SUCCESSOR LIABILITY IN TRANSACTIONS First Run Broadcast: June 14, :00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T.

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1 SUCCESSOR LIABILITY IN TRANSACTIONS First Run Broadcast: June 14, :00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes) The general rule is that when a buyer takes ownership of an asset it takes ownership only of the asset and not also the liabilities or other obligations of the seller, unless those other liabilities are explicitly assumed. But there plentiful exceptions to the general rule that tag the buyer with substantial liability for the debt or other obligations of the seller s business. This liability can dramatically scuttle the basic economic assumptions of the parties entering the sale. This program will provide you with a real world guide to identifying the risks of successor liability in various transactions, including liability under common and statutory law, special bankruptcy and foreclosure issues, and discuss drafting techniques to limit or eliminate the risk of successor liability. Successor liability in asset purchases in ordinary and major business transactions Fact patterns giving rise to successor liability business continuation, de facto mergers, fraud, product line continuation Buyer liability at UCC Article 9 foreclosure sales Successor liability under federal employment and environmental statutes and under state sales/use tax law Special issues in buying property out of bankruptcy Drafting techniques to limit or eliminate the risk of liability Speaker: John Murdock is a partner in the Nashville office of Bradley Arant Boult Cummings, LLP, where his practice includes business acquisitions and dispositions, commercial lending, and commercial law generally. He is a member of the Commercial Financial Services Committee of the ABA Business Law Section and formerly served as chair of its Lender Liability Subcommittee. He is also a Fellow of the American College of Commercial Finance Lawyers. Mr. Murdock received his B.S., magna cum laude, from Vanderbilt University and his J.D. from Vanderbilt University Law School.

2 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address Successor Liability in Transactions Teleseminar June 14, :00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER June 7, 2016 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: June 14, 2016 Seminar Title: Location:

3 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: June 14, 2016 Seminar Title: Location: Credits: Program Minutes: Successor Liability in Transactions Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

4 Successor Liability in Asset Acquisitions John E. Murdock III Bradley Arant Boult Cummings LLP Nashville, Tennessee (o) (615) I. Scope The purchase of a business may be accomplished by the purchase of the equity of the entity that operates the business or by the purchase of the relevant assets from that entity. If the equity of a business is purchased, the business entity itself remains liable for all of its obligations, and all of its assets remain available to satisfy its creditors. If the assets of a business are purchased, however, the purchaser does not necessarily inherit any of the liabilities of the seller. In fact, most business acquisitions that are structured as asset sales are so cast for the specific purpose of avoiding the purchaser's automatic assumption of liabilities of the seller. There are many ways that liabilities of a seller of assets may follow particular assets into the hands of a purchaser. This may result by agreement, as often the buyer contractually assumes liability for specific secured or unsecured obligations of the seller. It is also possible, however, that liabilities of the seller may fall upon the purchaser by operation of law. This can occur pursuant to statute, such as pursuant to the bulk sales provisions of the UCC in the few states where those provisions remain in effect, or pursuant to sales tax and property tax statutes that expressly impose liability upon successors at asset purchases. This can also occur through operation of common law principles. This monograph primarily addresses common law principles of successor liability in purchases of business assets. II. General Rule of Non-Liability A transferee of assets is not under ordinary circumstances liable for the debts of its predecessor. See, e.g., Luxliner P.L. Export, Co. v. RDI/Luxliner, Inc., 13 F.3d 69 (3d Cir. 1993); Polius v. Clark Equip. Co., 802 F.2d 75 (3d Cir. 1986); Conway v. White Trucks, a Div. of White Motor Corp., 692 F. Supp. 442 (M.D. Pa. 1988), aff'd, 885 F.2d 90 (3d Cir. 1989); Woodrick v. Jack J. Burke Real Estate, Inc., 703 A.2d 306, (N.J. Super. Ct. App. Div. 1997), cert. granted sub nom. Woodrick v. Fox & Lazo, Inc., 708 A.2d 65 (N.J. 1998), appeal dismissed, 724 A.2d 799 (N.J. 1998); 15 W. Fletcher, Cyclopedia of the Law of Private Corporations, There are, however, several significant exceptions to this general rule. 7/

5 III. Exceptions to General Rule of Non-Liability A. Assumption. The purchaser will become liable for the debts of the seller to the extent the purchaser agrees to assume the selling corporation's liabilities (or certain chosen liabilities). In a voluntary transaction, the asset purchase agreement generally will contain provisions detailing which liabilities are assumed and which liabilities are not assumed. In addition, a court may hold that a company has impliedly assumed certain liabilities if there is not an express exclusion provision and certain other factors are present. See Luxliner, 13 F.3d at 69; Kessinger v. Grefco, Inc., 875 F.2d 153 (7 th Cir. 1989), reh'g denied, 1989 U.S. App. LEXIS (7th Cir. July 19, 1989); Dayton v. Peck, Stow & Wilcox Co., 739 F.2d 690, 692 (1st Cir. 1984). B. De Facto Merger. The de facto merger theory is applied by courts to transactions purporting to be sales of business assets, but having elements more characteristic of a merger or consolidation. The theory arose under corporate law to prevent owners of a corporation from retaining the benefits of ownership of a business while shedding liabilities by a purported asset transfer to another corporation owned by the same shareholders. The following is a frequently used statement of the traditional elements of de facto merger. The elements required for a de facto merger are: (1) a continuation of the enterprise of the seller corporation, so that there is a continuity of management, personnel, physical location, assets and general business operations; (2) a continuity of shareholders which results from the purchasing corporation paying for the acquired assets with shares of its own stock, this stock ultimately coming to be held by the shareholders of the seller corporation so that they become a constituent part of the purchasing corporation; (3) the seller corporation ceases its ordinary business operation, liquidates and dissolves as soon as legally and practically possible; and (4) the purchasing corporation assumes those obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations of the seller corporation. 15 W. Fletcher, Cyclopedia of the Law of Private Corporations, (emphasis added); see, e.g., Arnold Graphics Indus. v. Indep. Agent Ctr., Inc., 775 F.2d 38, 42 (2d Cir. 1985); Philadelphia Elec. Co. v. Hercules, Inc., 762 F.2d 303, 310 (3rd Cir. 1985); Dayton, 739 F.2d at 693; Keller v. Clark Equip. Co., 715 F.2d 1280, 1291 (8th Cir. 1983). A few courts have held that a de facto merger can be found even in the absence of continuity of ownership, although this more liberal approach may also be considered in effect the 7/

6 same thing as the "mere continuation" analysis addressed below. See Cytec Indus., Inc. v. B.F. Goodrich Co., 196 F. Supp. 2d 644, 658 (S.D. Ohio 2002); Diaz v. South Bend Lathe Inc., 707 F. Supp. 97 (E.D.N.Y. 1989); Turner v. Bituminous Cas. Co., 244 N.W.2d 873 (1976); Woodrick, 703 A.2d at 312; Fizzano Brothers Concrete Products, Inc. v. XLN, Inc, 42 A.3d 951 (2012). Turner is often cited in cases addressing whether continuity of ownership is necessary to a holding of successor liability under any theory, i.e., the de facto merger theory, the "mere continuation" theory discussed below, or similar theories. In Turner, the plaintiff incurred injuries incurred in 1969 while using an allegedly defective press that was manufactured by T.W. & C.B. Sheridan Company prior to In 1964, T. W. & C. B. Sheridan Company had sold its assets for cash to a subsidiary of Harris Intertype Corporation (also named T.W. & C.B. Sheridan Company). The plaintiff sued Harris Intertype Corporation and its subsidiary on products liability grounds. The trial court dismissed Harris Intertype Corporation and its subsidiary because they had acquired only the assets of the seller and had not assumed liability for liability arising from products manufactured prior to their acquisition. The Missouri Supreme Court held that the absence of stock consideration did not preclude a holding of successor liability, and that the other elements of continuation of the enterprise were sufficient to support a holding of successorship. C. Mere Continuation. The "mere continuation" exception to the general rule of non-liability may be applied whenever the purchaser entity more closely resembles a reorganized version of its predecessor than an entirely new corporate entity. Factors taken into account in determining if a successor corporation is a "mere continuation" of its predecessor usually include the retention of same name, employees, supervisory personnel and same production facility in the same physical location; production of the same product; continuity of assets and general business operations; continuity of ownership; and whether the successor holds itself out as the continuation of the previous enterprise. See K.C Ltd. P ship v. Reade Mfg., 472 F.3d 1009 (8 th Cir. 2007); Mozingo v. Correct Mfg. Corp., 752 F.2d 168, 175 (5th Cir. 1985); Krogen Exp. Yachts, LLC v. Nobili, 947 So.2d 581, 2007 WL 5753 (Fla. Dist. Ct. App. Jan. 3, 2007); Turner, 244 N.W.2d at The "mere continuation" exception is sometimes phrased as requiring only a continuity of the business enterprise (without any consideration of continuity of ownership of the entity). See Turner, 244 N.W.2d at The relaxed standard for liability under this "continuity of enterprise" approach has met with mixed success and remains a minority rule. See Travis v. Harris Corp., 565 F.2d 443 (7th Cir. 1977); Elmer v. Tenneco Resins, Inc., 698 F. Supp. 535 (D. Del. 1988); Niccum v. Hydra Tool Corp., 438 N.W.2d 96 (Minn. 1989); Johnston v. Amsted Indus., Inc., 830 P.2d 1141 (Colo. Ct. App. 1992); Chem. Design, Inc. v. Am. Standard, Inc., 847 S.W.2d 488 (Mo. Ct. App. 1993). The notion that successor liability can arise absent continuity of ownership has found the greatest success in products liability cases, and a separate exception is now generally recognized in this context (discussed below). D. Fraud. The fraud exception to the general rule of successor non-liability applies when assets are transferred in order to avoid liability. This exception is usually applied to situations that are egregious and the fairness of liability obvious. If assets are transferred from one entity to another in order to avoid liability, the final transferee may be attacked as liable as a successor. See Raytech Corp. v. White, 54 F.3d 187 (3d Cir. 1994), cert. denied, 116 S. Ct. 302 (1995); Sullivan v. A.W. Flint Co., 1996 WL (Conn. Super. Ct. Aug. 5, 1996). 7/

7 Although not technically a "successorship" theory, a related risk is that purchased assets or their value may also be recovered by the seller in bankruptcy or by the seller's creditors under fraudulent conveyance laws if transferred for inadequate value. The Uniform Fraudulent Transfer Act and Section 548 of the Bankruptcy Code both allow the recovery of property transferred by a debtor for less than a reasonable value if the debtor is insolvent at the time or rendered insolvent. See In re WCC Holding Corp., 171 B.R. 972 (Bankr. N.D. Tex. 1994); E. Product Line. Some courts have adopted a separate exception to the traditional rule of non-liability that applies when a party acquires a manufacturing business and continues the output of its line of products. This exception first arose in Ray v. Alad Corp., 560 P.2d 3 (Cal. 1977). See Pacius v. Thermotroll Corp., 611 A.2d 153 (N.J. Super. Ct. Law Div. 1992). Under this exception, the purchaser assumes strict tort liability for defects in units of the same product line previously manufactured and distributed by the entity from which the business was acquired. The liability follows the product line and it is not necessary that the purchaser generally have the attributes of a successor under other theories. The rationale for imposing liability has been described as three-fold: (i) the virtual destruction of the plaintiff's remedies against the original manufacturer caused by the successor's acquisition of the business, (ii) the successor's ability to assume the original manufacturer's risk-spreading role and (iii) the fairness of requiring the successor to assume a responsibility for defective products that was a burden necessarily attached to the original manufacturer's goodwill being enjoyed by the successor in the continued operation of the business. Ray at 11. Ray has been accepted, rejected, and modified variously among different jurisdictions. See Pollack, Successor Liability in Asset Acquisitions, 1376 PLI/Corp 255 at 277; 18 A.L.R. 6 th 629. A number of jurisdictions have also found a separate basis for imposing liability as a result of a successor's failure to warn customers of defects in the predecessor's products that were discovered, or should have been discovered, by the successor. See Gee v. Tenneco, Inc., 615 F.2d 857 (9th Cir. 1980). IV. Successor Liability for Federal Statutory Obligations A. Federal Employment Law Matters. There is no statutory provision for successor liability for federal employment law purposes. Applying federal common law doctrines applied to labor relations cases, courts adopted a "substantial continuity" test for imposing liability upon asset purchasers for violations of federal employment laws. The "substantial continuity" test is similar to the "continuation of enterprise" notion under which continuity of ownership is not necessary to impose liability upon an asset purchaser. The standard for imposing successor liability for federal employment claims requires the district court to consider nine factors, the first two of which are key: (1) whether the successor company had notice of the charge or pending lawsuit prior to 7/

8 acquiring the business or assets of the predecessor; (2) the ability of the predecessor to provide relief; (3) whether there has been a substantial continuity of business operations; (4) whether the new employer uses the same plant; (5) whether the new employer uses the same or substantially the same work force; (6) whether the new employer uses the same or substantially the same supervisory personnel; (7) whether the same jobs exist under substantially the same working conditions; (8) whether the new employer uses the same machinery, equipment, and methods of production; and (9) whether the new employer produces the same product. See Rojas v. TK Communications, Inc., 87 F.3d 745, 750 (5th Cir.1996) (emphasis added). B. Federal Environmental Law Liability. Similarly to federal employment laws, federal environmental statutes do not address successor liability. Some courts have adopted a "substantial continuity" test for successor liability under federal environmental statutes. This test has been dropped or questioned by courts in response to the Supreme Court's holding in United States v. Bestfoods, 524 U.S. 51, 118 S. Ct. 1876, 141 L.Ed.2d 43 (1998). In Bestfoods, the Court held that the liability of a parent corporation for its subsidiary's environmental liability must be determined under state law rather than under federal common law. Applying this concept to successor liability for environmental violations, courts are now more likely to defer to state law of successor liability rather than to the "substantial continuity" test. In states where the traditional "de facto merger" and "mere continuation" standards have been relaxed in favor of a "continuation of enterprise" approach, however, there may be little difference in result. See Watson, United States v. General Battery Corp.: The Third Circuit Applies Federal Common Law Rather Than State Law to Determine Successor Liability Under CERCLA, Despite Opposing Results In Other Circuits--But Are the Splitting Circuits Really Just Splitting Hairs?, 20 Tul. Envtl. L.J. 219 (2006). V. Foreclosure Sales It has been held that the purchaser at an Article 9 foreclosure sale can be subject to successor liability. See Ed Peters Jewelry Co. v. C & J Jewelry Co., 124 F.3d 252 (1st Cir. 1997); Miller v. Forge Mench P ship, 2005 WL (S.D.N.Y. Feb. 2, 2005); Milliken & Company v. Duro Textiles, LLC, Mass. Super. No. BRCV (June 10, 2005). VI. Practice Considerations A. While the protection against trailing liabilities of the seller afforded by an asset sale structure is not complete, it is always better than no protection at all. If there is material concern over possible liabilities of the seller, an asset purchase is preferable to an equity purchase. B. Although the courts are split on whether continuity of ownership is necessary to impose successor liability under the de facto merger or "mere continuation" theories, continuity of ownership is a very important factor to almost all courts. See Cargo Partner AG v. Albatrans Inc., 207 F. Supp. 2d 86, (S.D.N.Y. 2002). Therefore, if business relations permit, successor liability issues will always be mitigated in a cash sale in which the seller has no equity 7/

9 interest in the purchaser. If contingent consideration must be issued, a cash earn-out can provide a somewhat less risky alternative to equity, with some of the same economic effect to the seller. C. Some courts have listed the issuance of equity directly to owners of the seller as a factor supporting successor liability. If a transaction cannot be structured as a cash transaction, then it is useful for the equity in the purchaser to be issued to the seller entity rather than directly to the seller's owners. Even if the seller then distributes the equity to its owners, this structure lodges the equity in the seller sufficiently that if the seller is insolvent, its creditors will have ready access to the value of the equity (as a fraudulent conveyance and/or illegal distribution). It can be helpful if all the consideration given in a sale is available to the seller's creditors. D. The portion of the seller's enterprise that is acquired is often relevant to courts addressing successor liability. Therefore, the purchaser should not acquire assets or personnel of the seller's business that are not necessary to the purchaser. For example, if there are assets that the purchaser would merely liquidate anyway, it is best that these assets be left behind for the seller to liquidate upon an appropriate adjustment to the purchase price. E. The purchase agreement should be very clear as to the liabilities assumed and the liabilities not being assumed. If there are any material known liabilities that are not being assumed, provision should be made for their payment if possible. Courts are more likely to find successor liability respecting known liabilities. If there are any known liabilities that will remain unsatisfied, all possible efforts should be made to distinguish the business in the hands of the purchaser, and the seller's owners should not be allowed to take any consideration out of the seller. F. Although not an absolute defense to successor liability, the acquisition of assets at foreclosure sale can discourage attacks from creditors and can be of technical benefit, especially if the foreclosed debtor and its principals do not have any continuing interest in the purchaser. G. If successor liability is a material issue, the acquisition should be made by a single purpose entity that is organized and operated with due regard to protect the equity owner of the purchasing entity from becoming liable for the purchaser's obligations through veil-piercing and other similar theories. VII. Practice Tools A. A multi-state resource for case law on successor liability can be found at B. The ABA s Model Asset Purchase Agreement s Appendix A includes a useful treatment of successor liability. Information on this resource can be found at id= pbd. 7/

10 SUCCESSOR LIABILITY IN BANKRUPTCY Roger G. Jones Bradley Arant Boult, Cummings LLP Nashville (615) by the authors

11 Sales Free and Clear of Claims Section 363(f) permits sales free and clear of interests in such property Interests may include claims Sale order should state that the sale is free and clear of all claims against the debtor including successor liability claims Sale order should find that buyer is not debtor s successor and is not liable for successor liability claims 2

12 When Does Claim Arise? Claim defined as right to payment whether or not such right is contingent or unliquidated With respect to personal injury claims, courts are split on when right to payment accrues Some courts look to when the debtor s conduct occurs while others look to when the injury occurs Some courts look to due process considerations including adequacy of notice 3

13 Due Process Considerations Known and unknown claimants Adequate Notice Actual Notice Constructive Notice Channeling Claims/524(g) Future Claimants Representative 4

14 Recent Decisions Campbell v. Motors Liquidation Co. (In re Motors Liquidation Co.), 428 B.R. 43 (S.D.N.Y. 2010) In re Chrysler, 576 F.3d 108 (2d Cir. 2009), vacated and remanded, Indiana State Police Pension Trust v. Chrysler LLC, 130 S. Ct (2009) 5

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