Successor Liability Among Related Entities
Posted Sep 30, 2020
By Washington State Business and Real Estate Lawyer David C. Tingstad
This week’s post continues the discussion from last week about successor liability through the lens of Maple Valley Park Place, LLC v. Tax Resource Centers, Inc., No. 78832-9-I, 2020 WL 1853575 (Wn. App. Apr. 13, 2020).
In Maple Valley, the dispute on appeal surrounded MVPP’s attempt to pierce the corporate veil and pin the sole shareholder of NTS with personal liability for NTS’ debts. (For the full facts, refer to last week’s post here). The Court declined to pierce the corporate veil largely because the trial court concluded TRC had successor liability for the debt of NTS. The appeal focused solely on the veil piercing arguments. In this post I discuss the trial court’s attempt to “get into the weeds” of successor liability.
The appellate opinion relevantly states that after NTS closed, Harris started the new business, TRC, “using a combination of personal funds and resources from NTS.” The opinion never discusses exactly how TRC used NTS resources (which makes sense considering the finding of liability under the successor liability claim was not at issue on appeal). Fortunately, the trial court discussed these facts at length.
In early 2015, NTS defaulted on its lease with MVPP. In November 2015, MVPP filed suit against NTS for amounts due under a lease. In May 2016, MVPP obtained a default judgment against NTS and instituted proceedings to collect that judgment. As MVPP attempted to collect against NTS, Harris, NTS’ sole shareholder, formed a new corporation (TRC) and caused TRC to lease a new space. A few weeks later, NTS notified its clients that NTS would cease doing business by the end of the year.
TRC commenced operations using many of the assets once owned by NTS. TRC 1) used NTS’ furniture and office supplies, 2) began using NTS’ telephone number, 3) possessed and used NTS’ client list, 4) operated NTS’ social media platforms, and 5) employed much of NTS’ employees. TRC never paid NTS for the use of these assets.
Washington follows the majority rule that, in general, a corporation purchasing the assets from another corporation does not become liable for the debts and liabilities of the selling corporation. Columbia State Bank v. Invicta Law Group PLLC, 199 Wn. App. 306, 319, 402 P.3d 330 (2017). Buyers prefer to purchase assets, instead of stock because purchasing assets allows the buyer to avoid taking on the seller’s liabilities.
However, there are exceptions to the general rule. Exceptions to the general rule of non-liability arise where:
(1) there is an express or implied agreement for the purchaser to assume liability; (2) the purchase is a de facto merger or consolidation; (3) the purchaser is a mere continuation of the seller; OR (4) the transfer of assets is for the fraudulent purpose of escaping liability.
Id. at 320 (emphasis added). Upon satisfaction of any one of these situations, the successor/buyer may be liable for predecessor/seller’s debts, EVEN IF the successor/buyer strictly receives assets.
In Maple Valley, the trial court analyzed two exceptions—“mere continuation” and “fraudulent purpose”—in its’ analysis of successor liability.
To support a determination that a successor company acts as a “mere continuation” of its predecessor, there must be (a) common identity of officers, directors, and stockholders of the two corporations; and (b) the insufficiency of consideration transferred to the predecessor for the assets transferred. Columbia State Bank, 199 Wn. App. at 320. The trial court found the first element satisfied as Harris was the sole shareholder and officer of both NTS and TRC. As for the sufficiency of consideration, the trial court found the consideration insufficient because TRC paid nothing to NTS when it acquired NTS’ assets. Therefore, TRC became the successor in interest under the “mere continuation” theory.
To support a determination that a transfer of assets is for the fraudulent purpose of escaping liability, there must be (1) a showing of fraud or actions otherwise lacking good faith; (2) insufficient consideration for the assets; and (3) predecessor being left unable to respond to the creditor’s claims. Eagle Pacific Ins. Co. v. Christensen Motor Yacht Corp., 85 Wn. App. 695, 707, 934 P.2d 715 (1997). The trial court found that Harris formed TRC with the intent to avoid paying NTS’ obligations. The court also found consideration insufficient on the same grounds as the second element in “mere continuation.” Finally, the third element was clearly satisfied as NTS lacked the financial ability to satisfy the judgment obtained by MVPP. Therefore, TRC also became the success in interest under the “fraudulent purpose” theory.
As the Maple Valley decision applies these principles to corporations, practitioners may logically question whether these principles apply to other entities (i.e. LLCs, LLPs, etc.). To put it simply, yes. See Columbia State Bank, 199 Wn. App. at 320 (“The particular form of the business entity is not determinative. Therefore, for the first factor [of “mere continuation”], … the court will consider the continuity of individuals in control of the business as satisfying this factor.”).
One also cannot help but wonder how far these principles extend. To satisfy “mere continuation,” there must be continuity of individuals in control of the business, as discussed above. Yet, how much “continuity” constitutes enough “continuity?” In Maple Valley, Harris did not bring on any additional shareholders or directors to TRC, which resulted in straightforward analysis. However, what if the facts changed slightly?
For example, let’s say a nine-member LLC operating a restaurant ceases to do business under that entity as a result of a massive debt incurred, then forms a new LLC, this time with 12 members—nine of which were members in the prior LLC—for purposes of operating that same restaurant. Is the “continuity” element satisfied in this situation? It may certainly look that way. But what if the LLC only has one member, instead of nine, and brings on only one other member given the exact same scenario? Or what if that one member goes and brings on five more members given the exact same scenario? Significantly, this scenario may avoid liability under the “mere continuation” doctrine of successor liability but may still present liability under the other doctrines of successor liability.
Successor liability among related entities with the same owners in a service-based context is relatively simple to establish because we rarely see any consideration passing between the entities. Maple Valley is a good example. For owners of related entities, care must be taken to pay adequate consideration in transferring assets between entities to avoid successor liability. On the debt collection side, successor liability may be easier to establish than most practitioners realize. As always, be careful out there!
For more Washington business entity law considerations, refer to this blog every Wednesday at 12 PM, noon.
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