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Bar Journal - Fall 2004

Bielagus v. EMRE: NH Rejects Expansion of Traditional Test for Corporate Successor Liability Following an Asset Purchase

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INTRODUCTION

Under traditional corporation law, a firm that buys the assets of another firm does not thereby incur liability to the seller’s creditors. According to the New Hampshire Supreme Court, this general rule is implicit in New Hampshire law. In particular, this rule is implied in RSA 293-A:12.01, which permits "free alienability of corporate assets in the regular course of business . . . to maximize their productive use."1 Provided that the transaction complies with the requirements of the Business Corporation Act,2 the only statutory basis for imposing liability on the buyer would be a violation of the Fraudulent Transfer Act.3 Application of the Fraudulent Transfer Act would result in liability in cases of actual fraud, purchase for less than reasonably equivalent value, or an insider preference. However, there is a rich body of case law creating other exceptions to the general rule under the collective label "successor liability." Under the successor liability theories, if an asset acquirer is deemed the "successor" of the transferor, then the acquirer is liable for the transferor’s debts as though it were the transferor. In essence, successor liability is an exercise of the court’s equitable power to elevate substance over form. Four theories of successor liability are commonly listed together and invoked indiscriminately in tort, contract, labor, and environmental in modern New Hampshire cases. A fifth, the "product line" theory in products liability cases, is closely related.

Disappointed creditors understandably press for broad application of successor liability. In Bielagus v. EMRE of New Hampshire, the Supreme Court recently put a firm limit on successor liability on ordinary commercial contracts. In the process, the Court rejected one common theory of successor liability and its underlying rationale for both tort and contract claims.4

THEORIES OF SUCCESSOR LIABILITY

Generally, an acquirer of corporate assets will be deemed the transferor’s "successor" for liability purposes if one of four circumstances is found to exist. First, an express or implied agreement between the contracting parties to assume the obligations of the transferor. Second, the asset acquisition amounts to a de facto merger of the two corporations. Third, the acquirer of the assets is a "mere continuation" of the transferor. Fourth, the transfer of assets is entered into fraudulently in order to escape liability for the transferor’s debts.5

The first circumstance, express or implied agreement, is a matter of contract law. It can, however, lead to unexpected liability in poorly documented or executed transactions.6 The second circumstance, de facto merger, is used when the form of the transfer does not accurately portray its substance and a court decides that the new organization is simply the older one in a new guise.7 The third circumstance, mere continuation, focuses on the continuation of the ownership of the original entity rather than continuation of the business operations. It is in substance a reorganization rather than a sale.8 The fourth circumstance, fraudulent transfer, focuses on whether the transfer is a sham or fraud on the creditors.9 This is not necessarily limited to situations where fraudulent transfer statutes would apply,10 nor is the remedy limited by the value of the assets transferred.11

A minority of jurisdictions have added a fifth circumstance, known as the product line exception. Under the product line exception, liability is imposed on the purchaser of a corporation’s assets.12 Under this theory, a successor corporation, which continues to manufacture a predecessor’s product line, assumes strict tort liability for defects in units of the same product line.13 In 1988, the New Hampshire Supreme Court rejected the product line theory of successor liability in Simoneau v. South Bend Lathe, Inc.14

MERE CONTINUATION V. SUBSTANTIAL CONTINUITY

There are narrow and broad versions of the continuation theory of successor liability, and the choice between them was central to the decision in Bielagus. The trial court applied an expanded version of the mere continuation exception. This broader "continuity of the enterprise," or "substantial continuity,"15 theory of successor liability used by the trial court was previously applied by the United States District Court for the District of New Hampshire in Kleen Laundry,16 a Comprehensive Environmental Response, Compensation, and Liability Act 17 (CERCLA) case. The broad continuity theory of successor liability has long been used in certain labor disputes,18 and more recently in CERCLA and products liability law cases.19

While the "mere continuation" rule requires that the seller and successor have essentially the same owners, the "substantial continuity" theory does not.20 Rather, the fact-finder determines whether a successor corporation is a continuation of its predecessor by examining other factors, including: (1) retention of the same employees; (2) retention of the same supervisors; (3) retention of the same production facilities; (4) production of the same product; (5) use of the same name; (6) continuity of assets; (7) continuity of business operations; and (8) representation as the same corporation to others.21 None of these is material under the traditional "mere continuation" rule. They are, however, relevant to the traditional de facto merger theory, but are unlikely to be decisive.

In Bielagus, the New Hampshire Supreme Court affirmed the trial court’s denial of liability under the facts of the case but disapproved of its application of the broader theory of continuity. In Bielagus, the court held that the continuity theory is not recognized under New Hampshire law in the context of commercial, contract, or products liability cases.22

FACTUAL BACKGROUND OF BIELAGUS

The relevant facts of this case were not in dispute. The plaintiffs, Barbara Bielagus and The Norwood Group, Inc., were holders of an unsecured promissory note for one million dollars executed by the defendant’s predecessor, The Norwood Realty, Inc., in 1986. The note was neither secured by Norwood Realty’s assets nor guaranteed by its shareholders.

In 1992, Norwood Realty defaulted on both the note and a separate secured obligation of $3.6 million dollars to the FDIC. When the plaintiffs filed suit in 1995 for the balance due on their note, Norwood Realty was soliciting offers to sell its assets. The plaintiffs obtained a jury verdict for the $530,000.44 balance due, on which a final judgment was entered in 2001.

In 1995, during the litigation, Norwood Realty negotiated an asset purchase agreement to sell virtually all of its business assets, including its trade name, to the defendant, Eastern Massachusetts Real Estate Corporation (EMRE). According to the agreement, EMRE was to pay $675,000.00 cash for the business assets of Norwood Realty’s real estate division. No shares of corporate stock were exchanged. The agreement included the purchase of furniture, fixtures, leases, license agreements, listing agreements, broker agreements, as well as operating expenses and accounts payable related to Norwood Realty’s residential real estate division. The agreement also required Norwood Realty’s shareholders to change the trade name for its commercial real estate division, which was not sold, and to execute non-competition agreements. EMRE offered two-year employment contracts to Norwood Realty’s former officers and only shareholders, Robert and Rose Marie Phillips. In addition, the agreement expressly disclosed the existence of the plaintiffs’ lawsuit, and provided that EMRE "shall not assume and shall not be obligated to pay any of the liabilities or obligations of [Norwood Realty], except liabilities and obligation [sic] accruing after the Closing Date."23

After the purchase, EMRE operated Norwood Realty’s residential real estate assets from the same branch offices and with most of the same brokers previously employed by Norwood Realty. The former Norwood Realty continued to operate under the trade name "Robert Spencer Real Estate Associates" and its commercial real estate division took the name Granite Commercial Group, Inc. All of the proceeds from the sale of Norwood Realty’s residential division were used to satisfy the secured debt owed the FDIC, leaving no funds to pay the plaintiffs unsecured claim. The surviving remnants of the original defendant apparently showed little prospect of paying the judgment. Thus, the plaintiffs sought to impose liability for their judgment against Norwood Realty on EMRE using successor liability theories.

The trial court ruled as a matter of law that EMRE was not liable for the judgment on the promissory note under either the de facto merger, substantial continuity, or fraudulent transfer theories of successor liability. On appeal, the plaintiffs abandoned the fraud theory but challenged the holdings regarding de facto merger and continuity. EMRE challenged the application by the trial court of the expanded "continuity of the enterprise" or "substantial continuity" variation of the mere continuation rule. EMRE asked for a ruling that such an expanded doctrine does not apply to commercial contract cases in New Hampshire.

THE COURT’S DE FACTO MERGER ANALYSIS

In successor liability, the de facto merger exception is used to ensure that each corporation, in the words of the New Hampshire Supreme Court, has "run its own race."24 "[A] de facto merger occurs when a company is completely absorbed into another through a sale of its assets; continues its operations by maintaining the same management, personnel, assets, location and stockholders; but leaves its creditors without a remedy for its outstanding debt."25 The four non-exclusive factors used by courts to find a de facto merger are: (1) whether there is a continuation of the enterprise of the seller corporation, including continuity of management, personnel, physical location, assets, and general business operations; (2) whether there is a continuity of shareholders such that the selling shareholders become a constituent part of the purchasing corporation; (3) whether the seller ceases its ordinary business operations, liquidates, and dissolves as soon as possible; and (4) whether the purchaser assumes the obligations ordinary and necessary for the uninterrupted continuation of normal business operations of the seller.26

For the New Hampshire Supreme Court, the keys to finding a de facto merger for purposes of successor liability are the same as in traditional corporate law – the exchange of stock and continuity of ownership – because the shareholders are the indirect beneficiaries of any increase in a corporation’s assets or any decrease in its liabilities.27 Although the New Hampshire Supreme Court declared the factors to be non-exclusive, it maintained that the factor of continuity of ownership in the form of a stock exchange usually tips the scales in finding a de facto merger. The Court does not expressly state whether a stock exchange resulting in continuity of ownership alone could constitute a de facto merger. However, in a more generalized fashion, the Court did note that if the results of a statutory merger are not achieved, then it is not likely there is a de facto merger.28

In Bielagus, the Court did not find a de facto merger was found even though continuity of Norwood Realty’s residential real estate operations existed with the same locations, management, personnel, and assets because there was no continuity of shareholders and the assets were not bought with stock.29 In addition, Norwood Realty did not cease its ordinary business practices, but rather it formed two new corporations, one responsible for its legal obligations, and the other to continue operating its commercial real estate operations.30 Norwood Realty did not pass the baton; it sold its residential real estate assets, paid its secured debts, changed its trade name, and continued its race in the commercial real estate market.31 Finally, the defendant assumed Norwood Realty’s business obligations, but expressly did not assume any obligations of the commercial real estate division or the known legal obligations (i.e., the note) incurred prior to the closing date of the Agreement.32 In the end, two of the four factors were found to be present, but not the factor deemed most important by the New Hampshire Supreme Court, and a de facto merger was not found. Indeed, the two factors that were present (continuation of the enterprise and assumption of ongoing obligations necessary to accomplish that) are present in all acquisitions of an ongoing business. The question remains whether an exchange of the successor’s stock for assets without dissolution of the resulting holding company could be enough to find a de facto merger for purposes of successor liability. Such a transaction could also be attacked as a "mere continuation."

THE COURT’S CONTINUITY ANALYSIS

Traditionally, the mere continuation rule of successor liability applies when only one corporation remains after the transfer of assets and "there is an identity of stock, stockholders, and directors between the two corporations."33 Under this version, liability is placed on the purchasing corporation because the purchaser is viewed merely as the seller reincarnated as a different entity.34 The critical factor in finding a mere continuation is the continuation of the beneficial ownership and control, not the business operation, after the transaction.35

Under the expanded "substantial continuity" version, proof of continuity of ownership is not required.36 Rather, the fact-finder determines whether a successor corporation is a continuation of its predecessor by examining eight factors, including: (1) retention of the same employees; (2) retention of the same supervisors; (3) retention of the same production facilities; (4) production of the same product; (5) use of the same name; (6) continuity of assets; (7) continuity of business operations; and (8) representation as the same corporation to others.37

The federal courts apply this broad continuity theory in contribution cases under CERCLA.38 Both federal courts and the New Hampshire Supreme Court use substantial continuity tests within their respective spheres of jurisdiction to determine when a successor is bound by a collective bargaining agreement.39 Other states employ it in products liability cases as an alternative to the product line theory,40 although only a "small minority of courts" have embraced either.41 None of these situations involves a party whose claim arises from a simple contract. They involve torts, other involuntary obligations, or overriding public policy interests— not directly-bargained, unsecured business loans. If the substantial continuity test were applied in cases like Bielagus, commercial creditors would receive a windfall (an extra obligor) and a fundamental characteristic of ordinary asset-purchase acquisitions would disappear in many, if not most, cases. The New Hampshire Supreme Court observed that the "expansive theory of successor liability… is grounded upon public policies that are not applicable to traditional commercial and contract law, which are governed by predictability of results and the intentions of the parties."42 The Court’s holding implied that, regardless of the merits risk or cost spreading might have for industrial torts or environmental cleanups, they make no sense when applied to transactions where the risks are defined and consciously allocated as part of a bargain.

Having dispensed with the broader continuity theory, the New Hampshire Supreme Court went on to hold that, under the traditional mere continuation exception, the defendant was not liable on the plaintiffs’ judgment.43 The fact that three separate entities with three different owners survived the asset purchase precluded successor liability as a matter of law under the traditional mere continuation exception.44

Under New Hampshire law commercial creditors are entitled to the obligations, collateral, and sureties for which they bargain, plus such protection against misapplication of assets as is given by the law of fraudulent transfers and the statutes under which the debtor is organized. Occasionally, a successor will be subject to an implied assumption, and occasionally there will be an actual fraud. Otherwise, when there is in fact a change of ownership, the courts will not impose successor liability.

CORRECTING FEDERAL MISUNDERSTANDING OF NEW HAMPSHIRE LAW

While a survey of the law of successor liability was clearly appropriate, it is possible that at least one of the reasons the Bielagus appeal was accepted had little to do with commercial transactions. The New Hampshire Supreme Court used this opportunity to reiterate its holdings expressly rejecting the doctrine of risk spreading as a basis for successor liability in products liability cases— holdings overlooked by the federal courts in diversity cases, by courts of other states, and by treatise writers.45

The federal courts have continually read into New Hampshire law the doctrine of risk spreading. In 1974, the First Circuit, interpreting New Hampshire law, used the doctrine of risk spreading in Cyr v. B. Offen to impose strict liability on a successor corporation in a products liability case, holding it liable for the manufacturing defects of its predecessor.46 Four years later in Thibault v. Sears, Roebuck and Co., the New Hampshire Supreme Court broadly rejected the doctrine of risk spreading, requiring proof of some fault on the part of the defendant before imposing strict liability. The Thibault Court stated that "the common-law principle that fault and responsibility are elements of our legal system applicable to corporations and individuals alike will not be undermined or abolished by ‘spreading’ of risk and cost in this State."47 In 1988, the United States District Court for the District of New Hampshire certified a question to the New Hampshire Supreme Court regarding whether New Hampshire law recognizes the product-line theory of successor liability, a primary justification for which is the opportunity for meeting the cost arising from the risk of injury by spreading it among current purchasers of the product line.48 The New Hampshire Supreme Court reiterated its reasoning in Thibault and expressly stated that "to the extent Cyr v. B. Offen suggests that we embrace risk spreading, it is no longer a valid interpretation of New Hampshire law."49 Apparently, however, the bar and federal bench have overlooked this rejection of the doctrine on which both the product line and substantial continuity theories rest. In at least three reported cases after Simoneau the federal district court has applied the broader substantial continuity test with no indication that counsel objected.50

In Kleen Laundry, the United States District Court for the District of New Hampshire again made use of the doctrine of risk spreading to impose successor liability under the expanded continuity theory in a CERCLA case.51 Although in Kleen Laundry the issue was governed by federal law "interpreted to further the goals of [CERCLA],"52 the Bielagus trial court relied upon Kleen Laundry as authority for applying the expanded continuity theory of successor liability in the context of commercial contract law. Thus, the New Hampshire Supreme Court was again faced with the doctrine of risk spreading, but this time the question was whether it applied in the context of contract law to impose liability on a successor corporation for the commercial debts of a predecessor.53 In rejecting the doctrine of risk spreading, again, the New Hampshire Supreme Court, in apparent frustration, noted that other courts and a products liability treatise have cited Kleen Laundry for the proposition that New Hampshire law recognizes the substantial continuity theory of successor liability.54 To which, the New Hampshire Supreme Court responded, "we take this opportunity to reiterate our Simoneau ruling that "to the extent Cyr does suggest that we embrace risk spreading, it is no longer a valid interpretation of New Hampshire Law."55

CONCLUSION

The New Hampshire Supreme Court has made it clear that New Hampshire law recognizes the four traditional exceptions to the general rule prohibiting the imposition of successor liability. 56 As well, the Court seems to implicitly contemplate the invocation of all of the traditional types of successor liability by creditors left with no effective remedy after an asset sale. Although the plaintiffs lost in Bielagus, their use of successor liability theory in an attempt to collect an unsecured debt from a successor corporation was challenged only to the extent they attempted to expand the traditional grounds. The applicability of successor liability in addition to fraudulent transfer law in this situation means attorneys structuring asset purchase agreements that leave creditors unpaid cannot rely solely on adequacy of consideration to protect the purchaser— it is still possible to be "too clever by half."57 However, the simple sale of unencumbered assets to new owners, free of the seller’s debts, is to be encouraged, and will not be subverted by any expansion of the traditional exceptions, even at the behest of product liability victims. The New Hampshire Supreme Court expressly rejects the expanded continuity exception for successor liability in commercial, contract, and products liability law.58 The general principle of free alienability has been declared in Thibault, in Simoneau, and now again in Bielagus. This should end the line of federal diversity cases undercutting that principle.

ENDNOTES

  1. Bielagus v. EMRE of New Hampshire Corp., 149 N.H. 635, 640 (2003).
  2. NH RSA 293-A, particularly § 12.02, Sale of Assets Other than in Regular Course of Business.
  3. NH RSA 545-A.
  4. Bielagus, 149 N.H. at 640.
  5. Id.; Marie T. Reilly, Making Sense of Successor Liability, 31 Hofstra L. Rev. 745, 746 (2003).
  6. An example is Zimmerman v. Suissevale, Inc. 121 N.H. 1051 (1981).
  7. Reilly, 31 Hofstra L. Rev. at 747.
  8. Welco Industries v. Applied Companies, 617 N.E.2d 1129, 1134 (Ohio 1993).
  9. Reilly, 31 Hofstra L. Rev. at 746.
  10. See, e.g., Lessard v. Applied Risk Management, 307 F. 3d 1020 (9th Cir. 2002).
  11. Reilly, 31 Hofstra L. Rev. at 765.
  12. See, e.g., Ray v. Alad Corporation, 560 P.2d 3 (Cal. 1977).
  13. Ray, 560 P.2d at 11.
  14. Simoneau v. South Bend Lathe, Inc., 130 N.H. 466, 467 (1988).
  15. The New Hampshire Supreme Court and other courts use these terms interchangeably. They both stand for the same concept of expanding the "mere continuation" exception. I will generally use the terms "substantial continuity" or "broader theory of continuity".
  16. Kleen Laundry & Dry Cleaning v. Total Waste Mgt., 817 F. Supp. 225, 231 (D.N.H. 1993).
  17. 42 U.S.C. §§ 9601-9675 (1994).
  18. Appeal of SAU #16 Cooperative School Board, 143 N.H. 96 (1998).
  19. Kleen Laundry, 817 F. Supp. at 231.
  20. Id. at 232; Bielagus, 149 N.H. at 645.
  21. Kleen Laundry, 817 F. Supp. Id. at 231; Bielagus, 149 N.H. at 645.
  22. 149 N.H. Id. at 645.
  23. Id. at 638.
  24. Id. at 641.
  25. Id.
  26. Id. at 642.
  27. Id.
  28. Id. at 643-644.
  29. Id. at 642.
  30. Id. at 642-643.
  31. Id. at 644.
  32. Id. at 643.
  33. Kleen Laundry, 817 F. Supp. at 231.
  34. Bielagus, 149 N.H. at 644.
  35. Welco, 617 N.E.2d at 1134.
  36. Kleen Laundry, 817 F. Supp. at 232, cited in Bielagus, 149 N.H. at 645.
  37. Kleen Laundry, 817 F. Supp. at 231, cited in Bielagus, 149 N.H. at 645.
  38. See, e.g., Kleen Laundry, 867 F. Supp. at 1136.
  39. Appeal of SAU #16 Cooperative School Board, 143 N.H. 96 (1998) (adopting the federal test).
  40. Turner v. Bituminous Cas. Co., 397 Mich. 406, 244 N.W.2d 873 (
  41. Mich. 1976T1976).
  42. Restatement (Third) Torts: Products Liability § 12, comment b.
  43. Bielagus, 149 N.H. at 646.
  44. Id. at 647.
  45. Id. at 646-6
  46. Id.
  47. See Cyr v. B. Offen, 501 F.2d 1145 (1st Cir. 1974).
  48. Thibault v. Sears, Roebuck & Co.,118 N.H. 802, 806 (1978).
  49. Simoneau v. South Bend Lathe, Inc., 130 N.H. 466.
  50. Id. at 470.
  51. Nichols v. Roper-Whitney Co., 843 F. Supp. 799 (D.N.H. 1994); MacClerry v. T.S.S. Retail Corp., 882 F. Supp. 13 (D.N.H. 1994); Kelly v Kercher Machine Works, 910 F. Supp 30 (D.N.H. 1995).
  52. 517 F. Supp. at 231.
  53. Id.
  54. See Bielagus, 149 N.H. at 635.
  55. Bielagus, 149 N.H. Id. at 646 (citing Savage Arms, Inc. v. Western Auto Supply, 18 P.3d 49, 56 (Alaska 2001) (citing Restatement (Third) of Torts: Products Liability § 12 (1998)).
  56. Bielagus, 149 N.H. at 646.
  57. Id. at 648.
  58. Lessard v. Applied Risk Management, 307 F. 3d at 1027 (Kozinski concurring) (9th Cir. 2002) (Kozinski concurring).
  59. Bielagus, 149 N.H. at 648.

Author

Michael J. Zaino, Class of 2004, Franklin Pierce Law Center, Concord, New Hampshire.

 

 

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