Friday, September 30, 2011

Merger Clauses - Why “Boilerplate” Matters

Merger Clauses
(Why “Boilerplate” Matters)

            Recently the Kentucky Court of Appeals was able to dispose of a case based upon the merger clause in the final agreement.

Larry Leedy formed and was the sole shareholder of Lifestar Ambulance Service, an assumed name of L.I.L., Inc. (“Lifestar”).  Several years later he entered into negotiations with Michael Pistole to sell Lifestar.  On December 9, 2003, Leedy and Pistole and Life Ambulance Services, Inc. (“LAS”) entered into a preliminary agreement for confidentiality while Pistole considered the investment.  On January 5, 2004, Leedy (through his agent) and Pistole signed a preliminary purchase agreement pursuant to which Pistole would buy the assets and assume the debts of Lifestar (the opinion does not address whether LAS was a party to this agreement).  That preliminary agreement provided it would be effective until a final purchase agreement was completed.  LAS’ Articles of Incorporation were filed on February 2, 2004.

Once Pistole’s operation of an ambulance services was approved by the fiscal court, Lifestar and LAS entered into a final purchase agreement.  One of the debts assumed was a $164,000 obligation to the IRS.  Ultiately the IRS sought to enforce that obligation against (and here the opinion is less than clear) Leedy’s estate and or his wife Myrtle, she being his heir.  Myrtle then brought suit against Pistole for the amount she paid the IRS in settlement of the claim, asserting that this obligation had been assumed by Pistole.  Pistole defended that he was not personally obligated on that amount; rather, only LAS was a party to the assumption of the obligation to the IRS.

            While the final purchase agreement was between Lifestar and LAS, Myrtle pointed to the preliminary confidentiality agreement and the preliminary purchase agreement, both providing that Pistole was a party.  Further, on the basis that LAS was incorporated after the preliminary agreements were signed, it was argued that Pistole, as promoter, was personally liable on the debts undertaken by the then nonexistent corporation.

The trial court granted Pistole summary judgment, and this appeal followed. Leedy v. Pistole, 2011 WL 2162686 (Ky. App. 2011) (Not to be Published).

Myrtle had two arguments, promoter liability and trust fund liability under KRS § 271B.14-070(4)(b). 

As for promoter liability, Myrtle relied upon the formulations of promoter liability set forth in Pierson v. Coffey, 706 S.W.2d 409 (Ky. App. 1985) and Kennedy v. Fulton Mercantile Co., 108 S.W. 948 (Ky. 1908).  Essentially, an actor purporting to bind a corporation that does not exist is personally liable on the debts created.  The Court of Appeals found, however, that this rule was not applicable.  First, the preliminary purchase agreement provided that it would be effective only until the final agreement was completed.  Second, the final purchase agreement was entered into on LAS’ behalf after its incorporation, Pistole was not individually a party to the final agreement, and that agreement provided in part:

“This constitutes the entire agreement.  There are no other representations or understandings other than those contained herein.”  2011 WL 2162686, *4.

Pistole, not being a party to the final agreement in which LAS agreed to answer for Leedy’s obligation to the IRS, could not be held responsible on that debt.

As an aside, why is the concept of promoter liability being discussed as if it is a notion of the common law?  In 1988 the Kentucky General Assembly adopted a statute on promoter liability.  KRS § 271B.2-040.  “We [the courts] are ever mindful that the ‘judicially created common law must always yield to the superior policy of state enactment and the Constitution.’” Willis v. Louisville/Jefferson County Metro Sewer District, 2020 WL 4137492, *3 (Ky. App. 2010) (citations omitted).  If a common law concept has been reduced to statute, why are cases, rather than the statute, being cited?

The Court disposed of the trust fund argument on the basis that it had not been raised with the trial court and therefore could not be raised on appeal.  Apparently ALS has been sold (the opinion does not address whether it was an asset or a stock sale, but as ALS was administratively dissolved in 2005 it likely was an asset sale), and pursuant to KRS § 271B.14-070(4)(b) Myrtle sought to collect the net sale proceeds that were distributed to Pistole to have them applied against the debt to the IRS.  It would have been a good argument.  See also Bear, Inc. v. Smith, 303 S.W.3d 137, 146-47 (Ky. App. 2010). 

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