Not so Fast-- Successor Liability and Corporate Shell Games
Under Pennsylvania law, it is well established that “when one company sells or transfers all of its assets to another company, the purchasing or receiving company is not responsible for the debts and liabilities of the selling company simply because it acquired the seller’s property.” Continental Ins. Co. v. Schneider, Inc., 582 Pa. 591, 599, 873 A.2d 1286, 1291 (2005).
However, a party can overcome the general rule of non-liability if it can establish that:
(1) the purchaser expressly or implicitly agreed to assume liability;
(2) the transaction amounted to a consolidation or merger;
(3) the purchasing corporation was merely a continuation of the selling corporation;
(4) the transaction was fraudulently entered into to escape liability; or
(5) the transfer was without adequate consideration and no provisions were made for creditors of the selling corporation.
Id. There is also a product-line exception which requires that the entity selling its assets must cease to exist as a functioning business entity before the purchasing entity can be held liable under a successor theory. See Heritage Realty Management, Inc. v. Symbiot Snow Management Network, LLC, 2007 W.L. 2903941 (W.D. Pa. 2007).
Most cases in this area simply combine the analysis related to the merger and continuation exceptions. See Berg Chilling Systems, Inc. v. Hull Corp., 435 F.3d. 455, 468 (3rd Cir. 2006). In determining whether a transaction is a de facto merger or a continuation, courts look to the following factors:
(1) There is a continuation of the enterprise of the seller corporation, so that there is a continuity of management, personnel, physical location, assets, and general business operations;
(2) There is a continuity of shareholders which results from the purchasing corporation paying for the acquired assets with shares of its own stock, the stock ultimately coming to be held by the shareholders of the seller corporation so that they become a constituent part of the purchasing corporation;
(3) The seller corporation ceases its ordinary business operations, liquidates, and dissolves as soon as legally and practically possible; and
(4) The purchasing corporation assumes those obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations of the seller corporation.
Id. (citing Philadelphia Electric Co. v. Hercules, Inc., 762 F.2d 303, 310 (3rd. Cir. 1985) (applying Pennsylvania law))). Significantly, while not all factors are required to weigh in favor of de facto merger to establish successor liability in a given case, Pennsylvania courts (and especially federal district courts within the Commonwealth) do strongly emphasize the “continuity of ownership” factor as the most critical part of this four-factor test. Id. See also Heritage Realty, 2007 W.L. at *8.
There is no bright line rule as to what percentage of ownership must be acquired by the seller in the new company to constitute “continuity of ownership.” Id. However, two recent decisions by the United States Bankruptcy Court in the Eastern District of Pennsylvania have found that ownership interest of 71% and 41.26% in the new company were sufficient to constitute continuity of ownership. Id. (citing In Re: Total Containment, Inc., 335 B.R. 589, 617-18 (Bkrtcy. E.D. Pa. 2005) (71% ownership after transfer is sufficient) and In re Asousa Partnership, 2006 WL 1997426 (Bkrtcy.E.D.Pa. 2005) (41.26% ownership is sufficient).
