The New York court permits the seller’s landlord to pursue the buyer based on the successor liabilities doctrines of (1) actual fraud to hinder the landlord and (2) de facto merger.
M&A Stories
June 29, 2023
Introduction:
When acquiring a business, buyers have the ability to choose which liabilities they assume. However, there are instances where certain liabilities may still be attached to the acquisition, despite the buyer’s preference.
Background:
In this case, the buyer was involved in the consolidation of radio stations. They purchased the assets of the seller’s radio network for $3.5 million. The seller’s founder/president and COO obtained ownership in the buyer’s acquisition subsidiary and continued to operate the network for two years after the transaction.
The deal closed about 8 months after the landlord of the seller’s Manhattan offices had filed a lawsuit against the seller for unpaid rent. The court awarded a judgment of $500K against the seller about two years after the closing.
Lawsuit:
Since the seller failed to pay the landlord, the landlord took legal action against the buyer in a Manhattan state court, relying on New York’s successor liability doctrines. The buyer requested the court to dismiss the lawsuit.
Outcome:
The court denied the buyer’s motion and allowed the landlord to proceed with the claim against the buyer using two successor liability doctrines. First, the court permitted the landlord to explore, through discovery, the claim that the buyer intentionally defrauded the landlord. Second, the court allowed the pursuit of successor liability against the buyer under the theory that although the transaction was structured as an asset purchase, it effectively merged the seller into the buyer, according to New York’s de facto merger doctrine.
The critical factor for the court was the fact that the seller’s founder/president obtained an ownership interest in the buyer’s acquisition subsidiary.
Case Reference:
See Trinity Centre LLC v. Gen Media Partners LLC, Index No. 656215/2021, Motion Seq. No. 002, Supreme Court, New York County (June 7, 2023)
Comment: While it may be difficult for the landlord to prove that the buyer intended to defraud them, the de facto merger theory could potentially favor the landlord due to the seller’s founder holding equity in the buyer group. The receipt of buyer equity, commonly known as “rollover equity,” is a common occurrence in private equity deals.
The lesson learned from this case is the importance of conducting thorough due diligence. The landlord’s lawsuit was a matter of public record during the buyer’s due diligence process. By being aware of the potential risk and taking appropriate measures such as having the seller settle the landlord’s debt before the closing or withholding a portion of the purchase price, the buyer could have mitigated the exposure to the landlord’s claim.
By John McCauley: I write about recent legal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
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Check out my books: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles and Selling Assets of a Small Business: Problems Taken From Recent Legal Battles
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