It’s a common situation for attorneys, you have a client, your client is owed money from another business, the debtor business is then “sold” to another and “new co” comes into existence. The question—can you hold “new co” accountable for the debt incurred by “old co”? A recent opinion from Judge James B. Loken, writing for the Eighth Circuit Court of Appeals, sets out a good outline for how and why a properly structured purchase of a debtor’s assets at a private foreclosure sale means there is no successor liability to a debtor’s unpaid creditors.
In the case at issue[1], both the debtor and the eventual buyer of the debtor’s business roasted coffee. After conducting due diligence into the debtor’s operation, the buyer decided not to purchase the assets directly from the debtor noting that the debtor had substantial financial liabilities. Later, the debtor’s secured bank demanded repayment in full of the debtor’s $5 Million debt, foreclosed when the debtor failed to pay. The Bank then sold its collateral to the buyer at a private foreclosure sale for about $2 Million. Accordingly, the sale, which the Court found to be “commercially reasonable,” left the bank with a remaining balance owed of more than $3 million and rendered the debtor unable to pay any of the $2.7 Million unsecured claim of its supplier of green coffee. The coffee supplier then sued the buyer in federal district court based, in part, on claims of successor liability. The district court granted summary judgment in favor of the buyer, dismissing the successor liability claim as well as everything else and the supplier appealed.
Upholding the district court’s grant of summary judgment, Judge Loken noted that the agreement between the bank and the buyer clearly stated the buyer would not be liable for any debts owed by the debtor at the time of the sale. Further, Judge Loken stated he found “no prior case imposing successor liability” and said that “prevailing law [is] to the contrary.” In support of the Court’s opinion, Judge Loken stated the “well-settled general rule” adopted “virtually” everywhere is that the sale of “all assets” does not make the buyer liable for debts of the seller. With exceptions only in cases involving: (1) de facto merger, (2) fraud, or (3) a mere continuation of the seller’s business.
To determine whether “new co” is merely a continuation of “old co,” Judge Loken said, “the test is whether there is a continuation of the corporate entity of the transferor — not whether there is a continuation of the [seller’s] business operation.” In the case at issue, the Court found there was no continuation because the sale was an arm’s-length transaction with no continuity of ownership or management after the sale. There mere fact that the buyer kept the employees and retained the seller’s top executives for a few months after the purchase was not dispositive of the issue. With the Court noting that such a practice is “common after such acquisitions and is not evidence of ‘mere continuation’ of the company.”
As to fraud, Judge Loken noted the buyer purchased the assets from the bank, not from the debtor. “There is nothing inherently wrongful or fraudulent in purchasing assets at a foreclosure sale, free of encumbrances, rather than directly purchasing the assets (from the debtor).”
The Court also noted that the unpaid supplier suffered no prejudice; the bank was not paid in full as a result of the sale which, therefore, left nothing for unsecured creditors.
All in all, Judge Loken’s opinion serves as a good primer for determining whether the sale in question was properly arms-length so as foreclose claims of successor liability as to the buyer for the seller’s debts.
[1] Ronnoco Coffee v. Westfeldt Brothers Inc., 18-1498 (8th Cir. Sept. 19, 2019)
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