Successor Liability
By: Valerie Marciano
Shutting Down and Starting New
Have you ever thought about shutting down your business and
starting a new one? If you do, will the debts and liabilities from
your existing business follow you into the new one? That depends on
many technical details, and there is a new court ruling that makes
it more challenging.
Under Arizona law, the idea that debts and liabilities can
follow you from one business to another is called "successor
liability." The general rule is that a new business is not liable
for the debts and liabilities of the old business unless a creditor
can prove one of the following:
- The new business agrees to be liable;
- The new business is formed by merging the old business with
another business;
- The new business is merely a continuation or reincarnation of
the old business; or
- The transfer of assets from the old business to the new
business is to defraud the creditors and escape liability from
existing debts.
The traditional way for an entrepreneur to form a new business,
without becoming liable for the debts of an old business, is to
form a new business entity such as a new S.-Corp. or LLC, and
purchase the assets. However, a recent Arizona Court of Appeals
decision makes it clear that the traditional plan might face new
complications.
The key to transferring business assets without transferring
liabilities is for the purchaser to pay full and fair value for the
assets. Many business assets are easy to identify and value because
they are tangible, i.e. you can see them and look at the market to
determine value. For example, buildings, factory machines,
vehicles, computers, furniture, tools, and equipment can all be
valued by appraisers who compare the asset to the market price for
similar products. It is easy for a new business to identify and pay
fair market value for tangible assets.
However, some business assets are "intangible." They cannot
easily be compared with products on the market. For example,
intangible assets can include the good reputation of the business
and its popularity among clients and customers. This is known as
"good will". Intangible assets are hard to value, and easy to
overlook when a new business is buying the building, vehicles,
tools, and equipment from the old business.
Intangible assets can even include the body of experience built
up in a team of key personnel who have worked together for many
years and developed connections in the industry, expertise in the
market, and efficient techniques. If that team transfers to the new
business, there is a good chance that "intangible" value goes with
it. This is the point emphasized in recent decisions by Arizona
judges.
If intangible assets transfer, without receiving fair value in
payment, the creditors of the old business may argue that the new
business should pay the debts and liabilities incurred while the
company was in business. A court may find that the asset transfer
was a fraud on the creditors of the old business, and the new
business should be liable up to the difference between the value
that was paid and the value received. Alternatively, a court could
find that the new business is merely a continuation of the old
business and should assume all of its' debts and liabilities.
The owner of a newly formed business might find itself liable
for old business debts even if it simply closes down the business
and walks away, without selling any tangible or intangible assets
to the new business they started. A court may find that they former
business owner's presence, expertise, reputation, contacts in the
industry, former customers, knowledge, and the prior company's team
members constitute intangible assets transferred without fair
value.
It is possible to leave behind an old business without being
saddled with its liabilities and debts. In order to avoid successor
liability, an entrepreneur must plan carefully and seek
professional advice in an effort to avoid a "successor liability"
claim.
3200 North Central Avenue
. Phoenix . Arizona