successor and alter-ego liability
TRANSCRIPT
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Successor and Alter-Ego LiabilityPresenters: Brendan L. McPherson, James R. Miller, Paul R.
Wood
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Introduction
Where Risk Arises: Nuts and Bolts of Successor Liability, Veil-Piercing, and Fraudulent Transfer Claims
Successor Liability: General Rule and Exceptions
Veil-Piercing Rules Successor Liability Exception and Fraudulent
Transfer Claims
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Brendan McPherson is a litigation shareholder whose practice focuses on complex financial issues relating to bankruptcy, real estate and disputes arising out of complex business transactions. A significant part of his practice relates to litigating claims of successor liability, alter ego/veil-piercing, and fraudulent transfers, and in this regard he frequently counsels clients both before and after merger and acquisition transactions.
Where Potential Risks Arise
Successor Liability & Veil-Piercing 101
Asset v. stock transactions General rule still applies: – Stock acquisitions: liabilities travel – Asset acquisitions: liabilities remain
Successor Liability 101
Successor liability – the exception not the rule
Exception 1: express/implied agreement Exception 2: consolidation/merger – “de
facto” Exception 3: mere continuation Exception 4: fraud
GENERAL RULE
The general rule is that the purchaser of a corporation's assets is not liable for that corporation’s debts. E.g., Johnston v. Amsted Indus., Inc., 830 P.2d 1141, 1142-43 (Colo. App. 1992); Ruiz v. ExCello Corp., 653 P.2d 415, 416 (Colo. App. 1982).
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James Miller is a litigation shareholder whose practice focuses on complex financial issues and securities litigation. Jim represents large financial institutions and clients involved in providing financial services. A significant part of Jim’s practice includes litigating claims relating to failed mergers and acquisitions. He has extensive experience with de facto merger and mere continuation claims and he has litigated a number of securities fraud cases.
EXCEPTIONS
There are several exceptions to the general rule. A company that purchases the assets of another company can become liable for the seller's debt where:
(1) there is an express or implied assumption of liability; (2) the transaction results in a merger or consolidation of
the two corporations; (3) the purchaser is a mere continuation of the seller; or (4) the transfer is for the fraudulent purposes of escaping
liability. Alcan Aluminum Corp. Metal Goods Div. v. Elect. Metal Products, Inc., 837 P.2d 282, 293 (Colo. App. 1992).
DE FACTO MERGER FACTORS
In evaluating a “de facto merger” the Court looks at these four factors:
(1) continuity of management, personnel, physical location, assets, and business operations;
(2) continuity of shareholders;(3) cessation of the seller's business and liquidation of its
assets; and(4) assumption by the purchaser of those liabilities of the seller
necessary to continue uninterrupted the seller's former business operations.
Johnston, 830 P.2d at 1146-47.
ORDER IN HRC-SVL CASE
The Court concludes that the Plaintiff has failed to meet by a preponderance of the evidence their burden of establishing that there was a continuity of management and a continuity of shareholders. The evidence showed that although there was a continuity in HRC's and HRC-SVL’s business operations to some extent the corporate operations were distinctly different. Due to this failure their claim that the asset purchase agreement between HRC and HRC-SVL must fail under the doctrines of "de facto merger" and mere continuation doctrines. Since the Plaintiff has failed under these doctrines then the Plaintiff has failed to establish that HRC-SVL is the successor to HRC's liabilities and thus liable for the debts accumulated by HRC, including the debts owed to the Plaintiffs. Thus, this Court rules that the Defendant, HRC-SVL, is not liable to the Plaintiffs for the liabilities owed by HRC under their successor liability claims.
MERE CONTINUATION OF CORPORATION
Successor liability litigation frequently involves the purchase and continuation of some aspect of the original going concern. The courts look to the following factors to determine whether to invoke the continuation exception and attach liability to the successor corporation:
(1) whether the successor and predecessor are in the same business;(2) the degree of similarity between the business operations of the
predecessor and successor;(3) whether the same equipment, physical structures, work force, and
supervisors used by the predecessor were also used by the new corporation;
(4) whether the employees were notified of any change in ownership;(5) whether there are common incorporators, officers, directors, or
stockholders between the predecessor and successor corporations; and(6) whether employees retained by the new corporation were re-hired under
new employment contracts.
MERE CONTINUATION OF CORPORATION - continued
In Brockman the plaintiffs sued on a promissory note executed by a former corporation. The plaintiffs named as defendants the trustees of the former corporation’s assets, the former corporation, certain individuals who were directors of the new corporation and the new corporation. The court of appeals held that the new corporation was a “continuation” of the former corporation. The two companies were in the same business; the directors, primary officers and major stockholders were the same; the new corporation used the same equipment and labor force; and the transferee took over performance of the former company’s existing contracts. As a result, the court ruled that the new corporation was liable on the promissory note of the former Corporation. Brockman v. O’Neill, 565 S.W.2d 796, 798-99 (Mo. Ct. App. 1978)
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Paul Wood has handled numerous post-merger dispute cases, many of which involved successor liability issues. Paul has tried cases involving alter ego, de facto merger and other successor liability theories. Paul’s experience in a wide range of industries, including securities broker/dealers, financial services firms, telecom, construction and manufacturing allows him to understand the clients' business and tailor proactive litigation strategies which fit into their overall business goals, rather than simply react to the facts of a particular case.
Piercing the Corporate Veil
Exception to the established notion of limited liability for corporate shareholders
Because there is a presumption of separateness between the entity and its owners, most courts recognize the exception only in "narrow circumstances.“
Equitable claim: may be decided by court, not jury. Party seeking to pierce the corporate veil bears the burden
of proof. Standard of proof varies from preponderance of the
evidence to clear and convincing.
Elements of a Claim
State law controls, so determine choice of law General elements of a claim:– Control and domination of corporation by shareholder– Improper use or purpose– Resulting injury
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Control and Domination
Must show "complete domination, not only of finances, but of policy and business practice in respect to the transaction attacked so that the corporate entity as to this transaction has no separate mind, will or existence of its own.“
Veil piercing doctrine also may apply to other types of entities such as limited liability companies.
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Control and Domination
Some of the factors considered:– Inadequately capitalized or undercapitalized to carry out the
corporation's business.– Failure to follow corporate formalities/keep corporate records– Identity of officers and directors– Commingling or diversion of funds or assets– Sole or majority stock control– Same offices and employees– Parent pays expenses/losses for subsidiary
No one characteristic governs, but the courts must look at all the circumstances to determine whether the doctrine should be applied.
Improper Purpose or Use
Requires proof that the control was used to commit fraud, perpetrate the violation of a statutory or other legal duty, or commit a dishonest and unjust act against claimant.
Improper conduct beyond establishing the corporation was controlled and dominated by the shareholder must be proved.
Claimant must prove improper use of corporate form caused injury
Proof of the underlying cause of action may help establish the second part of the test
Resulting Damage
Must show that the defendant's control, exerted in a fraudulent, illegal or otherwise unfair manner, caused the harm suffered.
Show it will be treated unjustly and damaged by the defendant's exercise of control and improper use of the corporate form unless the corporate veil is pierced
Typical scenario: Corporate creditor demands payment or attempts to execute on a judgment and learns that previously available assets have been spirited away by the owner to avoid collection.
Fraud and Fraudulent Transfers
Unlike some exceptions, lack of consideration key
Lack of consideration may trigger fraud exception or fraudulent transfer law
Fraud Exception
Is the asset purchase arm’s length, with a legitimate business purpose?
Or was the asset purchase orchestrated to avoid liability?
Fraudulent Transfers/Conveyances
As old as the Statute of Elizabeth in 1570 Standing: Applicable in bankruptcy (trustees
and debtors in possession) and out of bankruptcy (creditors)
Fraudulent Transfers/Conveyances
Two varieties: – Actual fraudulent transfers– Constructive fraudulent transfers
Actual Fraudulent Transfers
Intent to hinder, delay, or defraud creditors. Badges of Fraud: – The transfer or obligation was to an insider. – The debtor retained possession or control of the
property transferred after the transfer. – The transfer or obligation was disclosed or concealed. – Before the transfer was made or obligation was
incurred, the debtor had been sued or threatened with suit.
Actual Fraudulent Transfers
– The transfer was substantially all of the debtor’s assets. – The debtor absconded. – The debtor removed or concealed assets. – The value of the consideration received by the debtor was
reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred.
– The debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred.
– The transfer occurred shortly before or shortly after a substantial debt was incurred.
– The debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.
Constructive Fraudulent Transfers
Constructive Fraudulent Transfer = misnomer
Elements: – No reasonably equivalent value, i.e.
consideration – Transferor insolvent or made insolvent by the
transfer – Or other elements akin to insolvency
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Thank you, and we hope you will join us for our next webinar on September 20, 2016:
Claims By or Against (Former) Officers and Employees
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