As a commercial supplier (often
referred to as a creditor), it can be hard enough to turn accounts receivable
into revenue. This is especially true when the particular client or debtor goes
out of business and closes its doors. But as one door closes another door
opens. And just as the law allows for businesses to change freely from one form
to the next, the law also recognizes the right of creditors of defunct or
reorganized businesses to demand repayment from the succeeding business. Under
the laws of Successor Liability, creditors can stay in the game and put
pressure on the debtor to pay what’s owed.
Consider the following typical
scenario: Creditor provides goods or services to Alpha Corporation on credit.
Alpha Corp. fails to pay. Between the time of nonpayment and the time it takes
Creditor to commence collection of the debt, Alpha Corp. is no more – Alpha has
either been sold to another business (say, Beta Corporation), or liquidated and
dissolved. Sometimes this is the end of the road for Creditor. But more often
than not, Beta Corp. is simply Alpha Corp. operating under a different name.
In such instances, there are several
ways for Creditor to knife through this corporate maneuvering and enforce its
rights to repayment.
or Implied Agreement of Assumption
When the CEO of Alpha decides to
sell the business to Beta, it is not uncommon for Alpha’s CEO to protect him or
herself from liability by negotiating an agreement by which Beta agrees to
assume the debts and obligations of Alpha, and hold Alpha’s CEO harmless of any
risks associated with the former business. In such cases, all Creditor needs to
do is to obtain a copy of the Buy/Sell agreement (accomplished through simple
legal discovery). If the Buy/Sell agreement shows Beta agreed to assume the
obligations of Alpha, Beta is liable to Creditor.
Even if Alpha’s Buy/Sell agreement
does not include an agreement of assumption, Creditor may still have a right to
demand satisfaction from Beta.
Under the doctrine of De Facto
Merger, Creditor can successfully pursue repayment from Beta if Creditor can
establish just two of the following four factors: i) Beta is the continuation
of Alpha – this can be demonstrated by showing the physical location, operation,
management, employees, or clients have not changed (or are substantially
similar) throughout the acquisition of Alpha by Beta; ii) There is a
“continuity of shareholders” – meaning the ownership of Alpha and Beta are the
same or substantially similar; iii) There is a “cessation of operation” –
meaning Alpha quickly ceases operations after the sale; or iv) There is an
“assumption of obligations” – meaning Beta acquired all the obligations needed
to run the business, such as clients, contractors, vendors, leases, assets
(including phone numbers, websites, or intellectual property).
In addition to the two tests above,
Beta can be held liable to Alpha’s creditors if Creditor can establish Beta is
a “mere continuation” of Alpha. In order to meet this burden, Creditor must
i) Only one of the two businesses
remains after the transfer of assets from Alpha to Beta; and ii) There is a
commonality of stocks, stockholders, or directors between Alpha and Beta.
This burden is often met if the
owner of the former business maintains ownership in the succeeding business.
Lastly, Creditor can pursue and
prevail against Beta if Creditor can show that the sale of Alpha was for done
for the purpose of helping Alpha escape its obligations to Creditor. Fraudulent
Transfer can be proved (among other ways) by establishing that Alpha’s owners
were given ownership interest in Beta in exchange for the assets of the former
In short, California law provides
multiple avenues for suppliers and creditors to collect from business that are
defunct, dissolved, reorganized, or sold to other businesses. Just because the
business you sold to no longer exists in its original form does not mean you
cannot demand payment for goods and services rendered. Don’t be swayed by a
change in the name – stay in the game, and turn a write-off into revenue.