When a business is sold, creditors sometimes view the buyer as an alternate source of payment for claims against the seller under a theory of "successor liability". The "American Rule," however, is that a buyer of assets is not responsible for the liabilities of the seller. Like many rules there are exceptions, but as a recent New York case illustrates, the Rule can provide valuable protection for the careful buyer.
In Oorah, Inc. vs. Covista Communication and Birch Telecom, Inc. 2014 NY Slip Op 32484(U) (Sept. 25, 2014) decided by the Supreme Court, New York County, defendant Birch purchased the assets of Covista, which was enmeshed in pending litigation with Oorah. Oorah had sued Covista claiming it was liable for unpaid commissions under a Master Agent Agreement. After Birch purchased Covista's assets, Oorah amended its complaint to name Birch as a defendant, claiming Birch was liable under the Master Agent Agreement under a variety of "successor liability" theories.
Oorah alleged that Birch's acquisition of Covista's assets was a "de facto merger", meaning that is was a merger in substance if not in form. New York law requires four "hallmarks" to be present for a finding of "de facto merger": (1) continuity of ownership between buyer and seller, (2) cessation of business and dissolution of seller, (3) assumption by the buyer of liabilities required for the continuation of the seller's business, and (4) continuity of management, personnel, physical location and general business operation.
The Oorah Court found that while Covista had ceased operations and Birch may have assumed certain liabilities of Covista, there was no continuity of ownership or operations. Batting .500 might put you in the Hall of Fame but it does not establish a "de facto merger".
Oorah next claimed that the Birch/Covista transaction had been undertaken to defraud Covista's creditors. Birch paid cash for the assets, and Covista allegedly told Oorah that the sale proceeds would be dissipated by the time Oorah could obtain a judgment. The decision does not explore Covista's motives in making this statement, but holds that, absent allegations that Birch intended to assist Covista in evading its creditors, the fraud claim fails.
Oorah also alleged that there had been an "implied" assumption by Birch of Covista's liabilities under the Master Agent Agreement. New York recognizes "implied assumption" as an exception to the American Rule, but its definition is sadly indefinite. The Court, quoting an earlier decision, stated that "[w]hile no precise rule governs the finding of implied liability, the authorities suggest that the conduct or representation relied upon by the party asserting liability must indicate an intention on the part of the buyer to pay the debts of the seller."
The Court found that Birch's asset purchase agreement clearly disclaimed any assumption of liabilities by Birch, and so held that there was no "implied assumption" of the obligations under the Master Agent Agreement by Birch.
The Oorah decision shows that using an asset purchase structure with a well-crafted asset purchase agreement, a buyer can avoid liability for the seller's debts even where the seller is embroiled in pending litigation at the time the transaction is undertaken.
Should you have any questions regarding the content of this alert, please contact the author, John P. Lowe, Jr. at jlowe@hblaw.com, or our Corporate Practice Area Co-Chairs, James J. Canfield at jcanfield@hblaw.com, or Richard J. Day at rday@hblaw.com.