The Doctrine of Successor Liability and the Drift Towards the Assumption of Liability

Doctrine of Successor Liability: Tracing the drift from the `Traditional non-liability rule’ to `assumption of liability’ through judicial precedents AbstractTraditional corporate law has been applied over the years to deal with the liabilities arisen after one company’s acquires another company The general rule says that an acquiring corporation doesn’t assume any liabilities of the predecessor corporation. The courts over the years have evolved this traditional stance and laid down exceptions, making the successor corporations assume such liabilities. This paper has tried to trace and outline the diversion from the traditional rule of non-liability to the assumption of liabilities by the successor corporations.

There are four exceptions to this general non-liability rule which shall be explained in detail with progressing contentions in the research paper. The non liability principle creates hurdles in seeking remedy for the injured. The claimant might lose any right to damages if he fails to recover from the successor corporation. The liability can even be fixed in environmental issues, where companies will be fixed with `superfund liability’ and made to cleanup’ the environment. This principle of fixing liability on the successor corporation in various areas is known as `Doctrine of Successor Liability’. This doctrine attempts to bridge the gap between general rule of no-liability and tortious liability.

However, the doctrine also safeguards the interest of the successor corporation from assuming any liability for tort committed by the predecessor. This paper evaluates this doctrine through numerous case laws of multiple jurisdictions, with an insight from different governing statutes as well.

IntroductionDoctrine of successor liability’ is a relatively new and evolving field of Jurisprudence. Legal systems around the world largely rely on common law in the area of application this doctrine. A `successor’ is defined as “1. A person who succeeds to the office, rights, responsibilities, or place of another; who replaces or follows a predecessor.2. A corporation that, through amalgamation, consolidation, or other assumption of interests, is vested the rights and duties of an earlier corporation.”The Restatement of Tort (3rd.) (2000) “Chapter 3” outlines the “Libaility of Successor Manufacturers” Whether a successor can be liable for defective product sold the predecessor is decided generally by traditional corporate law emphasizes on the type of corporate acquisition between the two corporations. A cash purchase of the predecessor’s assets, instead of a merger or a stock purchase will attract traditional corporate laws, which holds that the successor will not be liable.’There are three ways through which a transfer can be done: (a) by statutory merger or consolidation; (b) through the purchase of the stock of a target corporation; and (c) through the purchase of assets of the target corporation. The traditionally, law of corporations governing the liability of a successor corporation is affirmed in many cases. Ifone corporation sells its assets to another corporation,then the later isn’t tortiously liable for the former’s conduct.

This principle is contended by many courts. Its purpose is to prevent the successor corporations of any liability that arises. It can be traced to the notion that the law does not force the purchaser to assume such liability. American jurisdictions also weave around the general notion that a successorcorporation, which acquires the assets of another company,won’t be legally responsible for the actions of its predecessor. Successor liability rule in New York holds that a purchaser is not liable for its seller’s liabilities except where there is an express agreement between them governing otherwise. The New York Supreme Court also affirmed the already existing general rule.

The logic seems equally applicable as the general rule regarding successor liability is well settled that a corporation does not assume its predecessor’s liabilities automatically.ExceptionsThere are four recognized exceptions to the general rule. First is applicable where the buyer agrees to assume, expressly or implicitly, the debts and liabilities. The second applies to the transaction where there isconsolidation or merger of the seller and purchaser. Thethird exception is attracted when the successor corporation is merely a continuation of the predecessor corporation.

The fourth exception applies to a colorable transaction which is entered in order to defraud the creditors or the shareholders of the seller corporation. The courts over the years have developed thesefour exceptions to the general rule of non-liability forassetpurchasers. Theseexceptions are made with a purpose to ensure that corporations don’t evade their liabilities through the use of transactional technicalities.Under the traditional approach, asset purchasers will be considered corporate successors if one of the following applies: Assumption- The purchaser expressly or impliedly agrees to assume the liabilities of the seller. The court has noted that an asset sale agreement amounts to a simple transfer, which establishes that the successor didn’t attain any liabilities because the identity of the predecessor was not used, nor was any of supervisors hired by the successor. The Court thus held that the buyer did not assume any liabilities of the predecessor, neither expressly nor impliedly. “Under the asset purchase agreement, the purchaser did not assume any of the liabilities of the seller”, because of a similar reason. In addition, Minnesota Business Corporations Act mandates the presence of a provision in a contract or an agreement to hold the transferee liable.

Now in case a situation arises where the language of such a provision in the agreement or a contract is found to be unclear or ambiguous, the courts assume that there is an implied liability on the buyer the for defective products, if any. Thus to avoid such discrepancies involving assumption of liabilities, it is best if such an agreement unequivocally states that there is no assumption of future products liability.De Facto Merger- The transaction amounts toa de factomerger or consolidation if the corporation assumes the liability of its predecessor.

The important concept in this exception is not the continuation of the business operation but the continuation of the corporate entity. The New York Supreme Court, Appellate Division, First Department, in Van Nocker v. A.W. Chesteron, Co discussed the second successor liability exception. The court notes that asset purchases can be said to be a de-facto mergers if it includes the following four factors:(i) continuation of ownership arising from the use of the successor’s stock as payment rather than the use of cash(ii) after the transaction the predecessor dissolves as soon as possible,(iii) the buyer assumes liabilities necessary to continue the business of the seller and;(iv) the buyer continues the using predecessor’s enterprise.The Court in Van Nocker v. A.W. Chesteron, Co. further explained that all of these factors may not be necessarily needed to prove a de-facto merger but presence of the first two is required. It also said that continuity of ownership exists ifthe shareholders of the predecessor corporation become direct or indirect shareholders of thebuyer. Continuity of ownership is a situation where the parties to the transaction become owners together of what formerly belonged to each.b The Van Nocker Court, failing to find either of the first two elements refused to evaluate the other factors.

The Fourth Department of the New York Supreme Court, Appellate Division, while determining whether a transaction satisfied the prerequisites of a de-facto merger, held that “[w]hile factors such as shareholder and management continuity will be evidence that a de facto merger has occurred, those factors aloneshall not be determinative.” The U.S. District Court for the Southern District of New York examined the continuity of ownership element of de facto merger stated, “[T]he 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.” The court further stated that the factors should be considered in a “flexible” manner and question the crux that whether it was the “intent of the successor to absorb and continue the operation of the predecessor.” It maintained `continuity of ownership’ as one of the pivotal requirements for a de facto merger. About the fourth factor the court stated that sheer hiring of employees of the seller was insufficient to conclude that there was continuity of management. In Kretzmer v. Firesafe Prods. Corp. the attorney had switched employers and brought along a secretary, an associate, and some cases, the Court held that such an instance didn’t amount to a merger or consolidation and thus there wasn’t a de facto merger. Hence, while dealing with the de facto merger exception, continuity of enterprise or ownership is considered prior to the tree other factors. Mere Continuation: If the corporation has the same shareholders, directors and officers, it will be eligible for this exception. In the Seventh Jud. Dist. the Court said that mere continuation” is a type of restructure in which one entity gets dissolved and another survives.

The dissolution should take place as soon as possible, but in this case the seller was not dissolved for more than a year, so the Court held it to be out of the ambit of mere continuation exception. In other jurisdictions this exception requires continuity of owners and/or directors. This exception is “problematic of application because it has never been quite clear just in what sense a corporation must continue in order to trigger the exception.”4. Fraudulent- The transaction was fraudulently entered into to escape liability. The New York courts have laid their emphasis on many fraudulent transactions but have not provided any exceptions for the same. If the creditors of the seller are being defrauded by the transaction, then also it will fall under this exception, Few of the instance can be; if the predecessor corporation holds the possession of the property but doesn’t actually own it, making its creditors believe that it still owns the property, if the proceeds of the sale are sent away, and if the property is sold for an insufficient amount to an acquaintance. The malafied intention to defraud has to be proven including those jurisdictions that have adopted the Uniform Fraudulent Conveyance Act.While as other jurisdictions presume such an intention. In situations like these, both the seller as well as the buyer can be held liable.The Continuity of Enterprise Exception.In 1983 Salvativ.

Blaw-Knox Food & Chemical Equipment, Inc., NewYork’s Court of Appeals recognized Continuity of Enterprise’ exception, it defined it as a part of “corporate reorganization,” The Supreme Court of Queens County later explained that the this theory was originally introduced by the Supreme Court of Michigan in Turner v. Bituminous Cas. Co. Salvati noted the Michigan Court’s rationale, that it to be unjust to allow the successor to avoid liability Salvati set forth the Michigan court’s three criteria test, such continuity would be there if: there wasa continuation of the enterprise of the seller;the predecessor dissolved promptly after the transaction, and the buyer assumed liabilities and obligations of the seller. Salvati accepted the logic put forward in the case of Turner. So the tests laid down by Turner and later reiterated in Salvati are similar to the factors laid down in Van Nocker. The Michigan Supreme Court extended the de facto merger doctrine by eliminating the continuity of shareholder requirement and applying that exception to cash transactions. Product Line Exception.In 1977, the California Supreme Court created the product line exception. The Court said: We therefore, conclude that a party which acquires a manufacturing business and continues the output of its line of products under the circumstances here presented assumes strict tort liability for defects in units of the same product line previously manufactured and distributed by the entity from which the business was acquired.

Anything to the contrary in Ortiz v. South Bend Lathe, supra, 46 Cal.App.3d 842, or Schwartz v. McGraw-Edison Co., supra, 14 Cal.App.3d 767 (see fn. 6, ante) is disapproved Different jurisdictions have different stands on the product liability exception. In Hickman v. Thomas C. Thompson both the buyer and the seller corporations were of Illinois, the buyer had bought the assets of the seller corporation. Later a resident of Colorado was injured by a product manufactured by this Illinois corporation.

There was an arm’s length agreement, for the purchase of assets, signed and executed in Illinois. In Illinois the product line exception doesn’t hold good. The district court opined that: 1) successor liability is a tort claim, and not a contract claim; 2) As the injury occurred in Colorado so the Colorado law applies; and 3) The Product line exception would be accepted by the Courts. Hickman court’s view was dissented in the Tenth Circuit in Florom v. Elliott Mfg., and held that Colorado would reject the product line exception. Comprehensive Environmental Response, Compensation & Liability Act and Successor LiabilityCERCLASuccessor corporations are liable the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). Thesubstantial continuity test under CERCLA is a continuation successor liability under any other asset purchase.

The same “general rule of non-liability” and the “exceptions” to it are also applicable in case of successor liability under CERCLA. Many courts have included corporate successor’s liability while interpreting the act. In United States v Bestfoods, the Supreme Court did not make this aspect of “superfund liability” redundant and kept the substantial continuity test alive in CERLA as well. The Court has laid down CERCLA’s purpose as: CERCLA’s primary purpose is remedial: to clean up hazardous waste sites. . . . Because it is remedial statute, CERCLA must be construed liberally to effectuate its two primary goals: (1) enabling the EPA to respond efficiently expeditiously to toxic spills, and (2) holding those parties responsible for the release liable for the costs of the cleanup. In that way, envisioned the EPA’s costs would be recouped, the Superfund preserved, and the taxpayers not required to shoulder the financial burden of nationwide cleanup. There are various factors which the courts apply while deciding whether a successor corporation should assume any liability Courts applying the substantial continuity test consider a range of factors to determine whether the buyer has substantially continued the predecessor’s enterprise these include; if any successor corporation continues retaining the following:same employees;same supervisors;same name;same production or service line;same production facilities;continuation of same assets;general business; andwhether the buyer continues the predecessor’s enterprise. It isn’t necessary that a corporation should fulfill all these criteria for it to assume liability of the predecessor. In New York v. Westwood-Squibb Pharm Co. the court held liable the asset purchaser corporation when it satisfied six of the eight factors. CERCLA’s purposes and principles of corporate successor liability are both in harmony with the substantial continuity test. However, there are discrepancies that may arise; e.g., sec. 113(f of CERLAprovides PRPs with a statutory right of contribution. 42 U.S.C. 9613(f)(1). Sec.113(f)(2) says that if PRPs enter into settlements with the federal government, it resolves it’s liability.ConclusionThe general rule of “non-liability” says that a “successor corporation” will not assume the liabilities of the “predecessor corporation” for defective products sold by the predecessor. But the courts over the years have developed principles holding the successor liable.

The rift between the liability law and general non-liability corporate law has led to the evolution of such rules by the courts. Mere continuation, de facto merger and the product line doctrines broaden and specify the areas for fixing of liability. These rules have also firmed protection against colourable intent of corporations to avoid liability.

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