As discussed in previous posts, the creation of a formal corporate entity and compliance with state prescribed formalities can offer business owners and members substantial protections from individual liability for business debts when acting by and through an entity. This compliance with formality can also offer substantial protections in the common event of one entity (a “Successor Entity”) purchasing, or otherwise succeeding, another entity (a “Predecessor Entity”).
As a general rule, in the absence of a contractual obligation, individual corporate entities are not liable for the debts of other corporate entities. However, there are exceptions to every rule and there are instances when a Successor Entity can be held liable for the debts and liabilities of a Predecessor Entity. Specifically, this so called “successor liability” can attached in instances where, “(1) the successor expressly or impliedly assumes liability of the predecessor, (2) the transaction is a de facto merger or consolidation, (3) the successor is a mere continuation of the predecessor, or (4) the transaction is a fraudulent effort to avoid the liabilities of the predecessor.” Premier Capital, LLC v KMZ, Inc. (2013).
The Appeals Court of the Commonwealth of Massachusetts recently considered this very successor liability standard. In Fashionhaus, LLC v T&C Mail Street, Inc. et al (2018), the Court considered whether the relationship between the defendant entities was that of two independent entities, such that the liabilities of the old entity were distinct from the new entity, or whether the defendant entities were essentially one in the same, such that the new entity could be held accountable for the old entities liabilities.
After considering a multitude of factual considerations, the Court ultimately held the defendant entities did not behave in a manner to impose successor liability onto the new entity. The Court determined that there was no de facto merger or consolidation as ‘all’ or ‘substantially all’ of the Predecessor Entities’ assets were not transfer to the Successor Entity and sufficient separation was maintain relative to the operations of the Successor and Predecessor Entities. Additionally, the Court found no evidence of fraud.
Thus, whether considering the purchase of an entity, or winding down an existing company to operate under a new corporate form, it is important that one understands how to avoid the pitfalls of potential successor liability. As previously noted, adherence to the prescribed steps is paramount to limiting future liabilities as they may relate to corporate entities. If you have questions with regard to business formation and/or operations you should consult with a knowledgeable attorney to determine your best options.