Superior Court Overturns Trial Court's Finding of Successor Liability Upon Purchaser in Asset Sale
On May 15, 2009, the Pennsylvania Superior Court entered an Order holding that a creditor of predecessor company that had sold its assets to a purchasing company did not have a claim against the purchasing (i.e. “successor”) company. Fizzano Bros. Concrete Prods. v. XLN, Inc., 2009 PA Super 89 (2009). The creditor company was attempting to use Pennsylvania’s successor liability law to sue the successor company from the breach of contract and warrant claims it had against the predecessor company. In reaching its decision, the Pennsylvania Superior Court overturned a Pennsylvania Trial Court that had imposed successor liability upon the purchasing company.
The general rule under Pennsylvania law concerning the purchase and sale of a business is if the transaction is structured as an asset sale then the purchasing (i.e. successor) company is not liable for the liabilities of the selling (i.e. predecessor) company. Because of this general rule asset purchases may be preferred over stock purchases in those situations in which the selling company has liabilities. This general rule of non-liability to the purchasing company can be overcome if either of five exceptions is established: (1) the purchaser expressly or implicitly agreed to assume liability; (2) the transaction amounted to a consolidation or de facto merger; (3) the purchasing company was merely a continuation of the selling company; (4) the transaction was fraudulently entered into to escape liability; or (5) the transfer was without adequate consideration and no provision was made for creditors of the selling company.
In this case, the Trial Court grounded its imposition of “successor liability,” (i.e. liability upon the successor to the company that originally created the liability) upon the doctrine of de facto merger. The de facto merger doctrine proceeds from the basic equitable principle that a company should not be permitted to escape its obligations to others through sham corporate reorganizations. In determining whether a de facto merger has occurred, Pennsylvania courts consider four factors: (1) continuity of ownership; (2) cessation of the ordinary business by and dissolution of the predecessor as soon as practicable; (3) assumption by the successor of liabilities ordinarily necessary for uninterrupted continuation of the business; and (4) continuity of the management, personnel, physical location and the general business operation. If all four of the above factors exist and are proven a Court should find a de facto merger has occurred. If a de facto merger occurred, then the liabilities of the first company are imposed upon the purchasing company.
The Trial Court held that the creditor proved three of the four above factors and that proving three of the four factors was sufficient to find a de facto merger occurred and to impose successor liability. The Superior Court held that the record did not support the Trial Court’s findings that the three factors were established. Furthermore, the Superior Court held that the record indicated there was no “continuity of ownership” and that “continuity of ownership” is a key element that must exist in order to find a de facto merger. According to the Superior Court, the Trial Court had mistakenly believed that the Superior Court had ruled in a prior case that the “continuity of ownership” is not an essential element in a de facto merger claim.
Update: the Pennsylvania Supreme Court, in Fizzano Bros. Concrete Prods. v. XLN, Inc., 615 Pa. 242 (2012), vacated the Superior Court’s order and remanded the case back to the trial court for additional proceedings. The Supreme Court rejected what it considered the Superior Court’s too narrow application of the “continuity of ownership prong” and held that the elements of the de facto merger were not a mechanically-applied checklist, but a map to guide the reviewing court to a determination that a merger had or had not occurred.