Asset Transfers and the Doctrine of Successor Liability
Citing the doctrine of successor liability, the Arizona Court of Appeals held a new business and its owner liable for the debt of a company that transferred assets to the new entity.
Bridge IT, Inc., was an Arizona corporation that provided technology
services to businesses. Sandra Higgins was Bridge IT’s president,
majority shareholder and principle employee. At its high
point, Bridge IT had 12 employees and annual sales of $2
Investments entered into a contract with Bridge IT that
called for Bridge IT to develop a website for Warne. A
contract dispute arose, and Warne sued
Bridge IT. Defending against Warne’s lawsuit proved to be a
major distraction for Higgins; business declined
drastically, and she hired a manager to run the company.
The litigation resulted in
multiple awards to Warne totaling more than $155,000. In an
attempt to collect on the ensuing judgments, Warne garnished
Bridge IT’s bank account, essentially putting the company
out of business.
After Warne filed its lawsuit and before the
case went to trial, Higgins created another corporation,
Bridge Info Tech. (Due to the similarity of names, we will
refer to Bridge IT as the “old company” and Bridge Info Tech
as the “new company.”) The newly created corporation was
inactive until the summer of 2003. At that time, Higgins
stopped working for the old company.
similarities between the old and new companies didn’t end
with the names:
The new company leased office space near the old
The old and new companies provided the same services and
sold the same products.
The old and new companies had at least five significant
clients in common.
The old and new companies were owned and managed by the
same people and benefited from the owners’ skills,
knowledge and market contacts.
When the new company began operating, it bought some of
the old company’s office equipment.
Holding judgments against the insolvent, inactive old
company, Warne filed suit in July 2004 against Higgins and
the new company. Warne was victorious again, getting
judgments against the new company and against Higgins
personally, equaling the $155,000 that the old company had
been ordered to pay.
judgment against the new company was based on the Uniform
Fraudulent Transfers Act (UFTA) and the doctrine of
successor liability. The judgment against Higgins was
based on the successor liability and trust fund doctrines.
In Arizona, the general rule is
that when a corporation sells or transfers its principal
assets to a successor corporation, the successor corporation
is not liable for the former corporation’s debts and
that may appear to be a huge escape route for the owner of a
troubled company, the rule is subject to various exceptions.
Legal responsibility transfers to the successor corporation
if any of these conditions is met:
the successor corporation expressly or impliedly agrees to assume the liabilities of the predecessor corporation; or
the transaction between the two corporations amounts to
a consolidation or merger; or
the successor is a mere continuation or reincarnation of
the predecessor; or
clear and convincing evidence shows that the transfer of
assets from the predecessor to the successor was for the
fraudulent purpose of escaping a debt or liability.
the appeal by Higgins and the new company of the trial
court’s verdict against them, the Arizona Court of Appeals
found that there was sufficient evidence to support the
jury’s conclusion that Bridge Info Tech (the new company)
was a mere continuation of, and a successor to, Bridge IT.
The mere continuation theory of successor liability requires
proof of “substantial similarity in the ownership and
control” of the two businesses, and the failure by the
successor business to pay reasonable value to the
predecessor business for the assets transferred.
addition to observing the similarities between the two
companies, as noted above, the Court of Appeals examined the
adequacy of the value paid for the assets transferred. The
Court acknowledged the finding of Warne’s expert witness
that the old company’s value as a going concern was
transferred to the new company, which used that value to
quickly become a going concern itself. Higgins’ position was
further weakened by the fact that the new company did not
pay the old company for the transfer of any assets other
than about $2,200 for office equipment. The old company’s
intangible assets (e.g., goodwill, customer contacts, and
the knowledge and skills of the owners and employees) were
transferred to the new company without any compensation,
further rendering the old company incapable of meeting its
obligation to Warne.
should be noted that the availability of intangible assets,
such as good will, for transfer and the value, if any, of
this type of asset is case-specific and largely dictated by
the type of business involved.
Warne, the Court recognized that this successful service
business had, but was not paid for, valuable customer
loyalty assets that simply followed the owner and key
employees. The result: The new company was liable for the
prior judgments Warne obtained against old company.
Trust Fund Doctrine
As for Higgins’ personal liability
for the entire obligation owed to Warne, a discussion of the
trust fund doctrine may be useful. The doctrine is meant to
ensure that all creditors’ claims against an insolvent
corporation are satisfied before any stockholders receive
anything. In this case, liability under the trust fund
doctrine required evidence that:
corporate assets were transferred to Higgins,
the transfer occurred while the corporation was
the transfer gave Higgins preferential treatment over
Court of Appeals found that all of those conditions were
met, making Higgins generally liable under the trust fund
doctrine. However, the Court declined to impose personal
liability on Higgins on either successor liability or
fraudulent transfer grounds.
Sandra Higgins chose a path that the
owners of many other troubled businesses have tried to
follow – i.e., to limit the recourse of the creditors of
Company A by transferring its assets, ownership, employees,
operations, processes, customer relationships, etc., to a
new, unblemished Company B, without the payment of adequate
value for the assets transferred.
exceptions to the doctrine of successor liability noted
above illustrate (a) how difficult it is for a successor
corporation to properly structure a transfer of assets so as
to avoid the debts and obligations of its predecessor and
(b) the readiness of the courts to punish sham transfers
from a predecessor to its successor.