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Acquiring another company is a common way to expand a business. The potential advantages of a strategic acquisition are numerous—it can add value to the combined entity by eliminating redundancies in operational costs, diversifying (if adding a new line of business), solidifying a supply line (by acquiring a supplier or customer), or increasing the market share and reducing competition (if buying a company in the same field). At the same time, there can be potential disadvantages as well, ranging from cultural integration problems to hidden liability issues. Indeed, depending on the situation, an entity that acquires another entity might be held liable for acts and omissions of the acquired entity, so it is important to conduct adequate due diligence and address any issues before it’s too late.
In Logan Bus Co. v. Auerbach, a recent case, the court had occasion to address successor liability under New York law.[1] In that case, defendants (insurance broker and his brokerage firms) enrolled plaintiffs (transportation industry employers) in a group self-insured trust providing mandated workers’ compensation coverage and later recommended them to renew their membership, even though they knew the trust did not provide adequate coverage.[2] Subsequently, the trust stopped issuing workers’ compensation coverage and the New York State Workers’ Compensation Board, which took over the trust, determined that the trust was insolvent.[3] Meanwhile, Capacity Group of NY LLC (“Capacity”) purchased the assets of the brokerage firms through an asset purchase agreement.[4] Plaintiffs sued the broker, his firms, and Capacity, asserting negligent misrepresentation, fraud in the inducement, breach of contract, and negligence, among other things, claiming that defendants failed to properly advise them on the suitability of the trust, were paid excessive renewal fees and commissions, and knowingly induced and participated in the fraud.[5] Capacity moved to dismiss the complaint, arguing that it did not have any liability for the alleged acts and/or omissions of the brokers arising out of their business operations prior to the asset purchase.[6]
Under New York law, an entity that acquires the assets of another is generally not liable for the torts of its predecessor, unless: (1) it expressly or impliedly assumed the predecessor’s tort liability; (2) there was a consolidation or merger of seller and purchaser; (3) the purchasing entity was a mere continuation of the selling entity; or (4) the transaction is entered into fraudulently to escape such obligations.[7] The de facto merger exception, in particular, is based on the concept that “a successor that effectively takes over a company in its entirety should carry the predecessor’s liabilities as a concomitant to the benefits it derives from the good will purchased.”[8] Plaintiffs alleged that the acquisition here fell into this category in that Capacity essentially took over the brokerage entities, had the same owners, managers, and employees, and maintained relationships with the same brokers.[9] Plaintiffs further alleged that the broker used Capacity email address to conduct his brokerage business with them and that Capacity referred to the brokerage entities as the “Exec” on customer receivable activity reports relating to workers’ compensation coverage that were sent to them.[10] The court found that plaintiffs adequately alleged the elements of a de facto merger, i.e.: “(1) continuity of ownership; (2) cessation of ordinary business and dissolution of the acquired corporation as soon as possible; (3) assumption by the successor of liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation; (4) continuity of management, personnel, . . . assets and general business operations.”[11] Accordingly, the court denied Capacity’s motion to dismiss plaintiffs’ claim based on successor liability.
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This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
Steps have been taken to verify the contents of this article prior to publication. However, readers should not, and may not, rely on this article. Please consult with counsel to verify all contents and do not rely solely on this article in planning your legal transactions.
About the Author
Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Firm, PLLC, which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: 407-517-0064; [email protected], or www.mcbrideattorneys.com.
[1] See generally Logan Bus Co. v. Auerbach, 2015 N.Y. Slip. Op. 31766(U) (Sup. Ct. Queens Cty. Aug. 5, 2015).
[2] Id. at 2.
[3] Id.
[4] Id.
[5] Id. at 2–3.
[6] Id. at 4.
[7] Id. at 4–5 (internal citations omitted).
[8] Id. at 5.
[9] Id. at 2.
[10] Id.
[11] Id. at 5.