Buyer beware: you may be liable for the defective products of your predecessor.

• Author: Meyer, Kenneth R.

COMPANY A is evaluating whether it should purchase the assets of Company B, which manufactures washing machines. Company A has been looking to break into the washing machine market and sees the purchase of Company B's assets as an excellent opportunity to do so. Company A is considering two courses of action if it purchases Company B's assets: 1) continue the manufacture of Company B's washing machine product line, using Company B's designs, specifications, diagrams, blueprints, personnel, and manufacturing facilities; or 2) cease the manufacturing of the product line, but continue Company B's ancillary business of repairing and servicing the washing machines it sold to its customers. Company A comes to you with a seemingly straightforward question: under these two scenarios, will it be held liable for product liability claims arising from Company B's manufacture and sale of defective washing machines, even if, as part of the asset purchase, it expressly declines to assume Company B's liabilities? Unfortunately, based on the current state of the law, you will not be able to provide Company A with an easy, clear-cut answer.

The General Rule and the Traditional and Non-Traditional Exceptions

In the United States, the general rule of corporate-successor liability is that when a company sells its assets, as distinguished from stock, to another company, the acquiring company is not liable for the debts and liabilities of the selling company simply because it succeeds to the ownership of the seller's assets. (1) There are four traditional exceptions to that general rule: 1) the successor expressly or impliedly assumes the predecessor's liabilities; 2) there is an actual or de facto consolidation or merger of the seller and the purchaser; 3) the purchasing company is a mere continuation of the seller; or 4) the transaction is entered into fraudulently to escape liability. (2)

The general rule and its four traditional exceptions (hereafter referred to as the "traditional approach") apply fundamental tort and corporate law principles to protect successor corporations from product liability. Under tort law, successor corporations are free from liability because they are not within the basic tort principle that "one engaged in the business of selling or otherwise distributing products who sells or distributes a defective product is subject to liability for harm to persons or property caused by the defect." (3) As a result, successor corporations are not liable for the products sold by predecessor corporations under the traditional approach. General corporate law reinforces nonliability for successor corporations because corporate law "favors free alienability of corporate assets and limits shareholders' exposures to liability in order to facilitate the formation and investment of capital." (4) Thus, to protect free market transfers of and between corporations, successor corporations are not subject to successor liability under the traditional approach.

Several jurisdictions, however, have developed two additional exceptions to the general rule of nonliability. Unlike the four traditional exceptions, these newer, nontraditional exceptions (hereafter referred to as "the non-traditional exceptions") do not emphasize the corporate form but instead focus on the acquiring entity's operations following the asset purchase. By doing so, the jurisdictions applying these exceptions are more likely to impose liability upon successor corporations. One of these exceptions is referred to as the continuity of enterprise exception. The Supreme Court of Michigan case, Turner v. Bituminous Casualty Co., is the seminal case adopting this exception. (5) Under this exception, a successor corporation may be liable for a predecessor company's injury-causing product where the totality of the circumstances surrounding the acquisition demonstrates a basic continuation of the enterprise from the seller to the buyer. Turner held that an individual injured by a predecessor's product could establish a prima facie case under this exception against the successor if he established the following facts: 1) a continuation of the seller corporation, in terms of a continuity of management, personnel, physical location, assets, and general business operations of the predecessor corporation; 2) the predecessor corporation ceases its ordinary business operations, liquidates, and dissolves as soon as practicable; 3) the successor corporation assumes the liability and obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations of the predecessor corporation; and 4) the successor corporation holds itself out as the continuation of the predecessor corporation. (6)

The second exception is the product line exception. This exception was first adopted by the Supreme Court of California in Ray v. Alad Corp. (7) Ray held that "a party which acquires a manufacturing business and continues the output of its line of products ... assumes strict tort liability for defects in units of the same product line previously manufactured and distributed by the entity from which the business was acquired." (8) In creating the product line exception, the Ray court identified the following three rationales for its decision: (1) when a successor corporation acquires a predecessor corporation's business, the transfer of ownership virtually destroys the potential plaintiffs' available remedies; (2) successor corporations are in a better position to assume risk-spreading responsibilities; and (3) because the successor corporation gained the benefits of the predecessor corporation's goodwill in the marketplace, it should also bear the predecessor's liability. (9)

Four years after Ray, the New Jersey Supreme Court adopted the product line exception in Ramirez v. Amsted Industries, Inc. (10) In Ramirez, the court explained the product line exception in the following manner: "where one corporation acquires all or substantially all the manufacturing assets of another corporation, even if exclusively for cash, and undertakes essentially the same manufacturing operation as the selling corporation, the purchasing corporation is strictly liable for injuries caused by defects in units of the same product line, even if previously manufactured and distributed by the selling corporation or its predecessor." (11)

Public Policies That Support the Non-Traditional Exceptions

Both the continuity of enterprise exception and the product line exception are based on the policy goals of protecting potential victims and addressing risk allocation between individuals and corporations fairly in the product liability context. Because the traditional approach to successor liability originated long before the advent of strict products liability, the courts that disagreed with the traditional approach broadened successor liability by applying strict products liability principles. Ultimately, both non-traditional exceptions are rooted in risk-spreading; namely, the assumption that successor corporations are in a better position to bear the risk of injuries involving products than are individual consumers because corporations can theoretically spread the cost of the liability across society by increasing the cost of their products. (12)

The Supreme Court of Michigan in Turner and the Supreme Court of California in Ray determined that the traditional approach to successor liability did not adequately or fairly allocate the risk of injury from defective products produced by a successor corporation. (13) The Turner court called the traditional approach's emphasis on corporate form, which effectively destroyed the rights of individuals injured by products to sue successors of cash transfers, both "unfair and unbelievable." (14) Turner stated that it "does not make sense or promote justice" to subject merged or de facto merged successor corporations to product liability suits, but at the same time to free cash transfer successor corporations from such liability...