When buying or selling a business, 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.
General Rule in New York: 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.[1]
This is a primary reason that sales and acquisitions of businesses are often structured as asset sales.[2] However, New York law contains four exceptions to that general rule.
| The Four Exceptions that Create Successor Liability under New York Law are[3]:
1. The Buyer expressly or impliedly assumes the Seller’s liabilities, 2. The Buyer is a mere continuation of the Seller (there was a de facto merger), 3. The Buyer continues essentially the same operations or product line of the Seller, or 4. The sale was an attempt to fraudulently evade creditors or escape obligations. |
Successor liability can also occur pursuant to certain federal statutes:
- Employee Retirement Income and Security Act (ERISA),
- Family and Medical Leave Act (FMLA), and
- Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA).
Exception #1. Buyer’s Express or Implied assumption of Seller’s Liabilities:
This exception requires that either the asset purchase agreement explicitly states that the Buyer will assume some or all of the Seller’s liabilities, or that the Buyer engage in some conduct that implies that it intended to pay the Seller’s debts or otherwise assume its liabilities.[4] Express language in the asset purchase agreement stating that Buyer will not be responsible for Seller’s liabilities, and requiring that Seller indemnify Buyer for pre-closing liabilities, can indicate that there was no express or implied assumption of Seller’s liabilities.[5]
Exceptions #2 & #3. De Facto Merger and Mere Continuation Exceptions:
Under New York Law, successor liability is most commonly litigated under the “de facto merger” exception. In general, “the de facto merger doctrine creates successor liability when the transaction between the purchasing and selling companies is in substance, if not in form, a merger.” [6]
| A court is more likely to find successor liability under de facto merger doctrine when:[7]
1. the owners of the Seller continue to be the owners of the Buyer (this is a necessary element of de facto merger),[8] 2. the Seller discontinued its operations or dissolved soon after the asset sale occurred, 3. the Buyer assumed the liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation; and 4. there is substantial continuity of the Seller’s management personnel, physical location, assets and general business operation. |
Exception #4. Fraudulent Attempt to Evade Creditors:
Courts look to “badges of fraud” to determine whether a transfer was a fraudulent attempt to evade creditors. These badges of fraud can include any of the following:[9]
- a close relationship among the parties to the transaction;
- a secret and hasty transfer not in the usual course of business;
- inadequacy of consideration;
- the transferor’s knowledge of the creditor’s claim and the transferor’s inability to pay it;
- the use of dummies or fictitious parties; and
- retention of control of the property by the transferor after the conveyance.
The most important factor in this analysis is whether the Seller retained control of the assets from which the creditors seek to recover.
As the factors above indicate, the contractual allocation of risk, control and consideration can be the difference in determining whether the Buyer is held responsible for the liabilities of the Seller. At the early stages of a transaction, the parties should consider whether they intend for the Buyer to assume any liabilities of Seller, whether there will be substantial continuity of the Seller’s business and whether the proposed transaction may creditor or other third party with a claim for which there is no adequate remedy. Due consideration of these factors is essential for the intended allocation of risk in the asset purchase agreement.
[1] Cargo Parker AG v. Albatrans, Inc., 352 F.3d 41 (2d Cir. 2003); Aguas Lenders Recovery Group v. Suez, 585 F.3d (2d Cir. 2009); In re New York City Asbestos Litig., 15 A.D.3d (1st Dep’t 2005)
[2] There are also significant tax differences to an asset sale which also factor heavily purchasing a business using an asset sale as opposed to a stock sale.
[3] Aguas Lenders Recovery Group v. Suez, 585 F.3d 686, 702 (2d Cir. 2009), citing Cargo Parker AG v. Albatrans, Inc., 352 F.3d 41, 45 (2d Cir. 2003)
[4] Danstan Props. v. Merex, 2011 WL 135843 at 3 (S.D.N.Y. 2011).
[5] Id.
[6] New York v. Nat’l. Serv. Indus., Inc., 460 F.3d 201, 205 (2d Cir. 2006).
[7] Martin Hilti Family Trust v. Knoedler Gallery, LLC, 2015 WL 5773895, 17 (S.D.N.Y. 2015).
[8] Barrack, Rodos & Bacine v. Ballon Stoll Bader & Nadler, P.C., 2008 U.S. Dist. LEXIS 22026, 17 (S.D.N.Y. 2008).
[9] ”Kaur v. Royal Arcadia Palace, Inc., 643 F.Supp.2d 276, 290 (E.D.N.Y.2007) (summary judgment) (citing Shelly v. Doe, 671 N.Y.S.2d 803, 806 (3d Dep’t 1998)).