Thursday, February 25, 2021

Avoiding New York's Successor Liability Pitfalls

In my current practice, I have had to wrestle with different kinds of business law issues. wrestled with the pitfalls of New York's laws concerning successor liability. A client had been sued along with prior entities from which it had purchased assets only, and it was my job to advise them on defending that claim. Asset purchase agreements can be extremely tricky, especially an unclear asset purchase agreement. 

Poorly drafted or unclear asset purchase agreements could potentially expose an asset purchaser to litigation under a theory of successor liability. Although the general rule in New York is that a corporation which acquires the assets of another is not liable for the torts of its predecessor," (Schumacher v Richards Shear Co., 59 NY2d 239 [1983]), there are, as always, exceptions.  

Here is my general discussion from a past blog post back in 2016:

 When buying or selling a business or any of a business's assets under New York law, potential successor liability of the buyer is a primary concern.

Successor liability means liability that the buyer of a business’s assets may have for the acts or liabilities of the seller of those assets performed prior to the purchase. Essentially, a buyer would be compelled to pay off debt that the seller accumulated prior to completion of the transaction. The general rule in New York is that the buyer of a business’s assets does not assume and is not liable for the seller’s liabilities unless otherwise expressly stated in the purchase and sale agreement.

However, there are exceptions:

1. Express or Implied Assumption by Buyer. This exception requires that either the asset purchase agreement explicitly states on its face that a buyer assumes some or all of the seller’s liabilities or that some action by the buyer implies an intention to assume the seller's liabilities in whole or in part. However, the opposite is also true. Express language in the agreement stating that a buyer will not be responsible for seller’s liabilities indicate no express or implied assumption of Seller’s liabilities. Thus, it is important to any buyer of business assets in New York make a clear writing about assumption of seller's liabilities.

2. De Facto Merger Doctrine. Under New York Law, the "de facto merger doctrine" creates successor liability when the asset purchase is a merger in substance, if not in form. A court will find successor liability under the de facto merger doctrine when:

the owners of the seller continue operations as the owners of the buyer; 

the seller discontinues its operations or dissolves soon after completion of the the asset sale;

the buyer assumes liabilities necessary for the uninterrupted continuation of the acquired business's operations; and 

there is substantial continuity of the seller’s management team, physical location, assets and general business operation.

3. Fraud. Courts look for some indication of fraud to determine whether a transfer of business assets was a fraudulent attempt to evade creditors. Examples that would lead a court to find a fraudulent intent include finding a close relationship among the parties to the transaction, inadequacy of consideration, the use of dummy or fictitious names, or a secret or hasty transaction not in the usual course of business. 

The best protection from successor liability is a clearly drafted agreement written by experienced business attorneys who know the applicable law in the jurisdiction.

Not soon after writing this blog, I had to delve even further into the intricacies of the law concerning successor liability. So I figured that I would share some of that knowledge for the wonks out there like me. 

Here are some cases of note on the factors described above that may constitute a de facto merger, here are a few: 

Fitzgerald v Fahnestock & Co., 286 AD2d 573, 574, 730 NYS2d 70 (1st Dept. 2001), citing Sweatland v Park Corp., 181 AD2d 243, 245-246, 587 NYS2d 54 (4th Dept.1992); 

Van Nocker v A.W. Chesterton, Co. (In re N.Y. City Asbestos Litig.), 15 AD3d 254, 255-256, 789 N.Y.S.2d 484 (1st Dept 2005)

Continuity of ownership is a central factor in determining whether a de facto merger occurred. It exists where the owners of the predecessor company become direct or indirect owners of the successor corporation as the result of the successor's purchase of the predecessor's assets, such as where the parties to the transaction "become owners together of what formerly belonged to each." Cargo Partner AG v Albatrans, Inc., 352 F3d 41, 47 (2d Cir 2003) [applying New York law].  

Where assets are sold for cash, and no basic, fundamental change occurs in the relationship of the stockholders to their respective corporations, and absent continuity of shareholder interest, the two corporations are strangers, both before and after the sale, then no de facto merger is said to occur. Subramani v. Bruno Mach. Corp., 289 A.D.2d 167, 736 N.Y.S.2d 315 (1st Dept. 1992) citing Travis v Harris Corp., 565 F2d 443, 447 (7th Cir 1977).  Even when an assignor dissolves in contravention of the sales agreement, courts have not found a de facto merger. 

There are plenty of decisions that hold what a de facto merger is not. 

Use of workers and physical plant shows neither a de facto merger with nor a mere continuation. Subramani, 289 A.D.2d at 168 (N.Y. App. Div. 2001)

The Court of Appeals has rejected the so-called “product line theory” of successor liability in Schumacher (See: 59 N.Y.2d at 245).  

Adoption of such a theory would be "a radical change from existing law implicating complex economic considerations better left to be addressed by the Legislature." City of New York v. Charles Pfizer Co, 260 A.D.2d 174, 176, 688 N.Y.S.2d 23 (1st  Dept. 1999); see: Restatement [Third] of Torts: Products Liability § 12, comment b, and note thereto. 

I could go on, but I am boring myself this point!  If anyone has any further questions on the law,, or if this issue of successor liability is one that your business is confronting, drop a line and let's discuss it further. 

Gene Berardelli is a street-smart attorney with with over fifteen years of experience in civil and commercial litigation. Gene has achieved several career achievements, including successfully settling a seven-figure personal injury claim, successfully arguing before the New York State Appellate Division and successfully representing clients in trial litigation, mediations and arbitrations against such recognizable entities as the City of New York, New York City Transit Authority, JPMorgan Chase, TD Wealth Management Services, Inc., The Long Island Railroad, and Macy*s. Gene is also a noted New York Election Law expert who has had his opinions cited in scholarly works and published in news and feature articles.


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