Asset Purchases and Successor Liability: California’s “Merely a Continuation” Doctrine
As a general rule, if your San Diego business buys the assets of another company in an asset purchase/acquisition, your business does not automatically assume the liabilities of the seller. In fact, that is one of the reasons to structure a transaction as an asset purchase, rather than a purchase of the company outright through a stock or ownership unit purchase. However, there are some circumstances in which the courts will look beyond the “asset purchase” form of the transaction and find that the buyer has successor liability for the obligations of the former owner of the assets. Environmental contamination is a common example in which plaintiffs will seek to have the courts find successor liability. A good corporate lawyer should be retained for any type of asset purchase, business acquisition, or merger to ensure that every step possible is taken to avoid successor liability. In this article, we discuss successor liability based on the “merely a continuation” doctrine.
Successor Liability in California
As noted, under California law, the general rule is that when one business entity sells or transfers all of its assets to another business, the latter is not liable for the debts and liabilities of the former. However, California courts — and most courts in the US — will ignore that general rule under four circumstances:
- The purchaser expressly or impliedly agrees to such assumption
- The transaction amounts to a consolidation or merger of the two corporations
- The purchasing business is merely a continuation of the selling business entity
- The transaction is entered into fraudulently to escape liability for debts
See McClellan v. Northridge Park Townhome Owners Ass’n, Inc., 89 Cal.App.4th 746 (Cal. App.2nd Dist. 2001).
With respect to the third item listed above — the “merely a continuation” doctrine — there are two ways that this can be proven: no adequate consideration was given by the purchaser for the assets or one or more persons were officers, directors, or stockholders of both business entities. This second method is the most common way in which successor liability is imposed after an asset purchase.
Note that either method can be used. Thus, even if the purchase price is unquestionably fair market value, if there is a shared officer, director, or shareholder, then successor liability can be found by a court under the “merely a continuation” doctrine. A good recent example comes from the case of 12400 Stowe Drive, LP v. Cycle Express, LLC, Case No. D069738 (Cal. App. 4th Dist September 28, 2018). That case involved, among many things, an allegation by a commercial tenant that the roof of the building leaked. The current landlord defended by claiming that any failure to fix the roof was the responsibility of the previous landlord. The current landlord/owner had bought the property in an asset purchase. The tenant sought to impose successor liability and to, thereby, hold the current landlord liable. The tenant produced evidence that transfer of the property was done for $0.00, manifestly below the fair market value. The tenant also produced evidence that both the former landlord and the new landlord had overlapping owners and managers.
The trial court held the current landlord to be liable on both grounds. The new business entity was deemed to be a mere continuation of the former business entity. The Court of Appeals affirmed.
This is the sort of fact pattern that should be avoided if you are considering engaging in any sort of asset purchase. As noted, a good San Diego corporate attorney can help you avoid the pitfalls.
Contact San Diego Corporate Law
For more information, contact attorney Michael Leonard of San Diego Corporate Law. To schedule a consultation, contact Mr. Leonard via email or by calling (858) 483-9200. Mr. Leonard has been named a “Rising Star” four years running by SuperLawyers.com and “Best of the Bar” by the San Diego Business Journal. Like us on Facebook.