MORE UNCERTAINTY IN UNCERTAIN TIMES – BUYING ASSETS MIGHT NOT PROTECT YOU FROM SELLER LIABILITIES
Conventional wisdom is that the purchaser of a corporation’s assets is not responsible for the corporation’s liabilities. Indeed, this is one of the primary reasons buyers generally prefer to acquire corporations through asset purchases, as opposed to stock purchases.
The Pennsylvania Supreme Court’s recent decision in Fizzano Brothers Concrete Products, Inc. v. XLN, Inc., 42 A.3d 951 (2012) gives purchasers reason to pause before relying on that conventional wisdom.
Over the years, courts have carved out narrow exceptions to the general rule that the purchaser of a corporation’s assets is not responsible for the corporation’s liabilities. Generally, courts have created these exceptions for public policy reasons, such as protecting creditors from corporations that sell assets to affiliates merely to avoid debts.
One of the exceptions to the general rule is the “de facto merger” exception. Under this exception, the general rule of no purchaser liability is defeated if a court finds that a purchaser’s acquisition of a corporation’s assets amounts to a de facto merger between the purchaser and the seller corporation.
For years, courts wrestled with a key question – can a “de facto merger” occur if the purchaser and the seller corporation do not have common shareholders?
The Pennsylvania Supreme Court attempted to answer that question in the Fizzano decision.
The facts of Fizzano are somewhat confusing. In 1991, System Development Group, Inc. – or “SDG” – licensed software to Fizzano Brothers Concrete Products, Inc.
In 2000, SDG transferred to its four shareholders software that was licensed to third parties such as Fizzano, and sold all remaining assets to XLN, Inc. SDG and XLN did not have any common shareholders. As part of the deal, the four SDG shareholders sold their SDG stock to XLN in exchange for promissory notes payable by XLN. XLN’s payments to the shareholders under the notes were secured by the software SDG had licensed to Fizzano. Under the terms of the agreement, once XLN paid the notes it would own the software.
In 2003, XLNT, Inc. – which had no common shareholders with either SDG or XLN – purchased XLN’s assets. As part of the deal, XLNT agreed to pay the shareholder promissory notes, and would own the software that SDG had previously licensed to Fizzano once the notes were paid.
After the software failed, Fizzano sued SDG, XLN and, later, XLNT.
At trial, XLNT invoked the general rule and argued it could not be held liable for SDG’s or XLN’s liability to Fizzano because it had only purchased XLN’s assets, not its stock.
The trial court disagreed and held XLNT liable under the de facto merger exception.
On XLNT’s appeal, the intermediate court of appeals – the Pennsylvania Superior Court –reversed the trial court and held XLNT was not liable. In doing so, the Superior Court created a bright-line rule easy for businesses and their professional advisors to understand – there can be no de facto merger and no purchaser liability for seller debts unless the seller corporation and the asset purchaser have common shareholders. Because XLNT had no common shareholders with either SDG or XLN, the Superior Court concluded XLNT was not liable to Fizzano.
However, Fizzano asked the Pennsylvania Supreme Court to consider the case further, and the Supreme Court agreed to do so. After considering the case further, the Supreme Court reversed the Superior Court. In doing so, the Supreme Court replaced the Superior Court’s bright-line test with a vague test that will require translation in future court battles. The Supreme Court held that a de facto merger and purchaser liability for seller debts may be found whenever there is “some sort of” ownership continuity between the purchaser and the seller corporation.
Although the Supreme Court ultimately sent the case back to the Superior Court for application of the “some sort of” test to the facts of the case, the Supreme Court did not stop there. Rather, the Supreme Court strongly implied that if a purchaser acquires corporate assets and – as part of the acquisition – agrees to make payments over time under a promissory note to shareholders of the seller corporation, there is “some sort of” common ownership between the corporation and the purchaser. In other words, if the shareholders of a seller corporation help finance the purchase of the corporation’s assets, it is possible the purchaser will be responsible for the selling corporation’s liabilities under the de facto merger exception.
If you are considering purchasing a business, beware – Fizzano is a trap for the unwary. You might be liable for debts and liabilities of the selling business – even if you purchase assets and the purchase documents state you do not agree to assume any of those debts or liabilities. It is critically important to have input from legal counsel on structuring deals to protect against such unintended liabilities.
If you have any questions, please feel free to contact Charles B. Blumenstock, Jr., Rhonda F. Lord, Anita H. Blumenstock, Jason T. Confair, or Clarence C. Kegel, Jr. at 717-392-1100.
We hope you find this issue of KKAL’s Business Law Watch helpful and informative. Please understand that the Law Watch is designed to provide information about current developments and required actions. It does not constitute legal advice, and businesses should consult a lawyer knowledgeable in this area of the law prior to taking specific actions on the issues addressed.
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