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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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