General Rule of Limited Liability

A fundamental principle of corporate law is limited liability. Only the corporation is liable for the products or services it buys or sells or for payment of its debts and obligations whether in tort for breach of some duty of care or in contract. Therefore as a general matter a corporation’s directors, officers, and shareholders are not individually liable for the obligations or debts of the corporation.

So too, individual corporations, even those having common ownership in whole or in part, or controlled, directly or indirectly by the same or related owners or single parent company, are not responsible for the debts of the other corporation.

So it is not uncommon for a vertically integrated enterprise that conducts separate business functions in a chain of production and sale of goods and/or services, to protect the enterprise from the risks of one segment by having separate corporations or limited liability companies for each separate business. So while a buyer of goods is liable to pay its suppliers, its owners and other related companies are not, as a general matter, liable for the debts and obligations of the purchaser of the goods.

Not surprisingly there are exceptions under which the law imposes liability on one corporation or shareholder for the debts and obligations of a judgment proof debtor corporation.

Veil Piercing

The corporate veil piercing theory enables a creditor to reach the assets of third parties who simplistically stated exercise “some form of pervasive control” of the activities of the debtor provided “there is some fraudulent or injurious consequence of … [what generally is an] intercorporate relationship.” In “rare cases” to prevent grossly inequitable results, a Court will pierce the corporate veil and impose liability on a shareholder or a related corporation. My Bread Baking Co. v. Cumberland Farms, Inc., 353 Mass. 614, 619 (1968).

There are twelve so-called “My Bread” factors a Court will consider in deciding whether to hold a third party liable: common ownership; pervasive control; confused intermingling of business activities or management; failure to observe corporate formalities; absence of corporate records; non-payment of dividends; insolvency at the time of the litigated transaction; siphoning away of corporate funds by the owners; non-functioning of officers and directors; use of the corporation for transactions of the dominant shareholder; and, use of the corporation to promote fraud. Attorney General v. M.C.K., Inc., 432 Mass. 546, 555 n.19(2000).

In a 2012 bench trial we secured a judgment of over $950,000 against each of nine related companies (both limited liability companies and corporations) for the separate contractual obligations of three of the defendant companies. 

Successor Liability  

A company that owes you money may be sold and the buyer does not assume liabilities. Or, a secured lender forecloses and a new company continues the business but does not pay the debts of the old company. You may have a claim against the new company under the doctrine of successor liability.

Generally when one company purchases the assets of another, the buyer does not purchase or otherwise become responsible for the debts of the seller.

It is fundamental public policy that creditors should be paid their just debts. So to protect innocent, good faith creditors, this general rule is subject to a public policy exception imposing successor liability under one of  four successor liability exceptions, where:
  1. There is a contractual basis, either implied or explicit, requiring the buyer to assume the seller’s debts;
  2. The transaction may be characterized as fraudulent under the Uniform Fraudulent Transfer Act;
  3. The transaction amounts to a de facto merger; or,
  4. The buyer entity is in fact a mere continuation of the seller corporation.
Cargill, Inc., v. Beaver Coal & Oil Co., Inc., 424 Mass. 356, 359 (1997).

Both the de facto merger and mere continuation of the same venture theories address the inherent unfairness of corporate debt being eliminated while the shareholders of the seller or foreclosed corporation retain their interest in the assets through ownership of the new corporation.  In other words, the otherwise legal form of the transaction may be disregarded when it does not accurately reflect the true economic substance of the deal.

In considering the application of the de facto merger doctrine in a sale of assets, Courts will consider a variety of factors:
  1. Whether there is a continuation of the seller’s enterprise with continuity of management, personnel, physical location, assets and general business operations;
  2. Whether there is continuity of ownership;
  3. Whether the seller ceases its ordinary business operations and liquidates as soon as practically possible; and/or,
  4. Whether the buyer assumes those obligations of the seller necessary to continue without interruption the seller’s normal business operations.
Cargill, Inc., v. Beaver Coal & Oil Co., Inc., 424 Mass. 356, 360 (1997).

In like vein, the mere continuation theory applies when the transaction is really just a reorganization of the same enterprise with a “new hat” for the seller. McCarthy v. Litton Industries, Inc., 410 Mass. 15, 22 (1991).  In other words, where the only change is one of form and the buyer is really the seller, it is fundamentally unfair for some or all of the shareholders to retain ownership of the assets while stripping the debt owed to third party creditors. Understand that there is no need that all the stockholders retain ownership in the new corporation for a Court to consider application of this exception. 

So even when an arms-length, third party secured lender validly forecloses on the assets of a corporation  and the managers and some of the shareholders of the seller purchase the assets at the foreclosure sale, the new company that continues the business conceivably might be liable under a successor liability theory for the unsecured debts of the insolvent foreclosed company. 

Fraudulent Transfer Claims

The Uniform Fraudulent Conveyance Act provides remedies for creditors of insolvent debtors in a number of circumstances.
Suppose you do business with company that owes you $600,000.  When so indebted to you this company mortgages all its assets to a bank. Six months later, the company closes its doors; the bank conducts a foreclosure sale of the insolvent company’s assets and pockets the proceeds.  As an unsecured creditor, you get nothing. 

In some circumstances you might have a remedy under the Massachusetts Uniform Fraudulent Transfer Act.  If the mortgage was given with the actual intent to hinder, delay or defraud you, you would have a claim against the debtor and possibly its shareholders.  You might even have a claim against the foreclosing bank for your unpaid debt if the bank did not take the mortgage “in good-faith and for a reasonably equivalent value.”

Suppose in this same transaction, the bank took the mortgage to secure a loan owed by a shareholder of the debtor.  Unless there was a quantifiable indirect economic value to the debtor company that was of equivalent value to the debtor’s assets mortgaged, the bank might be liable to you for some or all of your debt.  

Under the Uniform Fraudulent Transfer Act recovery can be had for “constructive” fraud even against a buyer who acted in good faith. Suppose a purchaser buys the assets of a company that is a subsidiary of a holding company. At the closing the acquisition price is not paid to the subsidiary but the money flows directly to the parent company of the seller.  Both the seller and its parent end up in bankruptcy.  If the debtor, the subsidiary company, did not receive some sufficiently adequate indirect economic benefit constituting “equivalent value” for its assets, the buyer has potential liability to the creditors of the bankrupt subsidiary.  In other words, the buyer who acted in good faith conceivably can be adjudged liable to pay the price again, this time to the creditors of the bankrupt.