• Successor Liability
  • November 23, 2009 | Author: Valerie L. Marciano
  • Law Firm: Jaburg Wilk, P.C. - Phoenix Office
  • Shutting Down and Starting New

    Have you ever thought about shutting down your business and starting a new one? If you do, will the debts and liabilities from your existing business follow you into the new one? That depends on many technical details, and there is a new court ruling that makes it more challenging.

    Under Arizona law, the idea that debts and liabilities can follow you from one business to another is called "successor liability." The general rule is that a new business is not liable for the debts and liabilities of the old business unless a creditor can prove one of the following:

    • The new business agrees to be liable;

    • The new business is formed by merging the old business with another business;

    • The new business is merely a continuation or reincarnation of the old business; or

    • The transfer of assets from the old business to the new business is to defraud the creditors and escape liability from existing debts.

    The traditional way for an entrepreneur to form a new business, without becoming liable for the debts of an old business, is to form a new business entity such as a new S.-Corp. or LLC, and purchase the assets. However, a recent Arizona Court of Appeals decision makes it clear that the traditional plan might face new complications.

    The key to transferring business assets without transferring liabilities is for the purchaser to pay full and fair value for the assets. Many business assets are easy to identify and value because they are tangible, i.e. you can see them and look at the market to determine value. For example, buildings, factory machines, vehicles, computers, furniture, tools, and equipment can all be valued by appraisers who compare the asset to the market price for similar products. It is easy for a new business to identify and pay fair market value for tangible assets.

    However, some business assets are "intangible." They cannot easily be compared with products on the market. For example, intangible assets can include the good reputation of the business and its popularity among clients and customers. This is known as "good will". Intangible assets are hard to value, and easy to overlook when a new business is buying the building, vehicles, tools, and equipment from the old business.

    Intangible assets can even include the body of experience built up in a team of key personnel who have worked together for many years and developed connections in the industry, expertise in the market, and efficient techniques. If that team transfers to the new business, there is a good chance that "intangible" value goes with it. This is the point emphasized in recent decisions by Arizona judges.

    If intangible assets transfer, without receiving fair value in payment, the creditors of the old business may argue that the new business should pay the debts and liabilities incurred while the company was in business. A court may find that the asset transfer was a fraud on the creditors of the old business, and the new business should be liable up to the difference between the value that was paid and the value received. Alternatively, a court could find that the new business is merely a continuation of the old business and should assume all of its’ debts and liabilities.

    The owner of a newly formed business might find itself liable for old business debts even if it simply closes down the business and walks away, without selling any tangible or intangible assets to the new business they started. A court may find that they former business owner’s presence, expertise, reputation, contacts in the industry, former customers, knowledge, and the prior company’s team members constitute intangible assets transferred without fair value.

    It is possible to leave behind an old business without being saddled with its liabilities and debts. In order to avoid successor liability, an entrepreneur must plan carefully and seek professional advice in an effort to avoid a “successor liability” claim.