CHAPTER § 6.04 Successor Liability for Pre-Acquisition Conduct of a Subsidiary

• Jurisdiction: United States

§ 6.04 Successor Liability for Pre-Acquisition Conduct of a Subsidiary

Plaintiffs generally advance one (or a combination) of the following three theories to impose liability on a parent corporation for the pre-acquisition conduct of its subsidiaries: (1) successor liability; (2) piercing the corporate veil; and/or (3) direct liability.

[1] Successor Liability (Standing Alone)

The general common-law rule of successor liability is actually one of non-liability: a corporation that acquires some or all of another corporation's assets does not also acquire the liabilities of the predecessor.¹⁶⁷ This traditional rule was developed in the context of corporate and tax law and is designed to protect acquiring companies from the unassumed debts and liabilities of the companies whose assets they purchase.¹⁶⁸ However, this general rule of successor non-liability is subject to several exceptions.

Under the four traditional, widely adopted exceptions, a corporation may be held liable for the torts of its predecessor if: (1) the successor expressly or impliedly agreed to assume the predecessor's liability; (2) there was an actual or de facto consolidation or merger; (3) the purchasing corporation is a "mere continuation" of the selling corporation; or (4) the transaction is entered into fraudulently to escape such liability or obligations or is made without sufficient consideration.¹⁶⁹ These historically narrow exceptions were primarily designed to protect creditors and minority shareholders rather than tort victims, and product-liability plaintiffs have encountered difficulty in establishing successor liability under these exceptions.¹⁷⁰ Some jurisdictions have developed additional exceptions to the general rule of successor non-liability, including the "continuity-of-enterprise" or "product-line" theories, which focus more on the practical effect of the acquisition than its form, and attempt "to balance 'the competing considerations of products liability and corporate acquisitions.'"¹⁷¹ Which particular exceptions are available for a court to impose successor liability will depend on the applicable law.¹⁷²

Where a plaintiff alleges that a successor corporation expressly or impliedly assumed the liabilities of the acquired predecessor, courts first look to the express language of the purchase and sale agreement.¹⁷³ Broad contract provisions in which the successor assumes a wide range of the predecessor's obligations and liabilities that are necessary and appropriate to the continuation of an ongoing business may suggest the intent to assume the risk of most or all of the predecessor's liabilities, including liabilities that may arise in the future and liabilities not specifically referenced in the agreement.¹⁷⁴ On the other hand, if the purchase agreement refers to the assumption of specific obligations or categories of obligations, a court is more likely to conclude that the successor did not intend to assume liabilities not referenced in the agreement.¹⁷⁵

Under the second exception, successor liability will be imposed where the corporate transfer amounts to a merger, consolidation, or stock sale. Even where the transaction is not styled as a merger or consolidation, or does not meet the formal, often statutory requirements for a merger or consolidation, the exception still applies where the transaction can be seen as a de facto merger. Courts look to several factors in determining whether there has been a de facto merger, including: (1) continuity of the business enterprise, including continuity of management, employees, location, and assets; (2) continuity of shareholders; (3) the payment of consideration by the purchaser in the form of the purchaser's stock; (4) cessation of operations and dissolution of the predecessor soon after the transaction; and (5) the successor's assumption of liabilities necessary for the continuation of the predecessor's business.¹⁷⁶ Some courts have held that the payment of stock in the purchasing company in exchange for the acquired company's assets is a key factor in finding a de facto merger, with some jurisdictions finding this commonality of ownership between the seller and the purchaser being an essential element.¹⁷⁷

The "mere-continuation" exception calls for the imposition of successor liability where there is such continuity of ownership and control between the successor and predecessor companies that the successor is effectively the same entity as the predecessor. For this exception to apply, the successor must do more than simply continue the business operations of the predecessor, retain the predecessor's trade name, or utilize the predecessor's goodwill; rather, the successor corporation must appear to be the same legal entity as the predecessor or "merely a new hat" for the predecessor.¹⁷⁸ As such, courts tend to construe this exception quite narrowly.¹⁷⁹ Critical factors to a finding of "mere continuation" include a common identity of officers, directors, and stockholders between the predecessor and successor companies.¹⁸⁰ Other significant, if not essential, factors include the continued existence of only one company following the transaction and the inadequacy of the consideration for the sale of the predecessor's assets.¹⁸¹ In some jurisdictions, the de facto merger and "mere-continuation" tests are interchangeable.¹⁸²

Courts may also impose successor liability where the transfer of assets to the successor was undertaken fraudulently to escape the liabilities of the predecessor.¹⁸³

A minority of jurisdictions have also adopted the "continuity-of-enterprise" and/ or "product-line" exceptions to the general rule of successor non-liability. Under the "continuity-of-enterprise" theory, a successor may be held responsible for the predecessor's product liability where the successor continues the predecessor's business enterprise. This theory, in contrast to the traditional "mere-continuation" exception, focuses more on continuation of the predecessor's business operations than effective continuation of the predecessor's corporate entity or form, and liability may be imposed under the "continuity-of-enterprise" theory even where there is no continuity of owners or shareholders or where the sale of assets is for cash, rather than the purchaser's stock.¹⁸⁴ Nevertheless, some courts treat the "continuity-of-enterprise" theory as simply a less stringent and formalistic variant or expansion of the "mere-continuation" exception that is designed to accommodate the compensatory and risk-allocating policy objectives of product-liability law.¹⁸⁵

Similarly, under the "product-line" or "product-line-continuation" theory, liability for the conduct of the predecessor will be imposed on the successor where: (1) the successor acquired substantially all of the predecessor's assets, leaving no more than a corporate shell remaining; (2) the successor produces the same product line as the predecessor under a similar name, so as to hold itself out to the public as a continuation of the predecessor; and (3) the successor benefits from the original manufacturer's goodwill.¹⁸⁶ The rationale for this theory of successor liability is that: (1) there is a "virtual destruction" of the plaintiff's remedy against the predecessor; (2) the successor has the knowledge and ability to spread the risk among future consumers of the same product in the price it charges for that product; and (3) the successor benefits from the original manufacturer's goodwill and should not be able to enjoy this advantage while avoiding the associated burdens.¹⁸⁷ Accordingly, some jurisdictions that recognize the "product-line" theory only apply it where the successor, more than merely staying in the same general type of business as the predecessor, continues to manufacture the same product or type of product at issue.¹⁸⁸ Other courts require the elimination of the plaintiff's remedy against the predecessor as a condition precedent to imposition of successor liability under the "product-line" exception.¹⁸⁹ Finally, because this exception was created to advance the unique goals of strict product liability, the "product-line" rule should not apply where strict liability is not an available theory of recovery.¹⁹⁰

A parent corporation, however, should not be strictly liable under successor principles for the pre-acquisition liabilities of an entity acquired by the parent's separate subsidiary. Thus, parent companies can often insulate themselves from the liability of acquired subsidiaries if they accomplish the acquisitions through other subsidiaries.¹⁹¹

Plaintiffs' attempts to reach the parent corporation for conduct of subsidiaries acquired by other subsidiaries through some theory of successor liability have been generally unsuccessful, and with good reason. Principles of successor liability do not provide a basis for disregarding the separate corporate identities of a parent and its subsidiary merely because the subsidiary acquires another entity with preexisting liabilities.¹⁹² However, exceptions to this rule may lie where the parent's own activities meet the requirements of a successor theory, such as if the parent itself purchased and continued the business enterprise of the acquired entity.

In Morgan v. Powe Timber Co.,¹⁹³ which applied Delaware law, the plaintiffs tried to reach the assets of a parent corporation for toxic exposure at one of its subsidiary's facilities that occurred well before the parent's acquisition of that subsidiary. The parent had employed a "triangular merger" in acquiring the subsidiary, creating an interim subsidiary that was merged with the acquired entity at the time of the transaction.¹⁹⁴ The plaintiffs did not argue that the veil should be pierced, but instead argued the court should "pierce the merger" on the basis of successor-liability principles.¹⁹⁵ The plaintiffs argued that creating a holding company for the sole and express purpose of acquiring a business should not insulate the parent...