Collecting trade debt after an asset sale: Is a successor liability claim an option?

The letter usually begins with “Dear Vendor.” It goes on to explain how, as a result of circumstances beyond its control, Smith Corp. failed to thrive and its assets were sold off.
The letter may also inform you that Jones Co., a new entity located at the same address (as confirmed by the letterhead) has purchased the assets and will continue the business.
“But,” you are warned, “Jones Co. is not liable for Smith Corp.’s debts, including the debt to you.”
Do you simply write off the debt and accept the loss, or do you have another option?
In Massachusetts, until recently, trade creditors seeking to hold a successor company liable for a predecessor’s debts were limited as a practical matter to claims of fraudulent transfer, violation of the Bulk Sales Act and to pierce the corporate veil – notoriously difficult claims to win except under very specific facts.
The remaining common law claims for successor liability generally only succeeded in cases involving environmental and product liability law. The claims succeeded in those cases on the basis that public policy demanded a remedy for victims of defective products and the costs of environmental remediation, even after the responsible party had ceased to exist.
When it came to contract claims and trade debt, however, Massachusetts courts would respect the corporate form and deny creditors a remedy, even when the new company continued the business of the old company in the same location, with the same employees, same owners and same products or services, essentially different only in name.
But times have changed.
Trade creditors in Massachusetts now have the ability to collect from successor corporations. In 1997, the Massachusetts Supreme Judicial Court held in Cargill, Inc. v. Beaver Coal & Oil, Co., 424 Mass. 356, that it considers “the fair remuneration of corporate creditors a policy worthy of advancement.”
In Cargill, the successor company purchased substantially all of the assets of the predecessor company and continued the business (oil delivery services) from the same location, to the same customers and with the same employees.
Significantly, the owner of the predecessor company also received stock in the successor company, a preexisting competitor in the marketplace. The lower court, on cross-motions for summary judgment, ruled that the predecessor company had simply become the successor and, relying on precedents involving claims under CERCLA and product liability, found successor liability under either the “mere continuation” or “de facto merger” theories.
The Supreme Judicial Court took the case directly from the Appeals Court in order to address for the first time at the appellate level the applicability of the successor liability doctrine to trade creditors.

The court held that four factors must be considered to determine whether successor liability exists, namely, whether:
1. there is a continuation of the enterprise, such as management, personnel, physical location, assets and general business operations;
2. there is a continuity of shareholders;
3. the seller corporation ceases its ordinary business operations, liquidates and dissolves as soon as legally and practically possible; or
4. the purchasing corporation selectively assumes obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations of the seller.
The SJC left for another day the question of how many of these factors must be present, stating cryptically: “No single factor is necessary or sufficient to establish a de facto merger.”
Cases from other jurisdictions, however, in applying the same four factors, have consistently held that the second factor – continuity of shareholders – is necessary to a finding of successor liability under either the mere continuation or de facto merger theories.
In other words, as long as one or more shareholders of the predecessor company becomes a shareholder of the successor company, a claim for successor liability may succeed.
Curiously, following the decision in Cargill, Massachusetts courts were not flooded with successor liability claims by trade creditors. Indeed, it does not appear any plaintiff succeeded on such a claim until this year, in an action brought by a textile manufacturer in Superior Court to collect on an $8.7 million trade debt from the successor to a fabric finishing company based in Fall River, Mass. (Milliken & Company v. Duro Industries, Inc., BRCV2002-1364). That case is now on appeal to the Massachusetts Appeals Court.
It seems hard to believe that over the past decade there have not been any other circumstances in which a valid claim for successor liability could have been brought on behalf of a trade creditor. If such claims have not been brought, it may be because lawyers are unfamiliar with the remedy, or assume that it still is only available in the fields of environmental contamination and product liability.
But such claims are likely to become more common soon. With the recent changes to the bankruptcy laws, a Chapter 11 proceeding is now a more expensive and less appealing option for many companies looking to restructure their debt. A “friendly” foreclosure sale, an assignment for the benefit of creditors, or an asset sale to a newly formed entity has become more attractive, notwithstanding the fact that the debtor is not discharged from its obligations under those scenarios, as it would be in a bankruptcy.
Attempting such a debt restructuring outside of bankruptcy may well open the door to a claim of successor liability.
The next time you receive a “Dear Vendor” letter, don’t assume the worst. Investigate. Find out who owns the new company and who owned the predecessor.
Bear in mind that a successful claim for successor liability revives not only your claim, but every other creditor’s as well. If the new company faces exposure on your claim, its ultimate liability may be many times greater. One of the hallmarks of successor liability is that the successor company pays only those obligations necessary to continue the operations of the predecessor. Some research and a carefully worded demand letter may put the obligation owed to you into that category.
Jeffrey J. Upton is a shareholder at Hanify & King PC where his practice includes general business counseling and litigation, real estate and employment litigation, arbitration and mediation, and intellectual property. He represented the successful plaintiff in Milliken & Company v. Duro Industries, Inc. discussed in this article. Jeffrey can be reached at [email protected] or (617) 423-0400.