In this case, Seller was a maker of a tar lugger, a holding tank for hot tar that is used in the roofing business. In the fall of 2013, Buyer purchased the assets of Seller’s tar lugger business.
About a year later, a roofer was performing work on a commercial roofing job at the White Sands Missile Range, a federal enclave in New Mexico. The tar lugger being used for the job overturned, spraying and burning the roofer with hot tar. Seller had made the tar lugger.
The roofer sued Buyer. The roofer claimed that Buyer was responsible for the tar lugger made by Seller. One of the roofer’s legal theories was the de facto merger doctrine.
The court noted that the general rule under New Mexico law is that Buyer, as the purchaser of Seller’s assets, does not automatically acquire the liabilities or obligations of Seller.
The roofer argued that an exception to this rule is the de facto merger doctrine. The court noted that applicable New Mexico law has not recognized the de facto merger doctrine as an exception to the general rule of successor non-liability. Nevertheless, the court considered its application in this case.
A de facto merger cannot exist unless there is continuity of shareholders. In this case Seller did not become a shareholder in Buyer, so the de facto merger exception should not apply. However, the roofer argued that it does apply because Seller received part of the purchase price in the form of an earnout of 20% of the net profits of Buyer’s commercial roofing division products over a five-year period, up to a cumulative maximum of $250,000.
The court rejected this argument because the continuity factor also requires Seller to transfer liabilities to Buyer. The court described the Buyer/Seller transaction as a “mere sale of assets from one corporation to another, without a transfer of Seller’s liabilities; meaning that the Buyer/Seller transaction “does not satisfy the continuity of shareholders factor for a de facto merger”.
This case is referred to as Ramos v. Foam America, Inc., No. CV No. 15-980 CG/KRS, United States District Court, D. New Mexico, (August 13, 2018).
Comment. A creditor of a business sold in an asset purchase transaction often looks to the buyer as a deep pocket. However, it is difficult to recover from the buyer except under several circumstances.
One legal doctrine that may get the seller’s creditor there is the de facto merger doctrine. It does not apply in all 50 states but where it does apply, the owner of the seller must take an ownership interest in the buyer.
In this case the owner of Seller did not receive any stock in Buyer. However, it was entitled to receive a portion of its purchase price as an earnout.
It would make buyers sleep better if the court said that a typical earnout that is paid to seller over a relatively short period of time is not the same as seller owning shares in the buyer. I say that because it is not unusual for a buyer to assume some liabilities. Does an earnout with assumption of payables and perhaps warranty liabilities make the buyer responsible for all of the seller’s liabilities under the de facto merger doctrine? That does not make sense nor seem fair.
By John McCauley: I help people start, grow, buy and sell their businesses.
Telephone: 714 273-6291