SC Lawyer, March 2006, #5. Successor Liability: not just for contracts anymore.

• Author: By Tim Orr

South Carolina Lawyer

2006.

SC Lawyer, March 2006, #5.

Successor Liability: not just for contracts anymore

South Carolina Lawyer March 2006 Successor Liability: not just for contracts anymore By Tim Orr A. A Hypothetical

At a bankruptcy auction, Marvin and his colleagues were the highest bidders on the physical assets of Palmetto Rockets, Inc. (Palmetto), a bankrupt custom motorcycle manufacturer in the Upstate. As the highest bidder, Marvin won the rights and title to the assets. He signed a formal asset transfer agreement with the owners of Palmetto Rockets. The agreement provided that, in exchange for $1.6 million, Marvin would receive the real estate, buildings, inventory, industrial tools (welders, presses, dyes) to produce custom-made motorcycles and the right to use the Palmetto Rockets' name. Pursuant to the agreement, Palmetto Rockets was to be responsible for the accounts receivables and all liability for motorcycles that Palmetto Rockets had sold previously. Within days, the supervising bankruptcy court approved the sale and transfer of assets. Soon after, Palmetto Rockets wound down its business, closed its books and dissolved itself as a corporation.

Marvin, one of the purchasers of the assets, planned to close the former Palmetto Rocket facility in the Upstate and move it to his hometown in Jasper County. Marvin planned to continue making motorcycles at the new location. There were still some partially built motorcycles on the shop floor in the Upstate that Marvin planned to complete. So, while locating a new factory in Jasper County, Marvin established a new business called "Palmetto Motorcycles, LLC" (Motorcycles). He transferred all his rights won at auction to Motorcycles. This new company, which did not share any officers or stockholders of Palmetto Rockets, did re-hire some of Palmetto's employees. The new company made a few more motorcycles for a few months at the same location, using many of the same employees and using the same Palmetto logo. Palmettorockets also contracted with Palmetto's CEO as a consultant and gave him a seat on the board of directors for a term of three years in exchange for cash.

When all the dies, molds and manufacturing equipment were moved to Jasper County, Marvin closed the Upstate plant, terminated employees and opened Motorcycles in Jasper County. Only three employees followed the business from the Upstate to Jasper County. Business was great. Marvin was able to use the Palmetto's sales contacts and the Palmetto name to market his new Motorcycles brand.

Five years after the auction, Hotrod was seriously injured while driving a motorcycle manufactured by Palmetto. Palmetto, not Motorcycles, designed, manufactured and sold the particular motorcycle two years before it went bankrupt. Hotrod filed suit against Motorcycles in South Carolina. Hotrod contends the motorcycle was defective and unreasonably dangerous. Hotrod claims that because Motorcycles purchased Palmetto's assets, Motorcycles became the successor to Palmetto and, as such, is liable for the motorcycle Palmetto made.

Marvin was very perplexed. Neither he nor his business partners believed that they or their product was at fault for Hotrod's injuries. How could Marvin and Motorcycles be responsible for a product Palmetto made years ago? All they did was buy the machines and equipment to make motorcycles, right? Did Marvin and Motorcycles purchase more than just the assets? If caveat emptor applied, Marvin would have to bear any consequences of his purchase. Does caveat emptor apply to buyers such as Marvin? Should Motorcycles be able to take the good of the deal but not any of the bad?

B. Simmons v. Mark Lift Industries, Inc. - the test for successor liability

Under the doctrine of successor liability and the Supreme Court of South Carolina's recent interpretation of it, Palmettorockets may well be held liable for a product made by its predecessor Palmetto. On October 24, 2005, the Supreme Court of South Carolina held, in a certified question from the U.S. District Court:

in the absence of a statute, a successor company ordinarily is not liable for the debts of a predecessor or selling company unless (1) there was an agreement to assume such debts, (2) the circumstances surrounding the transaction warrants a finding of a consolidation or merger of the two corporations, (3) the successor company was a mere continuation of the predecessor, or (4) the transaction was entered into fraudulently for the purpose of wrongfully defeating creditors' claims.

Simmons v. Mark Lift Indus., Inc., 366 S.C. 308, 622 S.E.2d 213, ___ (2005) reh'g denied, ---- S.C. -----, ----- S.E.2d -----, (Dec. 12, 2005) (per curiam) (emphasis in original; footnotes omitted).

Although the full opinion also addressed the effect of a bankruptcy court order on a subsequently filed lawsuit, the decision is most important: for the first time the court decided what test South Carolina courts are to employ to determine successor liability in a products liability setting. The decision embraces the court's nearly century-old opinion in the commercial case of Brown v. American Railway Express Co., 128 S.C. 428, 123 S.E. 97 (1924), and extends the test applied by the Brown court for successor liability to all products liability actions. Significantly, the court's recent pronouncement in Simmons retained the "traditional" four exceptions to the rule of successor liability and rejected outright two expansive tests of determining successor liability. This decision puts South Carolina in line with the vast majority of states. But how will it affect other potential plaintiffs seeking to impose successor liability in commercial, tort and products liability settings?

C. Successor liability - the doctrine

Successor liability is a fictional tool that courts initially derived from the common law. The general rule of successor liability is: a company that acquires the assets of another company through the sale or transfer is not responsible for the selling company's debts and liabilities. See generally, David J. Marchitelli, J.D., Annotation, Liability of Successor Corporation for Injury or Damage Caused by Product Issued by Predecessor, Based on Successor's Express or Implied Agreement to Assume Liability or Where Transfer was Fraudulent, in Bad Faith, or Without Adequate Consideration 112 A.L.R.5th 113, 127 (2003); Am. Law Prod. Liab. 3d § 7:1 (Timothy E. Travers ed., rev. ed. 2004). The rule operates to extinguish liability between a selling company (predecessor) and its purchaser (successor). The general rule of no successor liability was developed within the framework of corporate and tax law. However, over the past 20 years, both state and federal courts have routinely applied the doctrine to commercial cases, business torts and - at least since the 1970s - products liability cases, irrespective of the underlying theory of liability or defect.

D. Successor liability - the exceptions

As with any rule, there are exceptions. In the successor liability arena, an exception, once established, precludes a successor from shirking liability through ostensibly legitimate - although complex and technical - legal transactions, such as mergers and re-incorporations, or by illegitimate means, such as outright fraudulent transfers. The exceptions to the successor...