Developing a Claim of Successor Liability-A Practical Guide to Recovery When Your Primary Target Defendant Has No Seizable Assets
April, 2005
by Michael S. Errera and Dean S. Rauchwerger
CM partner Dean Rauchwerger and associates Michael S. Errera and Cheri L. Baden have authored a practical guide on the alternative liability theories of successor liability and alter ego/piercing the corporate veil to pursue when a target defendant corporation no longer has recoverable assets. This article focuses on successor liability.
I. Hypothetical
Manufacturing company, Damaged Property, Inc., purchases a grinding machine from Predecessor, Inc., for use at its plant. Two years later, a belt comes loose in the machine, generating enough friction to cause the machine to start a fire, resulting in extensive damage to the plant and business interruption. An investigation reveals that the machine had a manufacturing defect. Damaged Property, Inc. wishes to recover its losses from Predecessor, Inc. However, Predecessor, Inc. is no longer in business, but a related corporation that purchased its assets, named Successor, Inc., was formed to continue its operations.
II. The Challenge
The company that caused the loss is no longer in existence (i.e., insolvency, merger, buy-out, etc.) and a new corporation with similar products, shareholders, assets and members is now in place.
III. Traditional Rules and Concepts
Historically, a successor company that purchased assets, unlike a stock purchase, was not liable for the debts and liabilities of its predecessor incurred prior to the transfer. The rule is intended to, among other things, protect the rights of persons involved in the corporation not directly involved with, or who were opposed to, the successor corporation's acquisition as well as mere transferees of assets who have no responsibility for the prior conduct of the transferor corporation. Where there was some acquisition of a company by way of a merger, with shares of stock given for consideration, the successor would assume the liability of the predecessor. Under the asset purchase scenario, exceptions still exist where the successor entity may be liable for the transferor's conduct.
IV. Theories of Recovery
A. Mere Continuation
The “mere continuation” theory focuses on the continuity or common identity of the directors, officers and shareholders from the predecessor corporation to the successor corporation. Courts also consider the asset purchase between the two companies and whether all or most of the assets were purchased and whether the seller of the assets went out of business shortly thereafter.
B. Continuity of the Enterprise
The “continuity of the enterprise” theory is an expansion of the “mere continuation” theory, with a particular focus on the similarity of the business operations. Several factors are in play: 1) continuation of the enterprise (key people of the predecessor are involved in the new entity, the same name, location, facilities or product is used, the assets were bought by the new entity and the operations are the same); 2) the seller dissolves or ceases doing business after the sale; 3) the purchaser assumes the liabilities and obligations ordinarily necessary to continue doing business; and 4) the new entity holds itself out as an effective continuation of the seller.
C. Product Line Doctrine
The “product line” theory focuses on the similarity of the finished manufactured product by the new company and the old entity. This theory is applied when a new company continues the output of the predecessor's line of products, and, as a result, the new entity assumes strict liability for the same product line previously manufactured, if the right of action against the predecessor company is no longer available. The minority view is that the predecessor was not required to have been manufacturing the product, only that the new company had to be in the same or similar general business as the predecessor. Some courts leave the determinative factors to consider to the legislature, while others have crafted their own tests. Activist courts generally consider: (1) if all of the assets were acquired, which leaves nothing but a corporate shell of the predecessor company; (2) if the new entity holds itself out to the public as a continuation of the predecessor by producing some of the product line under a similar name; and (3) if the successor company is benefiting from the goodwill (i.e., reputation) of the predecessor.
V. Checklist: Evidence to Consider & Areas of Inquiry for Imposing Successor Liability
1. What is the relationship between the predecessor and successor? Identify: 1) former business relationship or dealings between the entities, 2) all agreements entered into by the two entities, particularly clauses relating to the assumption of risk and/or liabilities, and 3) assets of the successor that may be used to secure loans of the predecessor.
2. Was there an asset purchase that took place? Determine: 1) when the asset purchase occurred and what the facts were surrounding it, 2) if all or only a portion (including accounts receivable, furniture, equipment, etc.) of the assets were transferred, 3) the amount of consideration that was paid to the predecessor for its assets, who paid it and whether that consideration was stock or cash, and 4) the financial status of the predecessor at the time of the sale.
3. What happened to the predecessor company? Determine: 1) if the predecessor is still in business. If it is not, determine if it dissolved at the time of the sale, and 2) if there was any overlap in the business conducted by the predecessor and that of the successor corporation.
4. Are predecessor employees now with successor company? Identify: 1) shareholders and owners of each entity, and 2) common officers, directors, managers and employees.
5. Does the successor company engage in the same business as the predecessor? Determine whether: 1) the same product is produced, 2) the same inventory is used and/or ordered by the successor, 3) the same type of clientele is being served by the successor, and 4) there was any overlap in the operations of the entities.
6. Does the successor company hold itself out as the same company as the predecessor? Determine whether: 1) marketing materials state the date the successor's business is claimed to have started or the number of years claimed to have been in business to see if there was overlap, 2) the successor uses the same building, trade name, patents, mailing address, letterhead, telephone or fax number, lease, equipment, etc. as the predecessor, and 3) the successor resumes contracts previously established with any of the predecessor's clients and whether the clients were notified of any change in ownership.
7. Does the successor company take advantage of the goodwill and reputation established by the predecessor? Determine: 1) any common clients between the entities or customer lists that exist for both entities, and 2) if any clients of the predecessor were being served by the successor prior to its establishment.
8. Does the successor entity have independent duties to warn of product hazards produced by the transferor entity? Determine: 1) the existence of continued maintenance or service agreements for the predecessor's products, 2) the successor company's knowledge or notice of product defects or hazards and 3) the extent of the ongoing relationship between the successor company and the predecessor's customers or end users.
If you are interested in receiving a copy of this practical reference guide and/or an in-house seminar, please contact CM partner Dean Rauchwerger (drauchwerger@clausen.com).•
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