to escape their financial obligations by transferring their assets to a newly formed corporation owned by the same shareholders and operated by the same personnel, leaving their creditors holding the bag. Fortunately, the theory of successor liability prevents such abuse.

The courts have created four exceptions to the above general rule and will treat the buyer of a corporation’s assets as a mere successor, fully responsible for the seller’s liabilities, where certain conditions are satisfied. Successor liability may be imposed where:

1. The purchaser expressly or impliedly assumes the seller’s liabilities
2. There was a consolidation or merger of the seller and purchaser
3. The purchaser corporation is a mere continuation of the seller
4. The transaction was entered into fraudulently to escape such liability.

A brief discussion of each exception follows.

Express or Implied Assumption of Liability

Although there is no issue where the successor expressly assumes the liabilities of the seller, the more difficult case exists where there is no express assumption of liability, but the purchaser voluntarily pays certain debts of the selling corporation. If, considering the totality of circumstances, the purchaser manifests an intent to assume the liabilities of the seller, the voluntary payment of some debts of the seller may obligate the purchaser to pay all the creditors of the seller.

Consolidation or Merger of Seller and Purchaser

Where there is a consolidation or merger of the seller and purchaser, there is no question the purchaser will be liable for the seller’s debts. However, this liability may also be found where the transaction is not in the form of a merger, but constitutes a merger in substance. The courts will examine four factors to determine if a “de facto” merger has taken place:

1. The continuity of ownership between seller and purchaser
2. Cessation of the ordinary business and dissolution of the predecessor
3. Assumption by the purchaser of the liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation
4. Continuity of management, personnel, physical location, assets and general business operation

Mere Continuation of the Seller

The mere continuation exception refers to the continuation of the seller in a different form, where the asset sale is in effect a form of corporate reorganization. In determining whether to impose successor liability under this exception, courts look to several factors, including:

1. A common identity of directors
2. A common identity of shareholders
3. Where only one corporation exists at the end of the transaction. Where the seller ceases to exist, this is indicative of a corporate reorganization.

Fraudulent Transaction

Finally, where a transaction is entered into fraudulently for the purpose of defrauding creditors, the courts will not hesitate to hold the purchaser liable for the debts of the seller. To determine if successor liability is appropriate, the courts look to the following indicia of fraud:

1. A close relationship among the parties to the transaction
2. A secret or hasty transfer not in the ordinary course
3. A transfer made for inadequate compensation
4. The seller’s awareness of creditor claims
5. The use of fictitious parties
6. The retention of control by the transferor

In sum, although the business indebted to you may have sold off its assets and no longer exists, the possibility of recovery is not eliminated if you can prove that the purchaser of those assets is the successor of the company indebted to you.