Successor Liability Following Sale of Corporate Assets

by | Apr 28, 2011 | Business & Commercial Litigation, Litigation

Sales of corporate assets have long been a legitimate method of raising capital. Sometimes, they are the only realistic way for small businesses to stave off insolvency. Yet, in the current economic climate, disappointed creditors often attempt to follow assets when their debts prove to be noncollectable. This article explains Indiana law on the subject of successor liability following asset sales and, accordingly, provides something of a blueprint asset buyers can use to avoid inadvertently assuming liabilities of the seller.

The general rule in Indiana is that when one corporation purchases assets from another, the buyer does not assume the debts and liabilities of the seller. Sorenson v. Allied Products Corp., 706 N.E.2d 1097, 1099 (Ind. Ct. App. 1999) (citing Winkler v. V.G. Reed & Sons, Inc., 638 N.E.2d 1228, 1233 (Ind. 1994)). There are four generally recognized exceptions to this rule: (1) an implied or express agreement to assume the obligation; (2) a fraudulent sale of assets done for the purpose of escaping liability; (3) a purchase that is de facto consolidation or merger; or (4) instances where the purchase is a mere continuation of the seller. Id. Under these exceptions, a successor corporation is liable only when the predecessor corporation no longer exists. Id. See also, Guerrero v. Allison Engine Co., 725 N.E.2d 479, 483 (Ind. Ct. App. 2000). However, an asset sale from an already insolvent seller, or one that renders the seller insolvent, will probably be scrutinized under the exceptions, even though the seller entity may technically still be in existence.

The Asset Purchase Agreement between buyer and seller should specifically state “Buyer does not assume or agree to pay any liabilities or obligations whatever connected with Seller or Seller’s business.” If some obligations are to be assumed, but no others, the Agreement should spell that out in detail.

As to potential successor liability for a fraudulent transaction, the courts have said that

Fraudulent intent can be inferred from certain indicia called “badges of fraud.” … Some of the badges from which fraudulent intent can be inferred include: 1) the transfer of property by a debtor during the pendency of a suit; 2) a transfer of property that renders the debtor insolvent or greatly reduces his estate; 3) a series of contemporaneous transactions which strip the debtor of all property available for execution; 4) secret or hurried transactions not in the usual mode of doing business; 5) any transaction conducted in a manner differing from customary methods; 6) a transaction whereby the debtor retains benefits over the transferred property; 7) little or no consideration in return for the transfer; and 8) a transfer of property between family members. …When there is a concurrence of several badges of fraud an inference of fraudulent intent may be warranted. … However, no one badge of fraud constitutes a per se showing of fraudulent intent. … Rather, the facts must be taken together to determine how many badges of fraud exist and if together they constitute a pattern of fraudulent intent.

Lee’s Ready Mix & Trucking v. Creech, 660 N.E.2d 1033, 1037 (Ind.Ct.App. 1996) (citations omitted).  In general, to avoid being labeled a fraud, the asset sale transaction should be at arm’s length. Assets should be sold for as close to fair market value as possible under the circumstances. An independent appraisal of assets prior to sale is very helpful.

The last two exceptions – a de facto consolidation or merger, or where the purchaser is a “mere continuation” of the seller – are closely related concepts. The criteria for establishing a de facto merger are: (1) continuity of ownership; (2) continuity of management, personnel, and physical operation; (3) cessation of ordinary business and dissolution of the predecessor as soon as practically and legally possible; and (4) assumption by the successor of the liabilities ordinarily necessary for the uninterrupted continuation of the business of the predecessor. Sorenson v. Allied Prods. Corp., 706 N.E.2d 1097, 1098 (Ind.Ct.App. 1999) Another case cited, as a major factor in support of a finding of de facto merger, a transfer of stock as consideration for the purchase of the assets. Travis v. Harris Corp., 565 F.2d 443, 447 (7th Cir. 1977).

The test for a “mere continuation” of the seller’s business is not the continuation of the business operation, but rather the continuation of the corporate entity. An indication that the corporate entity has been continued is a common identity of officers, directors, and stockholders and the existence of only one corporation at the completion of the transfer. The doctrine of “mere continuation” asks whether the predecessor corporation should be deemed simply to have re-incarnated itself, largely aside from the business operations. Factors pertinent to this determination include whether there is a continuation of shareholders, directors, and officers into the new entity. Cooper Indus. LLC v. City of South Bend, 899 N.E.2d 1274, 1290 (Ind.Ct.App. 2009).

In summary, if the asset sale is properly documented, reflects an arm’s length, fair market value transaction, and the seller and buyer do not have overlapping ownership, it is very unlikely that the buyer will find itself being subjected to liability for the debts of the successor. Please note that these concepts apply most directly to situations where an asset buyer is claimed to be responsible for the contract debts of the seller, as opposed to the tort liability of the seller. Different policy considerations are at work in the tort arena, especially as regards product liability, and the analysis is quite different.

More about Robert F. Parker

More about Robert F. Parker

Bob is an Of Counsel attorney at BCC and is resident in the firm’s Merrillville office. His practice is concentrated in commercial, professional liability, and personal injury litigation.