Explore the complexities of asset buyer liability in M&A transactions through a legal case analysis. Delve into successor liability and its application in a recent court decision.
M&A Stories
October 19, 2023
Introduction:
In the world of mergers and acquisitions (M&A), asset buyers typically take on the seller’s liabilities as specified in the purchase agreement. However, exceptions do exist.
Background:
In this case, the seller was a Delaware limited liability company with its primary operations in Texas or Missouri. They specialized in manufacturing highly engineered oil country tubular goods for the natural gas and crude oil drilling markets in the United States and Canada. The majority owner of the seller was a Connecticut-based financial firm with $9 billion in assets under management, focusing on distressed businesses.
Between June and November 2020, the seller purchased goods worth over $7 million from a vendor. Unfortunately, due to economic challenges during the COVID-19 pandemic, the seller couldn’t pay unsecured creditors, including this vendor.
On December 24, 2020, an affiliate of the seller’s owner, acting as the administrative agent for the seller’s secured creditors, initiated a foreclosure sale under New York’s Uniform Commercial Code (UCC) Article 9. The notice stated that the seller’s assets would be auctioned on January 4. It was also mentioned that the seller owed approximately $110 million to the owner and an unnamed group of lenders. The vendor was not informed of the sale.
The winning bidder at the auction was a company owned by the seller’s owner. However, this buyer did not assume the $7 million debt owed to the vendor.
Post-acquisition, the buyer took over the seller’s manufacturing facilities, maintained the same officers, produced and sold the same products to the same creditors, used the same equipment, and employed the same staff as the seller. Both the seller’s former website and the buyer’s current website provided nearly identical company descriptions. Additionally, the buyer remained under the ownership and control of the seller’s owner and its affiliates.
Legal Proceedings:
The vendor filed a lawsuit against the buyer to collect the unpaid invoice, citing several legal theories, including Delaware’s doctrine of successor liability. The buyer challenged this claim by filing a motion to dismiss.
Outcome:
The court determined that, if the vendor’s allegations were true, the buyer could be held liable under the theory of “mere continuation” successor liability for the $7 million claim. The court clarified that this exception required the buyer to be not just a continuation of the same business but a continuation of the same legal entity as the seller. This continuity typically involves common officers, directors, or stockholders between the seller and the buyer, resulting in a single corporation after the transfer.
Although Delaware courts apply this theory narrowly, the vendor’s claims align with its application in this case. The vendor asserted that the buyer, much like the seller, remained under the ownership and control of the seller’s owner and its affiliates. The buyer effectively replaced the seller, continuing the same business, employing the same facilities, personnel, and equipment, maintaining a similar website, and selling to the same creditors. Furthermore, the vendor identified key officers and employees shared between the buyer and the seller, reinforcing the idea that the buyer was a continuation of the seller.
Comment:
Vice Chancellor Will of the Delaware Court of Chancery expressed disapproval of the “shady circumstances” surrounding this asset sale.
Case Reference:
Cleveland-Cliffs Burns Harbor LLC v. Boomerang Tube, LLC, C.A. No. 2022-0378-LWW Court of Chancery of Delaware (Date Submitted: May 2, 2023. Date Decided: September 5, 2023).
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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