Avoiding Successor Liability When Purchasing a Business
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When purchasing a business, prospective buyers must take extreme care to ensure they are not also assuming the liabilities of that business. Florida follows the traditional corporate law rule which generally does not impose the liabilities of a predecessor business on a successor business. However, that rule is not absolute and exceptions exist that may result in a purchaser becoming responsible for the debts of the business being acquired. This Blog post will discuss the exceptions to the general rule and provide guidance on avoiding successor liability when purchasing a business.
In Bernard v. Kee Mfg. Co., Inc., Florida’s Supreme Court adopted the traditional corporate law rule and its exceptions by holding that the liabilities of the selling predecessor will not be imposed on the buying successor company “unless (1) the successor expressly or impliedly assumes obligations of the predecessor, (2) the transaction is a de facto merger, (3) the successor is a mere continuation of the predecessor, or (4) the transaction is a fraudulent effort to avoid liabilities of the predecessor.” 409 So.2d 1047, 1049 (Fla. 1982). The reason for the exceptions to the traditional rule is “based on the notion that no corporation should be permitted to commit a tort or breach of contract and avoid liability through corporate transformation in form only.” Lab. Corp. of America v. Prof’l Recovery Network, 813 So.2d 266, 269 (Fla. 5th DCA 2002). A purchaser intending to acquire only the physical assets, intangible assets or naming rights of the predecessor business must avoid falling into one of these four exceptions and unintentionally becoming liable for any debt as a result. What follows is an explanation of the four exceptions and how successor liability may be imputed under each.
Express or Implied Assumption of the Debt:
This exception can apply as a matter of contract depending upon the terms of the underlying agreement. For example, express assumption of the predecessor’s debt exists when the terms of the contract contain exact language to this effect. On the other hand, if the contract is ambiguous then it is possible that assumption of the predecessor’s debt could be implied through extrinsic evidence such as the statements made or actions taken by the owners and/or corporate officers involved in the business transaction. Ways to avoid assumption of the debt being implied is to clearly state in the contract that the predecessor’s liabilities are not being assumed or to have the seller warrant and represent that the business assets are free and clear of all liens and encumbrances, while also including a seller indemnification clause that protects the purchaser if there is a breach of those seller warranties and representations.
Express or implied assumption of debt will also occur as a matter of law if the statutory formalities for merger or consolidation are met. See Fla. Stat. § 607.1106. “When a merger becomes effective the surviving corporation shall thenceforth be responsible and liable for all the liabilities and obligations of each corporation party to the merger.” Fla. Stat. § 607.1106(1)(c).
De Facto Merger:
A de facto merger occurs where a business is absorbed by another without complying with the statutory requirements for a merger. Lab. Corp of America, 813 So.2d at 270. In finding de facto merger, a court can look to numerous factors reasonably indicative of commonality or of distinctiveness with the main focus being “whether there has been a change in form, but not in substance.” Id. Courts have identified a few of the more significant factors. “To find a de facto merger there must be continuity of the selling corporation evidenced by the same management, personnel, assets and physical location; a continuity of the stockholders, accomplished by paying for the acquired corporation with shares of stock; a dissolution of the selling corporation; and assumption of the liabilities.” Amjad Munim, M.D., P.A. v. Azar, 648 So.2d 145, 154 (Fla. 4th DCA 1994).
Not all of the events articulated above need occur at the same time. To illustrate, a de facto merger was found to have occurred even though the selling corporation was not dissolved until 18 months after the sale. See Knapp v. North Amer. Rockwell Corp., 506 F.2d 361, 367 (3d Cir. 1974). As one Florida court put it, “the bottom-line question is whether each entity has run its own race, or whether there has been a relay-style passing of the baton from one to the other.” Lab. Corp of America, 813 So.2d at 270.
Mere Continuation of Predecessor:
This exception exists when the successor business is merely a “continuation or reincarnation of the predecessor corporation under a different name,” such as when the “purchasing corporation is merely a ‘new hat’ for the seller, with the same or similar entity or ownership.” Bud Antle, Inc. v. Eastern Foods, Inc., 758 F.2d 1451, 1458 (11th Cir. 1985). Thus, some key factors in finding a continuation of the predecessor business include a “common identity of the officers, directors and stockholders in the selling and purchasing corporation.” Munim, 648 So.2d at 154. Florida’s Fourth District Court of Appeal also explained that “while having common attributes does not automatically impose liability on a successor corporation, merely repainting the sign on the door and using new letterhead certainly gives the appearance that the new corporation is simply a continuation of the predecessor corporation.” Lab. Corp. of America, 813 So.2d at 270.
Although technically they are two different exceptions, de facto merger and mere continuation of predecessor have very similar tests. Each “occurs when one corporation is absorbed by another, i.e., there is a continuity of the selling corporation evidenced by such things as the same management, personnel, assets, location and stockholders.” See Id. (quoting 300 Pine Island Assoc. v. Steven L. Cohen & Assoc., 547 So.2d 255, 256 (Fla. 4th DCA 1989). Similar to de facto merger, continuation of the predecessor presents itself when there is a change in form, but not in substance. Id.
Fraudulent Transfer of Assets by Predecessor:
Florida follows the Uniform Fraudulent Transfer Act (UFTA), which states that any transfer made with “actual intent to hinder, delay or defraud” any current or future creditor is considered a fraudulent transfer. Fla. Stat. § 726.105. Because actual intent to defraud is hard to prove, Florida courts, guided by the UFTA, will look to indicia of fraudulent intent referred to as “badges of fraud.” Fla. Stat. § 726.105(2). Stated another way, “when the legal effect of a conveyance is to hinder or delay creditors, the intent [to defraud] will be presumed, regardless of the actual motives of the parties.” Munim, 648 So.2d at 152. Certain badges of fraud include, but are not limited to: (1) the transfer occurring shortly before or after a substantial debt was incurred; (2) the debtor retaining possession or control of the property after the transfer; (3) the debtor absconding; or (4) the debtor becoming insolvent shortly after the transfer was made. Fla. Stat. § 726.105(2). Additionally, if the corporation was transferred to an insider or was sold for little or no consideration, fraudulent intent may also be inferred. Munim, 648 So.2d at 152.
In conclusion, Florida’s adoption of the traditional corporate law rule generally protects the buying successor company from the liabilities of the selling predecessor. However, prospective purchasers must be aware that this protection comes with exceptions. To ensure the predecessor’s liabilities do not follow its assets, a purchaser should consult with an attorney to determine whether any of the four exceptions listed above are present in the transaction or exist in the relationship between the two business entities and its leaders.