Successor Liability: Buying a Business May Result in More Than You Bargained For

When a corporation buys the business of another corporation, the acquisition is often accomplished under an asset purchase agreement. That way, the buying company can structure the deal so that, as a general rule, it acquires the selling company’s assets without inheriting the seller’s debts and other liabilities.

However, there are exceptions where responsibility will be imposed on the buyer for the debts and liabilities of the selling company. These exceptions are collectively referred to as successor liability and can arise in a number of situations. Liability can even result in the imposition of punitive damages on the successor for the acts of the predecessor that took place long before the asset purchase. Understanding when and how successor liability might arise is critical to evaluating whether to buy another company’s assets.

Over the years, five exceptions to the general rule of non-liability for the seller’s obligations have evolved. They are known generally as follows:

Express Assumption by Agreement

When a company acquires another company’s assets under a written agreement, the acquiring company may expressly agree to assume certain debts and liabilities. In this situation, the agreement will typically identify the specific liabilities that the buyer is assuming and unequivocally disavow responsibility for all other liabilities.

De Facto Merger

A merger is the consolidation of two companies into one company. An asset purchase transaction can be deemed a de facto merger where one corporation takes all of another’s assets without providing any money that could be made available to meet the claims of creditors. An example of a de facto merger is where the assets are sold in exchange for shares of the buyer’s stock which are promptly distributed to the seller’s shareholders.

Continuation Exception

Under the continuation exception, liability is imposed when the successor company is merely a continuation of the predecessor. This generally occurs when the assets are sold well below market value and the seller is unable to meet the claims of unsecured creditors. The continuation exception could apply if only a single company remains after the sale and one or more persons were officers, directors, or stockholders of both companies.

Fraudulent Transfer

Somewhat similar to the continuation exception, a fraudulent transfer occurs when assets are transferred to the purchaser to avoid having the assets used to pay down debts and liabilities. A simple example of this occurs where the shareholders of the selling company are awarded ownership in the buying company as payment for the assets.

Product-Line Successor

Under the product-line successor liability rule, a company that acquires a specific product line from another company can be held liable for injuries caused by defective products manufactured by the predecessor even though the buyer did not expressly agree to accept such liability. The rule applies where the buyer acquires the product line in addition to substantially all of the other assets of the selling company and thereafter continues to manufacture the same product line, typically using the seller’s original trade names and product packaging.

The rationale for this rule is that a person injured by a product is left without recourse against the selling company because it no longer exists. The successor company is considered better able to absorb the risk of harm from a defective product than the seller and has supposedly benefited from the seller’s goodwill by continuing the product line and marketing itself as a continuation of the seller.

Conclusion

The possibility of being held responsible for another company’s conduct occurring before the asset sale transaction is very real. A major goal of corporate asset purchasers should always be to structure asset sales to avoid the seller’s liabilities. Being mindful of these potential pitfalls can help the purchaser achieve that goal.