This blog post is prompted by an important, recent decision and case of “first impression” by the Connecticut Supreme Court containing valuable discussion of the special rules governing successor liability – Robbins v Physicians Women’s Health. (See case notes and citation below.) The following is oriented to Connecticut law, but many jurisdictions have similar rules.
How Successor Liability Arises – The General Rules:
Let’s assume a buyer wants to buy an existing business (or portion of a business). While there are many important considerations in a potential sale or purchase, successor liability (and how to avoid it) must be carefully considered. Agreements for business acquisitions are generally structured as either: (1) mergers or stock purchases of a company’s equity; or (2) purchases of the selling entity’s assets. Successor corporations may be liable for the debts and liabilities of the predecessor where there is a merger or consolidation of the two; or where there is a purchase of equity (corporate shares or LLC membership interests). Unlike most asset purchases where assets are typically transferred free of debts and liabilities. But care must be taken to ensure the right result.
Generally speaking, a purchaser can avoid successor liability by purchasing the assets of the selling entity, rather than purchasing the entity, itself. As the high court Robbin’s decision notes,” the general rules of corporate nonliability serve, in effect, as a security blanket to protect corporate successor from unknown or contingent liabilities of their predecessors”. But deals have to be structured correctly to avoid these perils and there are important exceptions.
Exceptions to the Rules Limiting Successor Liability:
As the Connecticut Supreme Court states in the Robbins decision, the rule limiting liability is nonetheless subject to four well-established exceptions. As successor corporation may be held liable for the debts and liabilities of its predecessor when: “(1) there is an express or implied assumption of liability; (2) the transaction amounts to a consolidation or merger; (3) the transaction is fraudulent; or (4) the transferee corporation is a mere continuation or reincarnation of the old corporation.”
The specific issue decided by the Supreme Court in Robbins was limited to: “Did the Appellate Court properly determine that the covenant not to sue executed by the Plaintiff in favor of a corporate tortfeasor does not foreclose imposition of successor liability, as a matter of law, on the subsequent purchaser of that company’s assets?” The Defendant in the case claimed the covenant not to sue executed by the Plaintiff in favor of a predecessor entity (Shoreline) prior to the acquisition by Physicians Women’s Health discharged any action against both Shoreline and its successors. The Supreme Court agreed.
The court found the covenant not to sue persuasive in precluding the Plaintiff from bringing an action against the subsequent purchaser, who later acquired Shoreline’s business. If you intend to purchase a business, it’s imperative that the purchase be structured to provide sufficient protections from these kinds of claims. And the old adage “Buyer Beware” always applies. Purchasers need to conduct appropriate levels of due diligence and have strong contractual provisions they can rely on after the closing to avoid the prospect of any later arising, expensive problems.
(Case Notes: The Robbins decision was published in 304 Conn. 926 and contains an interesting discussion of covenants not sue versus releases and various theories advanced by Plaintiff, including the liability of employers and joint tortfeasors under theories or respondent superior, which the court found unpersuasive “straw man” theories. The underlying case involved a medical malpractice claim that Plaintiff had settled with Shoreline where she provided covenants not to sue in connection with the settlement. Shoreline was later bought out by a successor medical provider and Plaintiff attempted additional recovery from Shoreline’s successor.)