TWO DEFENSES AGAINST SUCCESSOR LIABILITY IN ASSET PURCHASE DEALS
by Christopher P. Parnagian and Michael G. Zarocostas (Fall 2006)

It would not be uncommon for corporate counsel to recommend to a business buying client to structure a particular deal as an asset purchase. As you know, a key benefit of an asset purchase, as compared to a stock purchase or merger, would be that the tort liabilities of seller should, if things go as planned and as usual, remain solely with seller. For example, in connection with a purchase governed by New York law¹ of an Alabama manufacturing business by a Alabama buyer, the routine expectation of the parties in an asset deal would be that personal injuries resulting from a defective product manufactured and sold to a New York customer before the closing of the asset sale would be the responsibility of seller and not buyer. The parties would further expect that the proper defendant in any lawsuit by the injured person would be seller and not buyer.

Often, the fact that a deal is structured as an asset purchase serves as no impediment to zealous plaintiffs' counsel. In the example above, the injured person might bring suit in New York and allege a strict products liability claim against seller. If seller is judgment proof or if seller no longer exists -- or, frankly, even if there is no good reason at all -- plaintiff may sue buyer, too. Buyer, in turn, can defend itself in at least two ways. The first defense is substantive and is often asserted. The second defense is procedural; it, too, is potentially effective, but appears to be asserted less often.

The Substantive Defense

As a general rule, a buyer of some or even all of the assets of a seller does not succeed to the liabilities of seller. In New York and in many other jurisdictions, there are four exceptions to this general rule: (i) buyer expressly or impliedly assumes seller's liabilities; (ii) there was a consolidation or merger of buyer and seller; (iii) buyer was a "mere continuation" of seller; and (iv) the deal was done to fraudulently escape such liabilities.² Some states other than New York have adopted additional exceptions to the general rule, including the "product line" exception³ and the "continuity of enterprise" exception.⁴ Conscientious buyers' counsel, through a review of the then-applicable case law and careful drafting of the asset purchase agreement, can do much to protect against the triggering of any of these exceptions and can defend against the action by the tort claimant by arguing that the maker/seller of the product -- and not the putative successor -- is the only proper defendant because none of the four exceptions apply.

The Procedural Defense

In the recent Semenetz case,⁵ New York's high court took advantage of the opportunity to declare again that New York law embraces only the four traditional exceptions to the general rule about successor liability and that there is neither a product line nor continuity of enterprise exception. Accordingly, the Semenetz case was dismissed as against defendant buyer (i.e., the case was dismissed as against the putative successor to the tort liabilities of the maker/seller).

Interestingly, the Court of Appeals decision was an affirmance of the Appellate Division, Third Department's ruling, but on different grounds. The Third Department had ruled that the claims against defendant buyer failed because the trial court could not properly assert personal jurisdiction over defendant buyer. That is, according to the Third Department, a New York trial court must be able to assert personal jurisdiction over the alleged successor whether or not there is jurisdiction over the predecessor.

Lessons Learned

The substantive defense is a good one (especially when New York law is applicable) and should be asserted whenever possible, but the procedural defense can be powerful, too, and should be asserted as well. Regrettably, the Court of Appeals in Semenetz did not specifically endorse the "no jurisdiction" ruling of the Third Department, but the Third Department's ruling is nevertheless precedent for trial courts in the Third Department and could be persuasive authority in other departments.

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¹Choice of law questions are tricky in the context of successor liability cases, are handled differently by different courts, and are beyond the scope of this article. In this article and in the Semenetz case described below, it is assumed that New York law governs.

²See Schumacher v. Richards Shear Co., 59 N.Y.2d 239, 245 (1983).

³See, e.g., Ray v. Alad Corp., 560 P.2d 3 (Cal. 1977).

⁴See, e.g., Turner v. Bituminous Cas. Co., 244 N.W.2d 873 (Mich. 1976).

⁵Semenetz v. Sherling & Walden, Inc., 7 N.Y.3d 194 (2006). In Semenetz, an Alabama manufacturer sold one of its products to a New York customer in 1998, which product allegedly caused a personal injury in New York in 1999. Seller sold its assets in an asset deal to an Alabama buyer in 2000. The personal injury action was commenced in New York in 2002.