Caveat Emptor – “Free and Clear” Sales May Be Clouded by Successor Liability Claims

It is a generally recognized principle of law that a company purchasing the assets of another company does not assume liability for the selling company’s debts.  Under certain circumstances, however, this principle may be disregarded.  Under the state law doctrine of successor liability, there are several different theories under which the selling company’s liabilities could be imposed upon the buying company.  Because of this and other purchasing risks, buyers of assets of financially distressed companies have more and more frequently elected to steer sales through bankruptcy proceedings.  In doing so, the sales are conducted pursuant to Section 363 of the Bankruptcy Code, which enables a “free and clear” transfer of the assets.  But recent case law should put prospective purchasers of assets in bankruptcy sales on notice of the continued risk of potential successor liability claims, notwithstanding a sale order that absolves the buyer of any of the seller’s liabilities.

New Hampshire Successor Liability Law

New Hampshire courts recognize four situations in which a purchasing company may be held liable for the debts of the selling company: 1) the existence of an express or implied agreement regarding the assumption of debt between the companies; 2) the transaction amounts to a “de facto merger”; 3) the purchasing company is a “mere continuation” of the selling company; or 4) the transaction is a fraudulent attempt by the selling company to escape liability for its debts.   Kleen Laundry v. Total Waste Mgmt. Corp., 817 F.Supp. 225, 230 (D.N.H. 1993).

Express or Implied Agreement

The existence of an express or implied agreement is fact-specific and a matter of contract law and interpretation. Successor liability will be imposed if the purchase agreement and the intent/conduct of the parties reveal that the seller’s obligations were assumed by the buyer.  Attentive drafting of the asset purchase agreement should ensure that unwanted liabilities are not transferred to the buyer.

De Facto Merger

Under the “de facto merger” exception, successor liability will be imposed if “a company is completely absorbed into another through a sale of assets; continues its operations by maintaining the same management, personnel, assets, location and stockholders, but leaves its creditors without a remedy for its outstanding debt.”  Bielagus v. EMRE of N.H., 149 N.H. 635, 640 (N.H. 2003).  In making this determination, the New Hampshire Supreme Court held that the key question is “whether each entity has run its own race, or whether there has been a relay-style passing of the baton from one to the other.” Id. at 642.  New Hampshire courts rely on the following four non-exclusive factors when analyzing whether or not a “de facto merger” has occurred:

  1. A continuation of the enterprise of the seller corporation, so that there is a continuity of management, personnel, physical location, assets, and general business operations;
  2. A continuity of shareholders which results from the purchasing corporation paying for the acquired assets with shares of its own stock, this stock ultimately coming to be held by the shareholders of the seller corporation so that they become a constituent part of the purchasing corporation;
  3. Cessation by the seller corporation of its ordinary business operations and liquidation/dissolution as soon as legally and practically possible; and
  4. Assumption by the purchasing corporation of the obligations of the seller corporation that are ordinarily necessary for the uninterrupted continuation of normal business operations.  Kleen Laundy, 817 F.Supp. at 230-231.

Though none of the above factors are determinative, New Hampshire courts have placed great weight on the second factor, the exchange of stock of the purchasing corporation for assets of the selling corporation.  The New Hampshire Supreme Court stated that a factor that tips the scales in favor of finding a merger is “continuity of ownership, usually taking the form of an exchange of stock for assets.” Bielagus,149 N.H. at 642.  The courts have found this to be particularly important inquiry because shareholders are the indirect beneficiaries of any increase in a corporation’s assets or any decrease in its liabilities.  Id. at 644

Mere Continuation

Under the traditional application of the “mere continuation” exception, a corporation will not be considered a continuation of a predecessor unless only one corporation remains after the transfer of assets and there is an identity of stock, stockholders and directors between the two corporations.  Id.  With respect to successor liability cases brought under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), New Hampshire courts apply an expanded version of the “mere continuation” exception known as the “continuity of enterprise” or “substantial continuity” exception.  Kleen Laundy, 817 F.Supp. at 231.  However, with respect to most other cases, including commercial contract and tort cases, New Hampshire courts continue to use the traditional “mere continuation” exception addressed above. Bielagus,149 N.H. at 646.  The “mere continuation” and “de facto merger” exceptions are very similar and, as such, are often applied almost interchangeably.


A determination that the transaction is a fraudulent effort to avoid liabilities of the predecessor will result in successor liability being imposed upon the buyer.  Under the Uniform Fraudulent Transfer Act (UFTA), any transfer made with “actual intent to hinder, delay or defraud” any present or future creditor is a fraudulent transfer.  It has routinely been recognized that an asset transfer that is not made for adequate consideration and that is not made in good faith constitutes a fraudulent transfer.  In general, to avoid being labeled a fraud, the asset sale transaction should be at arm’s length and the assets should be sold for as close to fair market value as possible under the circumstances.

Bankruptcy and Section 363 Sales

As a result of the recent, unprecedented economic crisis, the trend in the restructuring cycle has been sales through the bankruptcy process.  Classic Chapter 11 reorganizations are few and far between.  But where a reorganization may not be plausible, Section 363 of the Bankruptcy Code provides an opportunity for distressed companies to sell their assets and for buyers to purchase those assets at a fair price and with many other benefits that may not be available in a sale conducted outside of bankruptcy.  Principal of the benefits being obtaining a court order that the sale is free and clear of all claims, interests and other debts arising in any way or in connection with the actions of the debtor, including claims based on theories of successor liability.

Section 363(f) of the Bankruptcy Code provides that a sale of assets may be approved free and clear of liens and other interests if one of five statutory conditions is met.  The conditions are:

  1. Applicable nonbankruptcy law permits a sale free and clear of interests;
  2. The interest holder consents to the sale;
  3. The interest is a lien and the sale price exceeds the total value of all liens on the property;
  4. The interest is in bona fide dispute; or
  5. The holder could be compelled in a legal or equitable proceeding to accept money satisfaction of its interest in the property.

Section 363 sales are typically governed by local court rules or pre-approved sale procedures.  The procedures are ultimately intended to maximize the sale price, but they also serve the equally important role of providing notice to interested parties, including those that may have claims against the seller.  In the end, the buyer wants to obtain the best deal possible with the greatest protections permitted by the bankruptcy court.  The sale price will be whatever the sale process produces, but the sale order will frequently contain provisions expressly providing, among other items, (i) that the sale is “free and clear”, and (ii) that the liabilities that can be asserted against the purchaser are limited and precluding creditors from asserting claims based on theories of successor liability.

Recent opinions, however, serve as a reminder to buyers of distressed assets that the risk of successor liability claims may never be truly extinguished even if a sale order has been entered that clears the buyer of any of the seller’s liabilities.

Teed v. Thomas & Betts Power Solutions, LLC, 711 F.3d 763 (7th Cir. 2013)

In Teed v. Thomas & Betts Power Solutions, LLC, the Seventh Circuit held that a purchaser that acquired substantially all of a company’s assets through a state court receivership sale was subject to successor liability for claims arising under the Fair Labor Standards Act (FLSA)–notwithstanding provisions in the sale order that precluded successor liability.

Several months after the lawsuits were filed against the seller for overtime pay under the FLSA, the seller’s parent company defaulted on its secured bank loan.  To pay as much of the debt to the bank as it could, the parent company assigned its assets—including its stock in the seller, which was its principal asset—to an affiliate of the bank.  The assets were placed in a receivership under Wisconsin law and auctioned off, with the proceeds going to the bank.  Thomas & Betts was the high bidder at the auction, paying approximately $22 million for the seller’s assets.  One condition specified in the transfer of the assets to Thomas & Betts pursuant to the auction was that the transfer be “free and clear of all Liabilities” that the buyer had not assumed, and a related but more specific condition was that Thomas & Betts would not assume any of the liabilities that seller might incur in the FLSA litigation. After the transfer, Thomas & Betts continued to operate the seller in much the same manner as prior to the sale, and indeed offered employment to most of the seller’s employees.

Following the purchase, the FLSA lawsuit plaintiffs (presumably, former employees of the seller and current employees of the buyer Thomas & Betts) sought to substitute Thomas & Betts as the defendant in the action. Thomas & Betts objected to their substitution as a defendant, but the trial court overruled the objection.  Thomas & Betts appealed the decision to the Court of Appeals for the Seventh Circuit.  Finding that no good reason existed to withhold successor liability, Seventh Circuit (Posner, J.) affirmed the trial court’s ruling.  In arriving at its decision, the Seventh Circuit found that when liability is based on a violation of federal labor or employment law (such as the FLSA), a federal common standard of successor liability applies.  The court acknowledged that had the matter been governed by state law, a different result would likely have been obtained as Wisconsin state law, like New Hampshire law, limits successor liability claims in most instances.  Here, however, the broader standard was applied and the court analyzed the matter by reviewing the five factors under the federal test:

  1. Whether the successor had notice of the pending lawsuit.
  2. Whether the predecessor would have been able to provide the relief sought in the lawsuit before the sale.
  3. Whether the predecessor could have provided relief after the sale.4.     Whether the successor can provide the relief sought in the suit.
  4. Whether there is continuity between the operations and work force of the predecessor and the successor.

In reviewing the factors as applied to the purchase transaction, the court held that “there is no good reason to reject successor liability in this case.”  Without such a ruling, the court was concerned that employers and purchasers could circumvent federal employment statutes and liability by structuring a purchase of assets and disclaiming liabilities.

In re Gruman Olson Ind., Inc., 467 B.R. 694 (S.D.N.Y. 2012)

Gruman Olson Industries designed, manufactured and sold products for the truck body industry.  On December 9, 2002, Gruman filed chapter 11 in the Bankruptcy Court for Southern District of New York.  On July 1, 2003, the Bankruptcy Court entered an order approving the sale of certain assets of Gruman to Morgan Olson, LLC, which was also engaged in the manufacture of products for the truck body industry.  The sale order contained several provisions that purported to limit Morgan’s potential liability for tort claims based on allegedly defective products manufactured and sold by Gruman prior to the sale to Morgan.  In particular, the sale of assets was ordered “free and clear of all … claims … and other interests … and all debts arising in any way in connection with any acts of [Gruman].”  In addition, the sale order provided that the purchase of the assets by Morgan would not subject Morgan to “any liability for claims against [Gruman] or the assets, including, but not limited to, claims for successor or vicarious liability.”

On October 8, 2009, some six years after the sale order was entered, Denise and John Frederico brought a personal injury action against Morgan and others in New Jersey Superior Court.  The complaint alleged that Ms. Frederico, an employee of FedEx, sustained injuries when the FedEx truck she was driving struck a telephone pole on October 15, 2008.  The complaint also alleged that the truck she was driving was manufactured, designed, and/or sold by Gruman in 1994 and was defective for several reasons.

On March 24, 2010, Morgan filed an adversary proceeding in the Bankruptcy Court seeking declaratory and injunctive relief barring the Fredericos from bringing their claims against Morgan in New Jersey state court. Morgan’s complaint alleged that the sale order and accompanying Asset Purchase Agreement “provided that the assets of the debtor would be sold and purchased without liability for products manufactured prior to the sale.”  The truck involved in the accident was manufactured by Gruman, not Morgan, and so, the complaint alleged, Morgan could not be held liable for any damage caused by any alleged defects in the truck.

In dismissing Morgan’s case, the Bankruptcy Court explained that the straightforward, threshold legal question was, does the sale order exonerate Morgan from liability to the Fredericos?  The Bankruptcy Court answered this question in the negative, leading to Morgan’s appeal.

In affirming the Bankruptcy Court’s decision, the United States District Court For The Southern District of New York held that claims of parties who cannot possibly be identified as of the time of the bankruptcy and, thus, cannot be provided notice of the bankruptcy, cannot be discharged by bankruptcy court orders for due process reasons.  The District Court reasoned that the requirement of notice is the cornerstone of bankruptcy code procedure and that notice requirements of bankruptcy law are “founded in fundamental notions of procedural due process.”  Therefore, because the Fredericos did not receive adequate notice of their potential claim in Gruman’s bankruptcy proceedings (because, at the time of the bankruptcy, there was no way for anyone to know that the Fredericos would ever have a claim), enforcing the sale order against the Fredericos and taking away their right to seek redress under a state law theory of successor  liability, when they did not have notice or an opportunity to participate in the bankruptcy proceedings, would deprive them of due process.


Both the Teed and Gruman decisions remind purchasers of distressed assets to conduct comprehensive due diligence and to closely analyze the liabilities of the seller, including both existing and potential claims; and, where due diligence may not be sufficient, to consider requesting a so-called “future claims representative” who can negotiate with the debtor for the creation of special trusts where funds may be set aside to pay claims that will be asserted for injuries caused by pre-petition conduct that do not occur until after the bankruptcy case is closed. Regardless of these court decisions, purchasers of distressed assets should still insist on sale orders with clear and unequivocal language authorizing the transfer of assets “”free and clear” of claims and precluding any assertions of successor liability.  If a purchaser is aware of potential liabilities that may not be discharged notwithstanding a broad sale order, the purchase price should be adjusted accordingly.