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Successor and Alter-Ego Liability
This document summarizes a presentation on successor and alter-ego liability. It discusses the general rule that an asset purchaser is not liable for a seller's debts, but outlines four exceptions: express or implied agreement, de facto merger, mere continuation, and fraud. It defines factors courts examine for de facto mergers and mere continuations. It also covers piercing the corporate veil and fraudulent transfer claims. The presentation aims to explain where risks can arise in mergers and acquisitions regarding successor liability, veil piercing, and fraudulent transfers.
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Successor and Alter-Ego Liability
- 1. Successor and Alter-EgoLiability Presenters: Brendan L. McPherson, James R. Miller, Paul R. Wood 1
- 2. Introduction Where RiskArises: Nuts and Bolts of Successor Liability, Veil-Piercing, and Fraudulent Transfer Claims Successor Liability: General Rule and Exceptions Veil-Piercing Rules Successor Liability Exception and Fraudulent Transfer Claims 2
- 3. Brendan McPherson isa litigation shareholder whose practice focuses on complex financial issues relating to bankruptcy, real estate and disputes arising out of complex business transactions. A significant part of his practice relates to litigating claims of successor liability, alter ego/veil-piercing, and fraudulent transfers, and in this regard he frequently counsels clients both before and after merger and acquisition transactions. 3
- 4.
- 5. Successor Liability & Veil-Piercing101 Asset v. stock transactions General rule still applies: – Stock acquisitions: liabilities travel – Asset acquisitions: liabilities remain
- 6. Successor Liability 101 Successor liability – the exception not the rule Exception 1: express/implied agreement Exception 2: consolidation/merger – “de facto” Exception 3: mere continuation Exception 4: fraud
- 7. GENERAL RULE Thegeneral rule is that the purchaser of a corporation's assets is not liable for that corporation’s debts. E.g., Johnston v. Amsted Indus., Inc., 830 P.2d 1141, 1142-43 (Colo. App. 1992); Ruiz v. ExCello Corp., 653 P.2d 415, 416 (Colo. App. 1982).
- 8. James Miller isa litigation shareholder whose practice focuses on complex financial issues and securities litigation. Jim represents large financial institutions and clients involved in providing financial services. A significant part of Jim’s practice includes litigating claims relating to failed mergers and acquisitions. He has extensive experience with de facto merger and mere continuation claims and he has litigated a number of securities fraud cases. 8
- 9. EXCEPTIONS There are severalexceptions to the general rule. A company that purchases the assets of another company can become liable for the seller's debt where: (1) there is an express or implied assumption of liability; (2) the transaction results in a merger or consolidation of the two corporations; (3) the purchaser is a mere continuation of the seller; or (4) the transfer is for the fraudulent purposes of escaping liability. Alcan Aluminum Corp. Metal Goods Div. v. Elect. Metal Products, Inc., 837 P.2d 282, 293 (Colo. App. 1992).
- 10. DE FACTO MERGERFACTORS In evaluating a “de facto merger” the Court looks at these four factors: (1) continuity of management, personnel, physical location, assets, and business operations; (2) continuity of shareholders; (3) cessation of the seller's business and liquidation of its assets; and (4) assumption by the purchaser of those liabilities of the seller necessary to continue uninterrupted the seller's former business operations. Johnston, 830 P.2d at 1146-47.
- 11. ORDER IN HRC-SVLCASE The Court concludes that the Plaintiff has failed to meet by a preponderance of the evidence their burden of establishing that there was a continuity of management and a continuity of shareholders. The evidence showed that although there was a continuity in HRC's and HRC-SVL’s business operations to some extent the corporate operations were distinctly different. Due to this failure their claim that the asset purchase agreement between HRC and HRC-SVL must fail under the doctrines of "de facto merger" and mere continuation doctrines. Since the Plaintiff has failed under these doctrines then the Plaintiff has failed to establish that HRC-SVL is the successor to HRC's liabilities and thus liable for the debts accumulated by HRC, including the debts owed to the Plaintiffs. Thus, this Court rules that the Defendant, HRC-SVL, is not liable to the Plaintiffs for the liabilities owed by HRC under their successor liability claims.
- 12. MERE CONTINUATION OFCORPORATION Successor liability litigation frequently involves the purchase and continuation of some aspect of the original going concern. The courts look to the following factors to determine whether to invoke the continuation exception and attach liability to the successor corporation: (1) whether the successor and predecessor are in the same business; (2) the degree of similarity between the business operations of the predecessor and successor; (3) whether the same equipment, physical structures, work force, and supervisors used by the predecessor were also used by the new corporation; (4) whether the employees were notified of any change in ownership; (5) whether there are common incorporators, officers, directors, or stockholders between the predecessor and successor corporations; and (6) whether employees retained by the new corporation were re-hired under new employment contracts.
- 13. MERE CONTINUATION OFCORPORATION - continued In Brockman the plaintiffs sued on a promissory note executed by a former corporation. The plaintiffs named as defendants the trustees of the former corporation’s assets, the former corporation, certain individuals who were directors of the new corporation and the new corporation. The court of appeals held that the new corporation was a “continuation” of the former corporation. The two companies were in the same business; the directors, primary officers and major stockholders were the same; the new corporation used the same equipment and labor force; and the transferee took over performance of the former company’s existing contracts. As a result, the court ruled that the new corporation was liable on the promissory note of the former Corporation. Brockman v. O’Neill, 565 S.W.2d 796, 798-99 (Mo. Ct. App. 1978)
- 14. Paul Wood hashandled numerous post-merger dispute cases, many of which involved successor liability issues. Paul has tried cases involving alter ego, de facto merger and other successor liability theories. Paul’s experience in a wide range of industries, including securities broker/dealers, financial services firms, telecom, construction and manufacturing allows him to understand the clients' business and tailor proactive litigation strategies which fit into their overall business goals, rather than simply react to the facts of a particular case. 14
- 15. Piercing the CorporateVeil Exception to the established notion of limited liability for corporate shareholders Because there is a presumption of separateness between the entity and its owners, most courts recognize the exception only in "narrow circumstances.“ Equitable claim: may be decided by court, not jury. Party seeking to pierce the corporate veil bears the burden of proof. Standard of proof varies from preponderance of the evidence to clear and convincing.
- 16. Elements of aClaim State law controls, so determine choice of law General elements of a claim: – Control and domination of corporation by shareholder – Improper use or purpose – Resulting injury
- 17. Control and Domination Must show "complete domination, not only of finances, but of policy and business practice in respect to the transaction attacked so that the corporate entity as to this transaction has no separate mind, will or existence of its own.“ Veil piercing doctrine also may apply to other types of entities such as limited liability companies. 17
- 18. Control and Domination Some of the factors considered: – Inadequately capitalized or undercapitalized to carry out the corporation's business. – Failure to follow corporate formalities/keep corporate records – Identity of officers and directors – Commingling or diversion of funds or assets – Sole or majority stock control – Same offices and employees – Parent pays expenses/losses for subsidiary No one characteristic governs, but the courts must look at all the circumstances to determine whether the doctrine should be applied. 18
- 19. Improper Purpose orUse Requires proof that the control was used to commit fraud, perpetrate the violation of a statutory or other legal duty, or commit a dishonest and unjust act against claimant. Improper conduct beyond establishing the corporation was controlled and dominated by the shareholder must be proved. Claimant must prove improper use of corporate form caused injury Proof of the underlying cause of action may help establish the second part of the test
- 20. Resulting Damage Mustshow that the defendant's control, exerted in a fraudulent, illegal or otherwise unfair manner, caused the harm suffered. Show it will be treated unjustly and damaged by the defendant's exercise of control and improper use of the corporate form unless the corporate veil is pierced Typical scenario: Corporate creditor demands payment or attempts to execute on a judgment and learns that previously available assets have been spirited away by the owner to avoid collection.
- 21. Fraud and FraudulentTransfers Unlike some exceptions, lack of consideration key Lack of consideration may trigger fraud exception or fraudulent transfer law
- 22. Fraud Exception Isthe asset purchase arm’s length, with a legitimate business purpose? Or was the asset purchase orchestrated to avoid liability?
- 23. Fraudulent Transfers/Conveyances Asold as the Statute of Elizabeth in 1570 Standing: Applicable in bankruptcy (trustees and debtors in possession) and out of bankruptcy (creditors)
- 24. Fraudulent Transfers/Conveyances Twovarieties: – Actual fraudulent transfers – Constructive fraudulent transfers
- 25. Actual Fraudulent Transfers Intent to hinder, delay, or defraud creditors. Badges of Fraud: – The transfer or obligation was to an insider. – The debtor retained possession or control of the property transferred after the transfer. – The transfer or obligation was disclosed or concealed. – Before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit.
- 26. Actual Fraudulent Transfers –The transfer was substantially all of the debtor’s assets. – The debtor absconded. – The debtor removed or concealed assets. – The value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred. – The debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred. – The transfer occurred shortly before or shortly after a substantial debt was incurred. – The debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.
- 27. Constructive Fraudulent Transfers Constructive Fraudulent Transfer = misnomer Elements: – No reasonably equivalent value, i.e. consideration – Transferor insolvent or made insolvent by the transfer – Or other elements akin to insolvency
- 28. Thank you, andwe hope you will join us for our next webinar on September 20, 2016: Claims By or Against (Former) Officers and Employees 28
- 29. Polsinelli provides thismaterial for informational purposes only. The material provided herein is general and is not intended to be legal advice. Nothing herein should be relied upon or used without consulting a lawyer to consider your specific circumstances, possible changes to applicable laws, rules and regulations and other legal issues. Receipt of this material does not establish an attorney-client relationship. Polsinelli is very proud of the results we obtain for our clients, but you should know that past results do not guarantee future results; that every case is different and must be judged on its own merits; and that the choice of a lawyer is an important decision and should not be based solely upon advertisements. © 2016 Polsinelli PC. In California, Polsinelli LLP. Polsinelli is a registered mark of Polsinelli PC
Editor's Notes
- #5 The chart represents a typical asset purchase transaction (of all or significantly all assets). Seller sells assets and presumably receives consideration. Each entity has its equity interests. The red represents potential liability to those beyond the seller, who was actually in privity with a claimant. The common source of each of these successor liability and/or veil-piercing claims is an aggrieved claimant who has recognized that the seller/remnant entity does not have the ability to satisfy their claims. Perhaps an employee of the seller company ran a red light and severely injured a person. Perhaps the seller breached a contract, and then sold all of its assets to a new entity. In all instances, the claimant is left without a viable recovery, and is unwilling to walk away uncompensated. We have noted the following scenarios: Claimant claims that the buyer entity is the legal successor in interest, or the veil of the seller entity should be pierced to reach the buyer. Claimant claims that the equity interests of the buyer/surviving entity should be responsible for liabilities of the seller Claimant claims that the equity interests of the seller/remnant should be responsible for laibilities of the seller Issue #1 – A finance company and firm client acquired an insurance agency out of bankruptcy. The client then caused the acquired company to sell substantially all of its assets to a newly formed, wholly owned subsidiary. The seller company became administratively dissolved with no further assets, and thus, it along with the newly formed buyer entity became a target of two separate successor liability causes of action. In one action, the plaintiffs claimed that the seller insurance agency breached duties associated with the procurement of director and officer liability policies, and that because the seller was no longer viable, the buyer should be held responsible. Likewise, in a case we recently prosecuted [important for our lender clients and where we represent plaintiffs] a distressed restaurant franchisor sold all of its assets to a newly formed company with different owners, but operating under the same name, concept, and franchise agreements, leaving our judgment creditor client without a feasible recovery. We pursued the buyer on claims of successor liability, with the new company ultimately agreeing to pay a significant portion of the judgment. Issue #2 – In both the insurance agency sale case, and another involving a large financial services company, the shareholders of the buyer entity were sued under a piercing and successor liability theory. In the financial services company case, the holding company had acquired a competitor in a stock sale transaction. The holding company then caused the newly acquired company, as a subsidiary, to transfer all assets to a pre-existing subsidy. The recipient and transferee of all of the assets was sued as a successor, but more frightening was that the parent company was sued on a piercing theory, on the allegation that it acted improperly by causing the transfer of assets. Issue #3 – In the case we recently prosecuted for the judgment creditor, we found that the former major shareholder caused all of his company assets to be transferred to a newly formed company, but rather than allow the seller/remnant entity to receive the consideration paid by the buyer, he was paid directly. We were able to make the former shareholder partly responsible for the corporate seller’s judgment based on theories of veil-piercing and fraudulent transfer. Jim and Paul are going to be discussing topics related to issues 1 through 3. I’m going to circle back around at the end of our webinar to address a fourth issue: that’s where, instead of seeing the transfer of cash or other consideration from the buyer/surviving entity to the seller/remnant entity, we see no transfer of consideration. That is likely to trigger a fraud exception, or even fraudulent transfer claims. We’ll talk about how that works.
- #6 The general rule still applies: in stock acquisitions, liabilities of a company remain with the company. However, the veil still remains in place between the company whose stock was sold, and its new shareholders or members. Conversely, when particular assets of a company are sold, the general rule is that the liabilities remain with the seller company.
- #7 It is fairly standard coast-to-coast (certainly in Kansas and Missouri) that a predecessor entity will not be liable as a legal successor in interest unless one or more of four exceptions apply: Where the purchaser expressly or impliedly agrees to assume debts Where the transaction amounts to a consolidation or merger (sometimes referred to as a de facto merger). Where the purchasing corporation is merely a continuation of the selling corporation. This is very similar to the consolidation/de facto merger exception. Does the buyer continue the operations of the seller? With the same employees be doing the same tasks? Will the website, email, phone remain the same? Will the locations of the business be the same? Ultimately, in our experience, courts would like to preserve the general rule of no successor liability, but where it is clear that buyer is, for all intents and purposes the same company, they may not allow a plaintiff to come up empty handed. Where the transaction was entered into fraudulently or in order to escape liability [Brief war stories might apply to one or more of these exceptions – for instance in Kansas City, in our restaurant franchisor case, there was actually a very bizarre provision in the Asset Purchase Agreement which seemed to indicate that the buyer would take care of all liabilities of the seller post-closing. This was a huge reason that we were able to accomplish a successful result for our judgment creditor client, and presumably, the buyer/defendant was not happy with their transactional counsel that included such a bizarre provision in the APA]
- #22 Harkening back to the first slide – where we had the chart should the sale of assets to a buyer/surviving entity, we basically assume that the buyer actually paid consideration for the assets it received. Where that happens, we are generally in the discussion that Jim and Paul were in – is the predecessor entity a mere continuation, or a defacto merger. BUT, there are circumstances where no consideration is paid. That’s where the fraud exception comes into play, or even the use of fraudulent transfer laws. We’ll discuss each.
- #23 Whether a successor entity can be tagged with liability under a fraud exception will generally come down to whether the asset purchase was arm’s length, or whether the asset purchase was simply orchestrated to avoid liability. A couple of examples will add a bit of color to that statement: In a Missouri Court of Appeals decision, Ernst v. Ford Motor Co., farm implement dealers sued Ford and New Holland after they acquired assets from the manufacturer that plaintiffs were dealing for. Plaintiffs argued that the purchase of assets was structured so that Ford and New Holland could avoid liability for the transferor’s obligations. The court of appeals found no fraud, indicating that the record simply did not support the allegations. There was no fraudulent intent associated with the termination of the dealer contracts that the plaintiffs complained about. It was a fairly run-of-the-mill asset acquisition from a distressed company. But that decision can be contrasted with a 1993 Tenth Circuit decision of Moore v. Pyrotech Corp. There, a pension fund made an investment in a company, while at the same time, the company decided a reserve takeover so that a parallel company could take the valueable assets, repay earlier investments, and leave the old shell company behind. Similarly, the Supreme Court of Kansas once found a successor company liable for the debt of a prior company, when the evidence indicated that the old company transferred all of its assets, the new company paid all liabilities but an outstanding judgment at issue, and hired the same employees and officers.
- #24 What I’d like to spend a bit more time on as we conclude today’s webinar is the issue of fraudulent transfers. The concept of a fraudulent transfer (also referred to as a fraudulent conveyance) dates back to the Statute of Elizabeth in 1570. The Statute of Elizabeth sought to (and modern fraudulent transfer legislative seeks to) prevent situations in which overburdened debtors place their assets in friendly hands, thereby frustrating creditors’ attempts to satisfy their claims against the debtor by providing a mechanism for those assets to be returned to the debtor (or the creditor to otherwise be made whole). Unlike preference law, which is primarily a federal bankruptcy concept, fraudulent transfer law is heavily embedded in state and federal law. Whereas a trustee or debtor in possession generally only has standing to bring preference claims, if a debtor is not in bankruptcy, a creditor has standing to assert a fraudulent transfer claim (under state law). The creditor may institute litigation against the debtor/transferor of assets, the transferee of the assets, or both. The creditor generally has the ability to have the assets that were fraudulently conveyed placed back into the hands of the debtor, or to obtain a money judgment for the value of the assets transferred. The Uniform Fraudulent Transfer Act (UFTA) is followed by most states.
- #25 Modern fraudulent transfer law includes traditional notions of actual fraud, where a debtor acts with the intent to hinder, delay or defraud its creditors, and a broader concept of constructive fraud, where the financially strapped debtor transfers assets for something less than the reasonably equivalent value of those assets.
- #26 When we think of the intent to hinder, delay, or defraud creditors, we’re really talking about something similar, if not identical to the fraud exception for successor liability. But what is interesting about fraudulent transfer law is that it is far more developed in terms of what constitutes an intent to hinder, delay or harm, because courts have determined that such a finding can be based on circumstantial evidence or inferences drawn from a transferor of asset’s conduct. Courts have developed certain “badges of fraud” and that has now been codified by most states.
- #27 Not all of the badges need be present, but the greater number established, the greater presumption or inference of the transfer being fraudulent. The burden of establishing an actually fraudulent transfer is upon the party asserting it. Actual fraudulent transfer example: Working on a matter in which a bank had a judgment against an individual. Individual had numerous oil & gas holdings. When collection efforts started, debtor transferred all of those interests to his wife, merely flipping title to them. This certainly fit the bill of an actual fraudulent transfer: because of the judgment, the debtor was insolvent, he gave the assets to an insider, and because of that he still had the benefit of those assets, they just weren't in his name.
- #28 As a bankruptcy judge recently told me, a constructive fraudulent transfer is really a misnomer. The word “fraud” should be there at all. It’s really a gift that is inappropriate under state or federal bankruptcy law. An example of a constructive fraudulent transfer in the mergers and acquisition context is the transferring of assets from a seller to a buyer, but a third-party receiving the consideration, not the seller party. Additionally, a constructive fraudulent transfer is generally pled in tandem with an actual fraudulent transfer because it could be a catch-all. Imagine a scenario in which creditors are focusing efforts against a company, and that company gives its software, with customer information to another company. While that might not fit the bill for an actual fraudulent transfer, it is likely a constructive fraudulent transfer, and the value of the assets transferred, or the assets themselves might be recovered by a bankruptcy trustee or a creditor or creditors outside of bankruptcy.