It is an article of faith among transactional practitioners that an entity seeking to acquire another entity without being saddled with its liabilities does so by acquiring assets. As a general proposition, that method works. “Most jurisdictions, including Massachusetts, follow the traditional corporate law principle that the liabilities of a selling predecessor corporation are not imposed upon the successor corporation which purchases its assets. . . .” Milliken & Co. v. Duro Textiles, LLC, 451 Mass. 547, 556, 887 N.E.2d 244, 254 (2008) (quoting Guzman v. MRM/Elgin, 409 Mass. 563, 566, 567 N.E.2d 929, 931 (1991)). There are however, four important exceptions to the general rule. An asset transfer may carry with it successor liability where, “(1) the successor expressly or impliedly assumes the liability of the predecessor, (2) the transaction is a de facto merger or consolidation, (3) the successor is a mere continuation of the predecessor, or (4) the transaction is a fraudulent effort to avoid liabilities of the predecessor.” Id.
The possibility that exposure to successor liability will flow from an express assumption of liability is no doubt self-evident to attorneys guiding clients through an asset acquisition. Moreover, most practitioners are aware of the concerns that emerge under the Massachusetts fraudulent transfer statute. See G.L. c. 109A § 5. In addition, “mere continuations” will not be hard to recognize. A mere continuation “envisions a reorganization transforming a single company from one corporate entity into another.” Milliken & Co., 451 Mass. at 556 (quoting McCarthy v. Litton Indus., Inc., 410 Mass. 15, 21–22, 570 N.E.2d 1008, 1012 (1991)). “The indices of a ‘continuation’ are, at a minimum: continuity of directors, officers, and stockholders; and the continued existence of only one corporation after the sale of its assets.” McCarthy, 410 Mass. at 23. It will not surprise most attorneys that shuffling the deck chairs will not be enough to shake free of liabilities of an enterprise continued under a nominally new entity.
The de facto merger, however, has fuzzier boundaries. Much like the alter ego analysis, found in My Bread Baking Co. v. Cumberland Farms, 353 Mass. 614, 233 N.E.2d 748 (1968), the de facto merger doctrine calls on courts to consult multiple specified factors to determine if there has been a de facto merger; however, “[n]o single factor is necessary or sufficient to establish a de facto merger.” Cargill, Inc. v. Beaver Coal & Oil Co., 424 Mass. 356, 360, 676 N.E.2d 815, 818 (1997). That is to say, the absence of any one factor will not preclude a finding of de facto merger, and, in some cases, the presence of some amount of each factor would not compel a finding of de facto merger.
Where successor liability is found to exist by virtue of a de facto merger, the successor entity stands in the shoes of the predecessor and is fully responsible for its liabilities, which can include liability for multiple damages under G. L. c. 93A. Milliken & Co., 451 Mass. at 565. Counsel advising a client in advance of an asset acquisition must confront the alchemy of these multiple factors to assess (or, maybe guess) whether the cumulative quantum of the factors is small enough to shake free from the acquired entity’s obligations, or substantial enough to expose the client to the liabilities from which it sought shelter. (Several other states have adopted some version of the de facto merger doctrine, with varying degrees of rigor applied in assessing the multiple factors. John H. Matheson, Successor Liability; 96 MINN. L. REV. 371.387-91 (2011). Delaware, for example, has a restrictive version of the doctrine that applies only where all assets of the predecessor are acquired, the purchase compensation is stock, and there is an agreement to acquire liabilities. Magnolia’s at Bethany, LLC v. Artesian Consulting Engineers Inc. No. CIV.A. S11C-04013ESB, 2011 WL 4826106, at *3 (Del. Super. Ct. Sept. 19, 2011)). Several courts have noted that the analysis for successor liability is largely uniform among the states but, nonetheless, a thicket. U.S. v. General Battery, 423 F.3d 294, 301 (3d Cir. 2005). “Beneath a veneer of uniformity, the ‘entire issue of successor liability . . . is dreadfully tangled, reflecting the difficulty of striking the right balance between the competing interests at stake.’” Id. (citing EEOC v. Vucitech, 842 F.2d 936, 944 (7th Cir. 1988)).
The factors considered in the analysis are whether:
(1) there is a continuation of the enterprise of the seller corporation so that there is continuity of management, personnel, physical location, assets, and general business operations; . . . (2) there is a continuity of shareholders which results from the purchasing corporation paying for the acquired assets with shares of its own stock, . . . (3) the seller corporation ceases its ordinary business operations, liquidates, and dissolves as soon as legally and practically possible, and . . . (4) the purchasing corporation assumes those obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations of the seller corporation.
Cargill, Inc., 424 Mass. at 359–60. Whether the transaction is used to defeat creditors’ claims is also a factor. Milliken & Co., 451 Mass. at 556. The de facto merger doctrine is equitable in nature and, therefore, subject to equitable defenses. Id.
There has been some elasticity layered into these factors. For example, although the doctrine originally assumed application to transactions where shares were exchanged for assets, the shareholder component can now be met where the shareholders of the former entity paid to acquire their shares in the acquiring entity and may be satisfied with a small percentage of ownership in the acquiring entity. Cargill, Inc., 424 Mass. at 361 (12.5 percent of shares acquired satisfied the shareholder component); General Battery, 423 F.3d at 306—307 (4.5 percent held to be enough, as “[t]he continuity of shareholders element is designed to identify situations where the shareholders of a seller corporation retain some ownership interest in their assets after cleansing those assets of liability.”). In one decision, the court ruled that the shares received by the owners of the predecessor entity did not have to be shares of the acquiring entity, but could instead be shares of the acquirer’s parent entity, at least where the purchaser was a wholly owned subsidiary of the parent. In re Acushnet River, 712 F. Supp. 1010, 1017 (D. Mass. 1989). Formal dissolution of the predecessor is not required to establish the discontinuation of the prior business. Cargill, Inc., 424 Mass. at 361. The predecessor in Milliken continued in business for a period after the sale of its operating assets to manage and lease out substantial real estate assets. Milliken & Co., 451 Mass. at 559-60. (The operational assets had transferred and the “selling” entity continued only as a landlord. The formal dissolution, originally a component of the de facto merger doctrine was not formally met, but the selling entity did not continue in its prior business.) Factors that indicate a continuation of the predecessor’s business include whether the successor entity continued the general business of the predecessor, used some of the same personnel to continue the business, and acquired assets from the predecessor (including customer lists) to continue the business. Id. at 360-61. See also Lanee Great Plastic Co., LTD v. Handmade Bow Co., No. SUCV200705245, 2010 WL 6650330, at *5 (Mass. Super. Ct. Dec. 26, 2010). Satisfaction of the fourth prong, assuming obligations necessary for business continuation, does not require taking on all obligations of the predecessor, but only those necessary to continue business uninterrupted. In Cargill, the court found it enough that the party acquiring assets assumed certain obligations such as paying creditors that agreed to continue to do business with the “successor,” assuming executory contracts, assuming service contracts, and assuming delivery obligations to customers with credit balances. Cargill, Inc., 424 Mass. at 361. As the court noted, “[e]ach case must be decided on its specific facts and circumstances. Id. at 362.