Using the Doctrine of Successor Liability to Stop Runaway Debtors
It is not uncommon for a plaintiff to obtain a judgment against a corporation but not be able to collect on the judgment because the corporation goes out of business. Typically, the debtor corporation genuinely failed because it could not generate sufficient revenue to satisfy its liabilities. However, in some instances, shifty debtor corporations attempt to exploit legal loopholes and prevent a creditor from using the corporation’s assets to satisfy the judgment. Di Monte & Lizak, LLC recently represented a creditor against a corporate debtor who attempted to employ this strategy.
In Mamacita, Inc. v. Colborne Acquisition Company, LLC, et al., Case No. 10-CV-6861, a creditor obtained a judgment against a corporation. In an attempt to avoid satisfying the judgment, the shareholders of the debtor corporation convinced their friends to form a new corporation that would purchase the old corporation’s assets. Pursuant to the scheme, the old corporation’s shareholders’ friends would own new corporation, but the old corporation’s shareholders would manage the new corporation and otherwise enjoy the benefits of owning the business.
The old corporation’s lender, who was complicit in the scheme, initiated an unnecessary Uniform Commercial Code (AUCC@) sale of the old corporation’s assets and then financed the new corporation’s purchase of the old corporation’s assets. The new corporation reaffirmed the old corporation’s obligations to the lender. In effect, no money changed hands, but the old corporation shed itself of liability to the creditor and the shareholders of the old corporation continued to enjoy using the corporate assets for their personal benefit.
After discovering the debtor corporation’s actions, the creditor hired Di Monte & Lizak to file a lawsuit, asserting a claim against the new corporation for successor liability. The new corporation filed a motion to dismiss, arguing that it was not liable for the obligations of the old corporation. In Illinois, a purchaser corporation is generally not liable for the debts of the seller corporation. However, there are four exceptions: 1.) an express or implied agreement of assumption; 2.) a merger of the purchaser and seller corporations; 3.) the purchaser is a mere continuation of the seller; and 4.) the transaction is for a fraudulent purpose. These exceptions are known as the doctrine of successor liability.
In response to the motion to dismiss, the creditor argued that the first exception applied because the old corporation expressly assumed the new corporation’s debt to its lender, and therefore, the old corporation impliedly assumed the new corporation’s debts to its other creditors. The creditor also argued that the second and third exceptions applied because nearly every aspect of the new corporation was a continuation of the old corporation’s business. Finally, the creditor argued that the fourth exception applied because the shareholders of the old corporation orchestrated the collusive UCC sale of its assets to avoid satisfaction of the creditor’s judgment.
With respect to the first exception, the court held that a purchaser corporation does not impliedly assume all of a seller corporation’s liabilities by expressly assuming one or more of the seller’s liabilities. The court also rejected the second and third exceptions because the owners of the new corporation were different than the owners of the old corporation. Despite rejecting the first three exceptions, the court found that the fourth exception applied. The court ruled that the creditor’s allegations of the old corporation’s and its shareholders’ fraudulent conduct was sufficient to state a claim for successor liability against the new corporation. Accordingly, the judge denied the new corporation’s motion to dismiss and allowed the creditor to proceed with its claim for successor liability against the new corporation, seeking to hold the new corporation liable for its judgment against the old corporation.
This real life example shows: 1.) the lengths that a corporate debtor may go to in order to avoid satisfying a judgment; 2.) the ability of a judgment creditor to pursue its judgment against a successor corporation; and 3.) that courts tend to find a way to make the claim stick if a debtor participates in fraudulent conduct to avoid satisfying a judgment. If you obtain a judgment against a corporation and the corporation appears to have gone out of business by selling all of its assets, you should consult an attorney to determine whether you have a claim against the purchasing entity for successor liability.