A Pair of “Recent” Decisions on Successor Liability

A Pair of “Recent” Decisions on Successor Liability

      A pair of recent (well, relatively recent) decisions remind us that successors may be liable for unassumed obligations of their predecessors. Pontacolini v. Dailybreak/CP, LLC, 2016 Mass. Super. LEXIS 24 (March 21, 2016) and Louro v. Pedroso, 2015 WL 3495330 (Super. Ct. N.J. June 4, 2015), review denied December 15, 2015.

      When two companies merge or consolidate, the company surviving the transaction is liable for all debts and obligations of each party to the transaction. In contrast, in a purchase/sale of assets, the general rule is that the purchaser is liable only for the seller obligations it assumed in the purchase/sale agreement; liabilities not assumed by the buyer remain those of the seller, and need to be satisfied out of the seller’s assets. Of course, those assets include the consideration received for the assets that were sold.

       That is all well and good if the seller has sufficient assets to satisfy the retained liabilities. But what happens when that is not the case? The law has developed “successor liability” principles that determine whether the purchaser can be held responsible for those unassumed liabilities.

      The Pontacolini decision arose out of the application for summary judgment filed by Dailybreak/CP, LLC seeking a determination that, as it had not assumed the liabilities of Dailybreak, Inc. to Nicholas Pontacolini, it was not liable thereon. That motion for summary judgment would be denied.

       In June, 2013, Nicholas Pontacolini became an employee of Dailybreak, Inc., serving as the regional sales director. His compensation was a combination of salary and commission.  Within four months, however, that relationship broke down, and by October 7, 2013, Pontacolini was no longer employed by Dailybreak, Inc. Thereafter discussions took place with the resolution of claims for earned but unpaid commissions. After making an application to the Attorney General's Fair Labor Division, Pontacolini was given a right to pursue an action against Dailybreak, Inc.

      In the meantime, however, on September 4, 2014, Dailybreak, Inc. and Dailybreak/CP, LLC entered into an asset purchase agreement pursuant to which the corporation sold all of its assets to the LLC for $175,000 plus certain earn-out rights. The LLC agreed to assume certain liabilities of Dailybreak, Inc. and entered into certain covenants, including the funding of an operating deficit, the subleasing the corporation’s office space, and that all employees of the corporation would be terminated by the corporation but then immediately rehired at the same compensation by the LLC. Pontacolini would bring his action for unpaid commissions against the LLC, asserting it to be the successor-in-interest to the corporation.

      While Massachusetts follows the generally applicable law that the purchaser of assets is not liable for unassumed debts and obligations of the seller, it does what it characterizes as a “de facto merger” analysis for imposing liabilities on a successor, looking to:

1) whether there is a continuation of the enterprise of the seller corporation so that there is continuity of management, personnel, physical location, assets, and general business operation; 2) whether there is a continuity of shareholders which results from the purchasing corporation paying for the acquired assets with shares of its own stock, this 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) whether the seller corporation ceases its ordinary business operations, liquidates, and dissolves as soon as legally and practically possible; and 4) whether the purchasing corporation assumes those obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations of the seller corporation. Milliken & Co. v. Duro Textiles, LLC, 451 Mass. 547, 557, 887 N.E.2d 244 (2008).

      While Dailybreak/CP LLC would rely upon the express terms of the asset purchase agreement, “alleging that the Agreement has immunized itself from liability as against Mr. Pontacolini's claim.”, the court found it to be insufficient. Rather, applying the factors of the Milliken decision, the court found that Dailybreak/CP, LLC could be found to be the successor-in-interest of Dailybreak, Inc. Therefore, the claim for the unpaid commissions could proceed forward.

      The Louro v. Pedroso decision involves a business transaction far less sophisticated than that considered in the Pontacolini case.

      Pedroso, an attorney, was the sole shareholder of Pedroso Law Firm, P.C. That professional corporation was the tenant of certain property located on Jefferson Street in Newark New Jersey. After Victor and Jennifer Louro acquired that property following a foreclosure and sheriff sale, they brought an action to expel Pedroso and his firm from the property, and as well sought to be compensated for unpaid rent for the use of that property. Before the damages were determined, the court issued an ejection order from the Jefferson Street premises. Undisclosed to anybody, Pedroso established a new LLC, Pedroso Legal Services, LLC, and in its name relocated his practice to Wilson Avenue in Newark.

      At trial, it was alleged that Pedroso, on behalf of Armando Pena, the prior owner of the property and a relative of Pedroso, prepared a pair of leases. One lease provided for a monthly rate of $2500, while the other provided for monthly lease payments the amount of $425. There was testimony that the second lease, at the $425 rate, was prepared once it became clear that the building was going into foreclosure and was allegedly put in place in an effort to defraud any subsequent purchaser.

      Ultimately, the jury would award damages at the rate of $1500 per month for 14 months of uncompensated occupancy of the Jefferson Street property. After trial, the plaintiff submitted a judgment in that amount, as well as interest and cost, seeking that it be issued against both the Pedroso Law Firm “and any subsequent law firm created by Felipe Pedroso.” Pedroso disputed that the judgment could be entered against anyone other than Pedroso Law Firm, P.C. (the entity he had already abandoned). The trial court determined that Pedroso’s new LLC would be included as a named defendant against whom the judgment would be entered.

      Pedrosa challenged that determination on appeal, all to naught. Rather, the judgment against the LLC would be affirmed.

      In the face of incomplete and evasive answers from Pedroso as to when he had organized the LLC and why he had done so, the trial court “concluded that the LLC is simply the new name of Pedroso’s law firm, which has continued in business.” In addition, focusing upon the fact that this case involved a law firm, the Appellate Division wrote:

Here, Pedroso believes he can evade the payment of a judgment for rent arrears on the office space his law firm occupied simply because he has decided to “rejuvenate” and to change the “image” of his firm under a new name and at a different location. The legal profession is not so disdainful of the rights of creditors that it would allow Rules 1:21-1A and -1B to be thus misused by a member of the New Jersey Bar. The Rules of Professional Conduct for lawyers in this State do require general honesty. See RPC 8.4(c).

Ultimately:

Here, Judge Dumont found that the LLC is merely a continuation of the law firm under its prior corporate identity. Pedroso’s license to practice law in this State was used in conducting the business of the prior law firm just as it is now used to conduct the business of the successor LLC. Appellant offered no credible evidence that the LLC is not a continuation of the law practice of the prior firm.

      A few take-aways.  First, sequentially organizing business organizations for the purpose and effect of avoiding liabilities will not work.  Not considered in either of these decisions, but always a factor, is whether doing so will give rise to liability under fraudulent conveyance statutes.  Second, asset buyers, seeking to limit their exposure for seller obligations, should ascertain the manner in which the seller will satisfy, and as necessary compromise, those obligations from the sale proceeds or other assets.  Leaving the seller unable to satisfy its obligations invites a claim against the buyer.