Commercial Division Blog

Posted: December 26, 2019 / Categories Commercial, Successor and Derivative Liability

Court Analyzes Successor Liability Under the De Facto Merger Doctrine

On December 13, 2019, Justice Emerson of the Suffolk County Commercial Division issued a decision in Marcum LLP v. Fazio, Mannuzza, Roche, Tankel, Lapilusa, LLC, 2019 NY Slip Op. 52010(U), analyzing successor liability under the de facto merger doctrine:

The plaintiff seeks leave to amend the complaint to add PKF O'Connor Davies, LLP, f/k/a O'Connor Davies, LLP ("PKF O'Connor"), as a party defendant and to add three new causes of action against PKF O'Connor for merger liability, defacto merger, and successor liability.

Preliminarily, the court notes that successor liability is not a separate cause of action, but merely a theory for imposing liability on a defendant based on a predecessor's conduct. The doctrine of successor liability does not create a new cause of action against the successor so much as it transfers the liability of the predecessor to the successor. It is an exception to the general rule that, when one corporate or other juridical person sells assets to another entity, the assets are transferred free and clear of all but valid liens and security interests.

Under both New York law and traditional common law, a corporation that purchases the assets of another corporation is generally not liable for the seller's liabilities. Successor liability, however, applies in four situations: (1) the buyer expressly or impliedly assumed the predecessor's tort liability, (2) there was a consolidation or merger of seller and purchaser, (3) the purchasing corporation was a mere continuation of the selling corporation, or (4) the transaction was entered into fraudulently to escape such obligations. The second exception subsumes the doctrine of de facto merger when a transaction, although not in form a merger, is in substance a consolidation or merger of seller and purchaser. The hallmarks of common-law de facto merger are: (1) continuity of ownership, (2) cessation of ordinary business and dissolution of the acquired corporation as soon as possible, (3) assumption by the purchaser of the liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation, and (4) continuity of management, personnel, physical location, assets, and general business operation. The plaintiff seeks to impose successor liability on PKF O'Connor under the first and second exceptions.

New York courts recognize the express-or-implied-assumption exception to the general rule of nonliability. In the few cases that have addressed this exception, courts have looked at the language of the purchase agreement to determine whether the successor has expressly assumed any liabilities of the predecessor.

The plaintiff contends that the Business Combination Agreement between the defendant ("FMRTL") and O'Connor Davies, LLP ("O'Connor Davies"), PKF O'Connor's predecessor in interest, reveals that O'Connor Davies assumed FMRTL's liabilities. Specifically, the plaintiff relies on the following language on the recitals page:

WHEREAS, the Transaction is to be effected by the transfer to O'Connor Davies from FMRTL of the Assigned FMRTL Assets (as hereinafter defined) in consideration of the assumption by O'Connor Davies of the Assumed FMRTL Liabilities (as hereinafter defined) and the issuance to FMRTL of a partnership interest in O'Connor Davies that shall be simultaneously and directly distributed to certain of the FMRTL Equity Partners (as hereinafter defined).

The plaintiff also relies on language in the bill of sale that "the Buyer has agreed to assume the Assumed FMRTL Liabilities (as defined in the Business Combination Agreement) and that the "Buyer . . . accepts and assumes from the Seller the Assumed FMRTL Liabilities." The plaintiff also contends that a reference to this litigation was included on Schedule 3(b) of the Business Combination Agreement, entitled "FMRTL Litigation."

The court finds that, contrary to the plaintiff's contentions, O'Connor Davies did not agree to assume liability for this litigation in the Business Combination Agreement. New York law holds that a whereas clause can be used to clarify the meaning of an ambiguous contract, but it cannot be used to modify or create substantive rights not found in the contract's operative clauses. The Business Combination Agreement is not ambiguous, and nothing in its operative clauses imposes liability on O'Connor Davies for FMRTL litigation. The Business Combination Agreement defines Assumed FMRTL Liabilities as "all liabilities of FMRTL arising in the ordinary course and relating to the period prior to the Closing Date, plus all liabilities of FMRTL arising in the ordinary course and incurred thereafter in connection with the business of FMRTL." Thus, O'Connor Davies only assumed liability for FMRTL liabilities arising in the ordinary course of FMRTL's business. Although there is little case law on what exactly constitutes a transaction in the ordinary course of business, the bankruptcy courts have held that it includes normal financial relations, i.e., recurring, customary credit transactions that are paid in the ordinary course of a debtor's business. Litigation is not such a recurring, customary transaction. Rather, it is extraordinary. Moreover, although a reference to this litigation was included on Schedule 3(b) of the Business Combination Agreement, it was included as part of FMRTL's representations and warranties. Article 4 of the Business Combination Agreement, entitled "Representations and Warranties of FMRTL" provides that, except as set forth on Schedule 3(b), no litigation, arbitration or administrative proceeding, claim, counterclaim, action or governmental investigation is pending or threatened against FMRTL. Thus, the reference to this litigation on Schedule 3(b) was for disclosure purposes only and did not create any assumption of liability therefor. Accordingly, the court finds that the plaintiff has failed to establish that the express-or-implied-assumption exception to the general rule of nonliability applies.

(Internal quotations and citations omitted).

As this decision explains, successor liability is the legal doctrine under which the buyer of a corporation's assets is responsible for claims against the seller. Contact Schlam Stone & Dolan partner John Lundin at if you or a client have questions regarding a situation where a corporation against which there is a claim has sold its assets.