- Successor Liability in Asset Acquisitions
- February 10, 2014
- Law Firm: Lee Tsai Partners Attorneys-at-Law - Taipei Office
In contrast to stock acquisitions and merger transactions where the liabilities of the acquired corporations are assumed by the acquiring entity, the general rule in the United States is that acquiring entities of assets in an asset acquisition are not liable for the liabilities of their predecessors. In the past 35 years, however, due to policy considerations such as the availability of other remedies to plaintiffs, the courts in various jurisdictions in the United States have carved out several exceptions that should be noted by companies entering into an asset acquisition. This note outlines the four traditional exceptions that the majority of states recognize and two non-traditional rules that entities entering into asset transactions where the laws of a state in the United States applies.
1. Express or Implied Assumption
The first traditional exception to the general rule of no liability in an asset acquisition is where the acquirer expressly or implicitly assumed the liabilities of the predecessor. If the acquirer of the assets has expressly assumed the liabilities per the terms of the purchase agreement, the acquirer will be liable for the liabilities expressly assumed. In certain cases, even where the purchase agreement is silent on assuming the liabilities, the acquirer may nevertheless be liable if a third party relies on the acquirer’s conduct or representations showing an intention by the acquirer to assume the liabilities of the predecessor. Acquiring entities assuming even one contract or obligation outside of those specified in the asset purchase agreement may assume the risk of being found to have implicitly assumed all of the predecessor’s contingent liabilities.
2. De Facto Merger
Where the end results of an asset transaction mimics the results of a merger except for the assumption of liability, courts may nevertheless impose the predecessor’s liability on the acquirer. Factors taken into account by the courts are:
a. continuity of ownership, which occurs where the acquirer pays for the acquired assets with shares of its own stocks so that the stock is ultimately held by the shareholders of the predecessor;
b. cessation of ordinary business and dissolution of the acquired corporation as soon as possible;
c. assumption by the successor of the liabilities ordinarily necessary for the interrupted continuation of the business of the acquired corporation; and
d. continuity of management, personnel, physical location, assets, and general business operations.
3. Mere Continuation
This exception is applied when the asset sale is viewed as a mere reorganization, i.e., liability is imposed where “in substance if not in form, the purchasing corporation is the same company as the selling corporation.” In determining where the mere continuation exception applies, the courts will frequently focus on the following factors:
a. the continued use of the predecessor’s name, facilities and employees;
b. there is a common identity of the stockholders or management of the successor and predecessor; and
4. Transaction is Fraudulent to Avoid Liabilities of Predecessor
The transaction is fraudulently entered into by a corporation to evade liabilities for debts. For example, a successor will be held liable where a showing is made that the successor corporation was created for the sole purpose of evading predecessor’s creditors, or where consideration for the transfer was inadequate or fictitious.
5. Product Line Theory
Under the product line exception, successor liability may be applied where the acquirer continues the output of the predecessor’s line of products, and, as a result, the acquiring entity assumes strict liability for the same product line previously manufactured, if the right of action against the predecessor is no longer available. The considerations courts in jurisdictions that recognize the product line liability exception include:
a. if all of the assets were acquired, which leaves nothing but a shell of the predecessor;
b. if the acquiring 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
c. if the acquiring entity is benefiting from the goodwill (i.e., reputation) of the predecessor.
This exception is only applied in a minority of the jurisdictions in the United States.
6. Continuity of the Enterprise Theory
The continuity of enterprise exception is an expansion of the de factor merger where successor liability may be imposed even where there is no continuation of shareholder and the sale is structured as a cash transaction. The courts will look to the following factors in determining the application of this theory:
a. continuity of management, personnel, assets, facilities and operations;
b. predecessor dissolves or decreases its ordinary course of business soon after the sale;
c. successor assumes predecessor’s liabilities to the extent necessary to continue its business without interruption, and
d. successor holds itself out as a continuation of the predecessor to the public.
Given the above exceptions to the general rule that no successor liability applies in asset transactions, acquiring entities in asset transactions should take precaution by, for example, conducting a thorough due diligence to identify practices or products that may result in post closing liabilities, draft clear purchase agreements that expressly exclude liabilities that acquiring entities do not intend on assuming and include comprehensive indemnification provision.