The seller’s practice entered into a contract with a doctor employee who left after the closing. The seller promised in the contract to give the doctor any medical records of any patient that followed the doctor. The doctor sued the buyer, claiming that the seller failed to give the doctor adequate medical records and arguing that the buyer was legally responsible for the contract under the successor liability doctrine.
M&A Stories
May 8, 2023
Introduction
When a corporation or limited liability company that owns a business is sold, the buyer acquires all its assets and is responsible for all its liabilities. On the other hand, if only the assets of the business are sold, the buyer can pick and choose which liabilities to assume.
The deal
In this transaction, the seller was a medical practice that sold its assets to a buyer. One of the doctors left the practice at the closing. The selling practice promised in a separation contract to provide the doctor with any medical records of patients that followed the doctor.
The lawsuit
The doctor did not get all the medical records of his patients and sued the buyer in Massachusetts Superior Court for breach of the separation contract. He argued that the buyer was responsible for the contract under the successor liability doctrine.
Successor liability, in the context of this transaction, refers to the legal concept where the buyer of the assets of the seller’s medical practice, may be held liable for the debts, obligations, or liabilities of the seller. This legal responsibility can arise even if the buyer did not sign or assume the separation agreement. The principle of successor liability is intended to ensure that the obligations of a business are not evaded through corporate restructuring or other transactions.
The Superior Court ruled that the buyer was not responsible for the separation contract. The doctor appealed to the Appeals Court of Massachusetts. The appellate court said that a buyer of the assets of a business is generally not responsible for seller liabilities that the buyer did not assume. However, there are several exceptions under the successor liability doctrine.
The doctor claimed that the buyer’s transaction falls under the de facto merger exception. The de facto merger is a legal doctrine that refers to a situation where two companies combine operations and functions to such an extent that the transaction is essentially a merger, even though it may not have been formally structured as one. The purpose of the de facto merger doctrine is to prevent companies from using asset purchase agreements to avoid legal obligations that would otherwise apply in a merger or acquisition context.
The court said that there were four factors it must consider to determine whether there was a de facto merger: whether (1) there is a continuation of the medical practice so that there is continuity of management, personnel, physical location, assets, and general business operations; whether (2) there is a continuity of shareholders which results from the buyer paying for the acquired assets with shares of its stock, this stock ultimately coming to be held by the shareholders of the seller medical corporation so that they become shareholders of the buyer medical corporation; whether (3) the seller corporation ceases its ordinary business operations, liquidates, and dissolves as soon as legally and practically possible; and whether (4) the buyer assumes those obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations of the acquired medical practice.
The court held that there was no de facto merger because the acquisition was for cash and no buyer stock, and because no managers of the seller’s medical practice managed the practice after the closing.
See Weinshel v. Southcoast Physicians Group, Inc., No. 22-P-685, Appeals Court of Massachusetts (April 13, 2023.)
Comment
Many state successor liability doctrines do not apply to all-cash asset acquisitions.
By John McCauley: I write about recent legal problems of buyers and sellers of small businesses.
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