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San Diego Asset Purchases and Avoiding Successor Liability: “Adequate Consideration Paid” is “Fair Market Value”

In general, under California law, if a person or business buys the assets of corporate entity, the purchaser does not assume any of the liabilities or obligations of the selling corporation. This is the “no-successor-liability” rule. Avoiding successor liability is the main reason that many businesses engage in an asset purchase transaction rather than merging with or acquiring the target business outright.

The main exception to this “no-successor-liability” rule is if the California courts deem the “asset purchase” to be a sham. That is, just because a deal is named and structured as an “asset purchase” does not prevent a lawsuit by a creditor to deem the “asset purchase” a sham. If a court holds that the asset purchase is really a merger or an acquisition, then the doctrine of successor liability becomes applicable. Successor liability means that a creditor can reach the assets of the buyer to satisfy a debt or obligation. This is why it is crucial to retain an experienced San Diego corporate attorney to provide advice and counsel when your business is considering a merger, acquisition, or an asset purchase. A well-crafted Purchase Agreement and professionally conducted due diligence are necessary to protect your business and avoid costly litigation.

One of the factors considered by California courts on the question of “sham transaction” is how much was paid for the assets — the consideration — and whether the consideration was adequate. The rule is that if the consideration is “fair market value,” then the consideration was adequate. A real world example comes from the case of Rumbeck v. Premier Valley Inc., Case No. F072262 (consol. with F072523) (Cal. App. 5th Dist. 2017) (unpublished).

Rumbeck involved two asset purchases. The original corporation was BP Realty, Inc. (“BPR”) which was a real estate brokerage company wholly and solely owned by Larry Rumbeck. In 2006, Rumbeck caused BPR to sell of its assets to a company called Endsley, Inc. (“Endsley”). As part of the payment, Endsley executed a $800,000 promissory note in BPR’s favor. After 2006, payments were made on the 2006 Promissory Note. However, the housing bubble burst in 2008 or so and, by 2010, Endsley was over $2.4 million in debt, which included the note to BPR with the Promissory Note falling into arrears.

In mid-2010, the owners of Endsley agreed to sell Endsley’s assets to a company called Premier Valley, Inc. (“PVI”). Endsley and PVI executed an Asset Purchase Agreement which provided that PVI desired to buy “substantially all of [Endsley’s] assets…” Furthermore, the Agreement specifically provided that PVI “shall not assume or become responsible for any of [Endsley’s] liabilities or obligations” and that PVI was not obligated to pay or discharge any of Endsley’s “duties, debts, obligations or other liabilities.” The purchase price was approximately $411,000. Thereafter, having no assets or business or cash flow, Endsley stopped making payments to Rumbeck on the 2006 Promissory Note. Eventually Rumbeck sued Endsley, the owners of Endsley, and PVI.

With respect to PVI, Rumbeck asserts that the July 2010 Asset Purchase was a sham and that, in reality, PVI had acquired Endsley and was liable on the 2006 Promissory Note via the doctrine of successor liability. Rumbeck’s main argument was that the consideration paid for the assets of Endsley was significantly less than its debts.

However, after a seven-day trial, the trial court ruled against Rumbeck. Under California law, the issue is not whether the consideration paid is less than the debts owed, but rather whether the consideration paid was fair market value. From 2009 to 2012, real estate values plummeted across the country. As such, the main assets held by Endsley — real estate — were worth substantially less than when those assets were acquired. Experts gave testimony at the trial about the fair market value of Endsley’s assets. Rumbeck’s experts opined that the fair market value was about $750,000. PVI’s expert opined that the value was between $105,000 and $210,000. The trial court — likely — split the difference and determined that $411,000 paid for the assets was fair and that the asset purchase was not a sham. The court ruled against Rumbeck.

On appeal, the California Court of Appeals agreed with the trial court and affirmed. The court noted the rule that the “crucial factor” in determining whether an asset purchase constitutes a de facto merger or an acquisition is “whether adequate cash consideration was paid for the predecessor corporation’s assets.” The court then held that consideration is adequate where a selling corporation received money equal to the fair value of the property conveyed. Since at trial, evidence had been presented that Endsley’s assets had a fair market value of something between $105,000 and $750,000, payment by PVI of $411,000 was considered fair market value. As such, the asset purchase was not a sham.

Contact San Diego Corporate Law

If you are considering an asset purchase or a business merger or acquisition, contact attorney Michael Leonard of San Diego Corporate Law. Mr. Leonard has many years of experience handling all aspects of the sale or purchase of businesses and assets in California. Mr. Leonard’s law practice is focused on business, transactional, and corporate matters. To schedule a consultation, contact Mr. Leonard via email or call at (858) 483-9200. Like us on Facebook

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