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A limited liability company (LLC) that completed an asset purchase of a corporation, was subsequently sued for damages allegedly caused by acts and omissions of a corporation that occurred long before the asset purchase.   Summary judgment was granted for the LLC on the basis that it was not subject to liability for the actions of the corporation because it was not a “mere continuation” of the corporation.

The issue on appeal was whether the trial judge was correct in granting the LLC’s motion for summary judgment based on the well-settled general rule that a corporation that purchases the assets of another corporation is not liable for the debts or liabilities of the transferor corporation. Groves of Palatine Condominium Assoc. v. Walsh Construction Company, 77 N.E. 3d 687 (Illinois 2017).

This case arises as a result of a condominium association suit against its general contractor for alleged defects in construction. The contractor in turn filed a third party claim against its steel erection subcontractor, K&K Iron Works, Inc. (the “Corporation”) as well as against K&K Iron Works, LLC, (the “LLC”) that acquired the assets of the Corporation through an asset purchase agreement. All work on the project had been completed years before the asset purchase agreement.

After its dissolution, the corporation was purchased by K&K Iron Works Holding, Inc. (the “Holding Company”), which was the sole shareholder. Several years later, the LLC purchased the assets of the corporation from the Holding Company. The asset purchase agreement specifically excluded the corporation’s liabilities.

Neither the original corporation nor the Holding Company received any interest in the LLC under the asset purchase agreement. And the majority owner of the LLC was not an employee, officer, or board member of either the original corporation or the holding company.

In analyzing the facts of the case, the court provided a concise explanation of the “mere continuation “ exception to the rule against liability for the sellers debts and liabilities. The court stated,

“The continuation exception to the rule of successor corporate nonliability applies when the purchasing corporation is merely a continuation or reincarnation of the selling corporation. In other words, the purchasing corporation maintains the same or similar management and ownership, but merely ‘wears different clothes.’ … ‘The exception is designed to prevent a situation whereby the specific purpose of acquiring assets is to place those assets out of the reach of the predecessor’s creditors. To allow the processor to escape liability by merely changing hats would amount of fraud. Thus, the underlying theory of the exception is that, if a corporation goes through a mere change in form without a significant change is substance, it should not be allowed to escape liability.’”

The court further explained that the test is “whether there is a continuation of the corporate entity of the seller—not whether there is a continuation of the seller’s business operation…. Accordingly, ‘the majority of courts considering this exception emphasize a common identity of officers, directors, and stock between the selling and purchasing corporation as the key element of a ‘continuation.’”

In this case, the court concluded, from examining the entire ownership history of the corporation, there was no continuity of ownership. What added some twist to the facts in this case was that one of the owners of stock in the original corporation is also an owner of the current LLC that purchased the corporation’s assets from the Holding Company that owned it for about six years before the LLC did the purchase.

In this regard, the court said, “we cannot find that the acquisition of the assets of the corporation by a former owner after an arms-length sale to an unrelated company and several years spent under different ownership means that the LLC was merely a continuation of the original corporation.”

In reaching this decision the court also rejected arguments that because the LLC purchased the corporation’s leasehold interest in office space, as well as the corporate website, this somehow proved a continuation of the original corporation by the LLC.  “The fact that the LLC chose to continue to operate out of the same facilities does not transform it into a mere continuation of the corporation.”

 

About the author: Article written by J. Kent Holland, Jr., a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 19, No. 10 (Nov 2017).

Copyright 2017, ConstructionRisk, LLC