1. society
2. work
3. contracts

TLLINOIS BAR
ByRaymond
P.Kolak.
Dccenrirer
1005
JOI.]RNAL
V o l u m e 9r3 N u m b e r l 2. P a s e s 6 0 5 - 6 5 6
Thc Magazine ol Illinois La$1ers
Buyingthe assets,ratherthan the stock,of a business
doesnot always
protectthe buyerfrom the seller'sliabilities.
Thisarticleshowswhen buyers
are exposedand tells how to protectthem from that risk.
Ihellangols
0fSuccessot
liability
When
Buying
lllinoi$Business
[ssets
he oldest maxim of the merger and acquisition lawyer is that sellerslike to sell stock and buyers like to
buy assets.By purchasing assets,buyers can obtain a
steppedup tax basis for them, which can lead to
greater depreciationdeductionsand lower taxes in the future.'
In addition, buyers can pick and chooseamong assets.They
might choosenot to buy cash or accountsreceivable,or might
opt to exclude assetsthat the seller does not want to sell or that
would not be a good fit with the buyer'sbusiness.
But perhapsthe chief re:rsonbuyers
like to but' assets
is to avoidliabilityfor
the seller's
obligations.
A purchaser
of
s t o c ke c q r r i r erst n i n t r c t i n t e r e sitn
the seller corporation, inclLrding
l
all assetsand liabilities.A buyer
" T h i s r r t i c l e s a s r e v i o v c db r ' . l a s r r r
S .O r n c l u t t ,
. f r n r e sO . S i l l i n r r n , . l i n rS i l l i r r a r r n d I i r a i u S p l i n t e r .
l. I.he rar basisol propcrn is licner,rllvits cost to
t h e t r r r p i r r e ru n c l c rl R ( . \ l 0 l 2 ( 2 6 t J S ( i \ l 0 l 2 ) , x r i f
e hurer pa|s a pricc fix irs\etsllreitcr than the tax birsis
ot rhc scllet,thc trr b.tsisof thc assctsfirr thc brrrer "steps
up" to equrl the purch,rseprice. Irr contrlst, thc tax l-,rsisof
I corp()rirti(nr'5rrssctscltts not chlngc nrerelt upon ir salc of its
stock trorn one shrrrcholderro lnother. It is possiblc irr l stock
derrl to qcr rr stepped-upbrsis in rsscts if the corporrtion nrrkcs
rrn election rrndcr ll{(- \.l.lll (26 IJSCISi.l8), but the electiorris
not rrlrvrrrsrn.tde bccltrrscthc corprlrltion must rcport grrirr(or
krss)ctlurrl ro the cliffercrrccbctu'ccn the trrir nrrrket virlue of its
rls\ct\ ilncl its trr blsis.
Ralntottd lt. Kolak practicesbusittessldtu tuith dtt
entph,tsison nrcrgersand acquisitictnstf ntiddlentLtrketcolrtpLtnies
as a principal in Eckhdrt Kolak
LLC, a Chic,tgo 1,11s
finn. He eanrcd his .lD tuith
hotutrs fxttt Gatrge V/ashirrytrn Uniuersitl,Latu
School, u'lserehe sen,edon the George rMashington
Lttu'Ru,ieu,.
540 | Il_l_r\-OrS
r]AR.lOURNAr. I DECEMBER
2OOs I VOr.. 9.1
enteringinto a merger or consolidation
with the sellingcorporationsimilarly receivesthe benefit and burden of all of
the sellert assetsand liabilities through
the lllinois BusinessCorporation Act.r
But a buyer of assets,accordingto the
common belief of merger and acquisition lawyers,takesonly the assetsspecified in the assetpurchaseagreementand
none of the seller'sscaryliabilitiesor obligations,known or unknown.
This article teststhat hypothesis.Do
mergerand acquisitionlawyersserveclients well by assuringthem that an asset
purchasewill avoid exposureto the seller's liabilities?The answersare surprising and should give buyers' attorneys
pausein an assetdeal.
As used in this article, the term
"seller" refers
to a corporationsellingits
assets,while "buyer" refers to the corporation buying the assetsof the seller,
unlessa differentlegalstrucrureis specified. Sincethis articleis intendedfor Illinois lawyers,the emphasisis on Illinois
law, althoughthe law of other stateswill
be discussedwhen necessaryto understandIllinois law.
The proper placeto begin is with the
most recentIllinois SupremeCourt case
on this issue.In the 1997 caseVernon
u Schuster,\the supremecourt set forth
the generalrule with which all corporate
lawyers are familiar: "The well-settled
general rule is that a corporation rhar
purchasesthe assetsof anothercorporation is not liable for the debts or liabilities of the transferorcorporation."4
This statement is echoed in many
other Illinois AppellateCourt casesiand
in treatises.'But considerthe four exceptions to this generalrule, also statedin
Vernon;-(1) Where the transactionis for
the fraudulentpurposeof escapingliability for the sellert obligations;(2) Where
there is an expressor implied agreement
of assumption;(3) \7here the transaction
amountsto a consolidationor mergerof
the purchaseror sellercorporation;or
(4) Where the purchaseris merelya continuation of the seller.We will consider
thesefour exceptionsin this article.
In general,a fraudulent transfer can accountof asbestosmined by the seller,
occur in fwo cases.The first is when which, understandably,argued in dethe transfer is made with actual intent fensethat the buyer had assumedall obto hinder, delay, or defraud any credi- ligationsof the mining division.The sevtor of the debtor.' The secondis when enth circuit held that "all debts,obligathe debtor makes the transfer without tions, contracts and liabilities" meant
receivinga reasonablyequivalentvalue "all," and so the buyer would be liable
in exchangeand either (1) the remaining in tort to the plaintiff.''
assetsof the debtor wcre
unreasonablysmall in relation to the transactionor
The best protection against
(2) the debtor believedthat
he would incur debts besuccessorliabilitv is not to buv
yond his ability to pay as
"the business"as an ongoing
they becamedue."'
Under the Uniform
entity at all, but rather to buy
Fraudulent TransfersAct,
individual assetsused in the
a creditor of the sellercan
assessthe seller'sliabiliry
businessas if sold on a
againstthe buyer of the assetsonly up to. not above,
liquidation basis.
the value of the assets
transferred." In contrast,
the exceptionsfor express
or implied agreementof assumption,deAn evenmore extremeexampleof the
facto merger,and mere continuationdo long-termexposureof a buyer assuming
not limit the creditor'sclaim to just the liabilities is found in North Shore Gas
value of the assetstransferred.''
Co u Salomon, Inc.'- In this case, the
There are few Illinois caseson this seller sold all of its assetsto the buyer
method of obtaining successorliability. except for one division, and the buyer
ln StandardDistilling (t Distributing Co agreed to "assume liabilities and obliu Jones(y Adams Co," a buyer purchas- gationsof every kind and character" of
ing assetsat an inadequateconsideration rhe seller"accruedto or existingon the
was held liablefor the seller'sdebtsuo to date of transfer."'tThe buyer facedenvithe valueof the assetsreceived.
ronmentalcontribution liability 56 years
later on accountof the division that was
Express or implied agleement
zot purchased.The United StatesDisof assumption
The method for avoiding this route
to successorliability ought to be obvious:just instructthe buyernot to assume
any liabilitiesin the assetpurchaseagreement. This is easiersaidthan done,however,sinceassumptionof someliabilities
makes good businesssense.For example, the buyer will usually want to assumeliabilitiesfor outstandingpurchase
orders placed by the seller'scustomers
and assumetrade liabilitiesto allow the
buyer to retain the good will of the seller's suppliers.
The case law on assumptionof liabilities is instructiveto the oractitioner
Raudulent transfer
in severalrespects.
For example,in KesIt should surpriseno one that the law singer u Grefco, Inc,la the buyer bought
of fraudulenttransfersappliesto salesof the mining division of the seller,and
businessassetsjust as to any other prop- agreed "to pay, perform and discharge
erty. Fraudulent transfersare governed all debts, obligations,contracts and liin Illinois under the Uniform Fraudulent abilities" of the division, excludingcerTransfersAct,' which gives a creditor tain tax liabilities.''About 23 yearslater,
remediesif a fraudulenttransferoccurs. both the buver and sellerwere sued on
2. rJ0.r
rl-crs5/l 1.50(4).
3. 179lll 2d338,588NEzd117211997:).
4. ld at 344-4-5, 688 NE2d at 117.5, relying on
Nl/ssoz y Continental Macbine Mfg Co, 251 Ill App
3 d 4 7 s , 4 1 7 , 5 2 1 N E 2 d 1 0 3 2 , 1 0 3 4 ( 2 d D 1 9 9 . 3 )a; n d
Dondhue u Perkins dy Will Archiects, Irc, 90 Ill App
3 d 3 4 9 , 3 . 5 1 , 4 1 3N E 2 d 2 9 , 3 1 ( l s t D l 9 l J 0 ) .
5. See, for example, Gray u Mundelein College,296
Ill App .ld 795,695 NE2d 1379 (lst D 1998); ParA
u Townson et Alexander, Inc, 287 lll App 3d 772,
679 NE2d 107 (3d D 1997); Steel u Morgan Marshall
lndustrie s, In c, 27 8 lll App 3d 24 1, 662 NE2d .59.5( l st
D 1996)1Hoppa u Schermerhorn6 Co,259 Ill App 3d
51,630 NE2d 1042 (1st D 1994); Ni/ssoz y Continental Machine Mfg Co,251 lll App 3d 415, 521 NE2d
1032 l2d D 1993).
6. \,0illiam M. Fletcher, l5 Fletcher Cyclopedia of
Priuate Corporations $7122 (ThomsonlWest perm ed
1999J.
7 . Vernon at .14.5,688 NE2d at 1 175-75.
8. 740 ILCS 160/1 et seq.
9. 740 ILCS 150/5(aXI ).
10. 740 ILCS 160/5(a)(2).
11. Ffetcher, 15 Fletcher Cyclopedia of Priuate CorPorations $7122 {cited in note o7.
12. SeegenerallS text accompanving notes 14-49.
1.1.239 rll 600, 88 NE 236 (1,909).
1 4 . 8 7 - 5F 2 d 1 5 3 ( 7 t h C i r 1 9 8 9 ) .
15. ld at 154.
16. Id.
1 7 . 9 6 3 F S u p p6 9 4 ( N D I l l 1 9 9 7 ) .
18. Id at 701.
vol.93
| DECEiTBER2OOsI TLLTNOISBAR JOURNAL I G41
S U C C E S S O RL I A B I L T T Y I C o n t i n u e d
trict Court for the Northern District of
Illinois held for the buyer,statingthat it
would defy logic that the buyer would
assumethe liabilitiesof assetsit had expressly excluded under the asser purchaseagreement.tt
iniured consumerwould have no remedy againstany party.r-The secondwas
basedon fairness:since the buyer succeededto all the benefitsof ownership
of the sellert assets,it was only fair to
imposethe burdensof the sellert obligations upon the buyer.' sFinally the court
Defacto mergiel
deemedit better for public policy reaThe Illinois BusinessCorporationAct sons to place the burden of the injured
setsforth statutory meansfor mergeror consumer'sinjuries on the buyer,which
consolidation,tobut the courts will rec- had greaterfinancialresourcesand could
ognize a defacto merger imposing the spreadthe burden of the potential damseller'sliabilitieson the buyer evenif the ageson othersthrough insurance.t'
The decisionin Ray must have been
procedure for merger under the Act is
not followed. Hoppa u Schermerhorn(y a great surpriseto the buyer corporation, which thought it was buying only
Cot' is a good example.
ln Hoppa, a personalinjury plaintiff the seller'sassetsand not its oroblems
obtained a default judgment againstthe and liabilities.Ray is still the law in Calseller,which had sold its assetsto a new ifornia, and the Ray product-lineexcepcorporation.The judgment was left un- tion or similar doctrinesexpandingsucsatisfiedbecausethe sellerhad dissolved, cessorliability are generallyfollowed in
and so the plaintiff sought to have the Alabama, Michigan, Mississippi, New
buyer added to the judgment." The ap- Hampshire, New Jersey,New Mexico,
Ohio, SouthCarolina,Pennsylvania,
and
pellatecourt held that the buyer was lia- 'Washington.3o
ble under defacto merger sincethe buyer
Ray appearsnot to be the law in Illiowned all of the assetsof the seller.had
nois,
however.Ray was forcibly argued
essentiallythe same shareholders,had
the sameemployees,management,loca- to a long string of Illinois appellatecourt
tion, telephonenumbers,and customer panelsand rejectedby at least 10 decilists,and managedthe samebuildings.' l sions.rrThe Illinois SupremeCourt has
The basic concept of the defacto never ruled on Ray, so the issueis techmerger doctrine, then, is that the statu- nically still open in Illinors.
Perhapsthe bestdiscussionof the reatory merger rules on assumptionof liabilities will apply to rwo corporarions sons for and against the Ray doctrine is
that effect the merger via a saleof assets found in Manh Hung Nguyen u Jobnson
undercertaincircumstances,
eventhough Machine (y Press Corp.iz Nguyen had
the specificstatutory processfor merger the samefact pattern as Ray: sellersells
assetsfor cash and then dissolves,and
is not followed.
The debate over defacto mergerswas the plaintiff injured by the seller'sprodheightenedin 1977 with the decisionof uct suesthe buyer.r3The first district apthe California SupremeCourt in Ray u pellate court rejected Ray and ser forth
Alad Corp.'o In Ray, the seller sold its the requirements for defacto merger in
assetsto the buyer for cash, the seller Illinois:
(1) there is a continuity of the busidissolved,and under the corporatelaws
of California at the time, all remedies nessenterprisebetweensellerand buyer,
againstthe sellereffectivelyended."The includingmanagement,employees,locabuyer usedthe seller'sname,businesslo- tion, and assets;
(2) there is a continuity of shareholdcation, assets,employees,management,
and goodwill." To the outsideworld and ers, in that shareholdersof the sellerbethe public, therefore,the buyer appeared come shareholdersof the buyer;
(3) the seller ceasesoperationsand
to be the samebusinessas had beenooeratedby the sellerfor many years.Aftir
dissolvesas soon as possibleafter the
closing, a consumer was injured by a transaction;and
product (manufacturedby the dissolved
(4) the buyer assumesthose liabiliseller),and filed suit againstthe buyer.
tiesand obligationsnecessary
for the unThe California Supreme Court held interrupted continuation of the seller's
that the buyer could potentially be lia- business.to
ble on three grounds for a product adln Nguyen, the second requirement,
mittedly manufactured by the seller.The continuity of shareholders,was absent
first was that the sellerno longerexisted, becausethe assetswere ourchasedfor
and that if the buyer was not liable, the cash and not exchangedfor srock and
642 | TLLTNOISBAR JOURNAL I DECEMBEn2qr5 | VOL. 93
other securities." The court examined
both strict tort liability principles and
corporate law to reject Ray. ITith regard
to tort liability, the court srated that the
buyer did not create the risk of harm because it had nothing to do with placing the product that injured the plaintiff
into the stream of commerce, and so the
court concluded that one who has done
nothing to create a risk of injury cannot usually be burdened with the duty of
preventing that injury. To do otherwise,
according to the court, would be to create a liability without duty.ro
The court refused to accept the argument that the buyer would be deemed to
have assumed the liabilities of the seller,
making an important distinction berween
the legal entity (the corporation) and the
business operations of the seller, which
do not constitute a legal enrity:
'When
one corporation merelysellsits assetsto another,the corporate entity that
had liabilidesdoes not becomea part of
the successor....The
successorhas paid a
substantialprice for the assetsof the predecessor,and the law should not require
the successorto pay a greater price, es1 9 .I d .
2 0 . 8 0 5r L C S5 / 1 1 . 0 5 .
21. Hoppa (citedin note5).
2 2 . l d a t 6 2 , 5 3 0N E 2 da t 1 0 4 3 - 4 4 .
2 3 . l d a t 6 6 , 6 3 0N E 2 da t 1 0 4 5 - 4 6 .
24. 19 Cal 3d 22, 560P2d 3 (CalSC 1977).
2 5 . I d a t 3 1 ,5 5 0 P 2 da t 9 .
2 6 . I d a t 2 6 , 5 6 0P 2 da t 5 - 5 .
27. ld at 32, 560P2dat 9.
2 8 . I d a t 3 4 , s 6 0 P 2 da r | 0 - I l .
2 9 . l d a t 3 2 , 5 6 0P 2 da t 9 - 1 0 .
(Third)of Torts:ProdLiab $12
30. SeeRestatement
Commentc (7998);RichardL. Cupp, Jr., Redesigning Successor
Liahility, 1999 U lll L Rev 845, 852-54
(1999).
31. Ni/sson (cited in note 5): M)'ers u Putzmeister,
I n c , 2 3 2 l l l A p p 3 d 4 1 9 , 5 9 6N E 2 d7 5 4 l 1 , s t D1 9 9 2 ) ;
Kaletau WhittakerCorp, 221 Ill App 3d 705, 583
NE2d 567 (1st D 1991); Greenu FirestoneTire 6
RuhherCo, Inc, l22 lll App 3d 204, 450 NE2d 895
(2d D 1984); Gonzalezu Rock \Yool Engineeringand
EquipCo, lnc,117 lll App 3d 435,453 NE2d 792 (1st
D 1983);Manh Hung Nguyenu JohnsonMachine dy
P r e s sC o r p , 1 0 4I l l A p p 3 d 1 1 4 1 , 4 3 3N E 2 d 1 1 0 4( 1 s t
D 1982);Barron u Kaneand Roach,Inc,79 lll App 3d
44, 398 NE2d 244 (1stD 1979);Domineu FuhonIron
Works,76 lll App 3d 253,395 NE2d 19 ( 1st D 1979);
Hernantlez
u lobnsonPressCorp,70 lll App 3d 564,
388 NE2d 778 (1stD 1979);Johnsonu Marshalland
HuschartMacb Co,66 Ill App 3d,766,384NE2d 141
( 1 s tD 1 9 7 8 ) .
32. Nguyen(citedin note31).
33. Id ar I 142-43,433 NE2d at 1105-05.
34. ld at 1143,433NE2d at 1106-07.
3 5 . I d , 4 3 3 N E 2 da t 110 7 .
35. Id. Recognizing
that lack of continui* of shareholderswill preventa finding of defacto mergers,
someplaintiffs have looked for other legaltheoriesto
imposeliabiliryon the buyer,suchas a duty to warn
of defectspresentin the seller's
products.The plaintiff
w a i v e dt h ei s s u eo n a p p e ailn N g u y e nI.d a t 1 1 5 1 , 4 3 3
NE2d at 1112.Thereis no dugvto warn unlessthere
is a continuingrelationship
betweenthe buyerand the
customers
of the sellerConzalezar 437-38,453NEZd
at />5.
peciallyafterthe fact of salewhen it is The "mere continuation" doctrine
uation, like de facto merger, requires
impossible
for the successor
to returnto
a
continuity of shareholders.o8
HowThe mere continuation
doctrine
negotiations
to changethe price....Of
ever,for not-for-profit corporations that
started
as
a
concept
analytically
distinct
course,if the predecessor
chooses
to dislack shareholders,
merecontinuationhas
solve,with dissolution
comesthedestruc- from defacto merger, but over time, parfound
been
where
the seller organized
tion of all pre-existing
liabilities....Never-ticularly in Illinois, has been blurred tothe
buyer,
and
the
seller's
officers became
theless,
the legislature
hasgivena parry gether with defacto merger. Vernon held
officers
of
the
buyer.o'
with a claimagainstthedissolving
that
mere
continuation did not make
corporafiontwo yearsfollowingdissolution
in the buyer liable for the
whichto asserthisclaim.tsole proprietor seller'sobIn 1988, the Illinois BusinessCorpora- ligations on the basisthat
Although Illinois law on
tion Act was amended to expand the what must be continuedis
fwo-yearperiod to five years,possiblyin the businessentity, not the
successorliability is generally
responseto this issue.r8
businessoperations:
favorable to buyers, remember
Although purporting to
The only elementof successor
liabiliry
apply
the
continuation
exthat Illinois law doesnot alwavs
that savedthe buyer in Nguyen was lack
ception to this case, the apof continuity of shareholders.
All of the
apply to lllinois buyers.
pellate court did not accuother threeelementsrequiredfor succesrately state the test of consor liability in defactomergerswereprestinuation. In determining
ent. Therewas continuity of businessenwhether one corporation
terprisebetweenthe sellerand buyer,the
is a continuation of another,the test used
3 7 . N g u y e na t 1 1 4 8 , 4 3 3N E 2 da t 1 1 1 0 .
seller ceasedoperations and dissolved
in the majoriry of jurisdictionsis whether
38. 805 ILCS5/12.80.
within rwo yearsafter the saleoccurred,
there is a continuation of the corporate
39. Nguyenat 1142,433NE2d at 1105.
entity of the seller - not whether there is
40.220 lll App 3d 832, 581 NE2d 288 (1stD
and the buyer assumedthe liabilitiesand
199r\.
a
continuation
of
the
seller's
business
opobligationsof the sellernecessary
for the
4 1 . I d a t 8 3 7 ,5 8 1N E 2 da t 2 9 2 .
eration,as the dissentappearsto emphauninterruptedcontinuation of the busi42.227 lll App 3d 705, 583 NE2d 557 ('lsr D
size....Commonidentity of ownership is 1 9 9 1 J .
t'
ness.
lackingwhen one soleproprietorshipsuc4 3 . 9 0 I l l A p p 3 d 3 4 9 , 4 1 3N E 2 d2 9 ( 1 s tD 1 9 8 0 ) .
ufhat degree of shareholderconti4 4 . I d a t J 5 2 , 4I J N E 2 da r 3 2 .
ceedsanother.o'
4 5 . V e r n o na t 3 4 6 - 4 7 , 5 8 8N E 2 d a t 1 1 7 6 7 7 . l n
nuity is necessary
to createa de facto
Bilandic
offered
a
strong
dissent,
Justice
PlazaExpressCo u Middle StatesMotor Freight,Inc,
merger? Must the seller receive only arguing that the identity of business op- 40
III App 2d 117,189NE2d 382 (1stD 1953),a sole
stock for the assets,or is somestock,ac- erations between the two sole propriproprietor transferredhis businessassetsto a corporacompaniedby cash,notes,or other prop- etors constituted circumstances demon- tion and took backall of its stock.The coroorationwas
held liablefor the tort of rhe :ole propriitor undera
erty sufficient?The first district appellate strating thar rhe mere continuation ex- merecontinuationtheory.The casecan bedisringuished
from Yernonin that the sameperson(the solepropricourt partially answeredthis questionin ceptions should in fairness apply.ou
etor) held the equity ownershipin both businesses.
Fendersonu Atbey ProdwctsCorp, KolMere continuation was found in Park
46. Vernonat 350-51,588NE2d at 117779 (Bilanman Diu,o" in which it held that stock u Totunson (y Alexander,lzc,ot in which
dic dissenting).
47. 287 rll App3d 772,579NE2d 107\3d D 19971.
comprising about 22 percentof the total the seller and buyer had the same ad48. Nl/ssozar 41,8,621,NE2d at 1034 (although
considerationgiven for the assetswas dress, fax number, motto, Fed Ex numcontinuityof the businessenterpriseexisted,mereconenough to impose successorliability. It ber, telephone number, major customer, tinuationdid not apply becausetherewas no continuiry
Accord,Green{citedin note31).
was not necessary,in the court's view, primary activity, check signatory, and of shareholders).
49. Kraft u Garfield Park CommunityHosp,296 lll
that stock constituteeven a majority of customer contact person. Mere continA p p 5 1 3 ,1 6 N E 2 d 9 3 6 ( 1 s tD 1 9 3 8 ) .
the considerationgiven.al
A token amount of stock is not
enough, however. Kaleta u Whittaker
Corp" held that a transfer of the buyer's stock worth $1,200 to the president
of the seller was not enough to satisfy
.
n
,..
J1
the continuity of shareholderrequirement for defacto merger where the pur230 Woodlawn Avenue - Aurora, Illinois 60506
chaseprice for the assetswas $290,000,
and the stock was receivedby the presTel: (630) 897-8380 Fax: (630) 897-5696
ident as employeecompensationrather
than as paymentfor the assets.Similarly,
a
Environmental Site Assessments;Phase I, II & III
Donabue u Perkins 6 Will Arcbitects,
Remedial Investigations, Design & Engineering
Inc" held that a buyer that took a secuUnderground Storage Thnk (UST)
rity interestin the seller'sstock and held
Management & Removal
voting rights in the stock under a voting
trust did not have an interestequivalent
to stock ownership for successorliability purposes.o'
DnUcHLER
ErwrnoNMENTAr,
INc.
LonsultrngEngtneers
VOL.93 I DECEMBER2OO5I ILINOIS BAR IOURNAL I 64.i!
SUCCESSOR LIABILITY
I Continued
lllinois law migfirt not apply
to lllinois corporations
of the elementsin Ray were met.''i
Thus, Illinois merger and acquisition
lawyers
cannot assumethat Ray will not
In view of the material changein reapply
to
their Illinois buyer, unlessthe
sult from Ray to caseslike Nugyen, deproducts or servicesnever leave
buyer's
termining which state's law applies is
critical to determiningwhetherthe buyer Illinois.If the buyer has operationsoutis liable in tort cases.Unfortunately,the sidelllinois, or if its productsare shipped
merger and acquisitionlawyer does not outsidelllinois, then Ray and caseslike
control which state'slaw applies. The it can impose successorliability on an
merefact that the buyer is an Illinois cor- Illinois buyer, even if no stock was exporation or that the assetpurchaseagree- changedin the deal.
ment is governedby Illinois law doesnot
Practice pointers
mean that Illinois law will be appliedto
As this review of Illinois law shows,
liability.
determinesuccessor
buyers
of assetsdo not enjoy the all-inln Barron u Kane and Roach, lnc,so
protectionagainstthe seller'sliaclusive
a businessbroker seeking to impose
successorliability in a tort casefiled in bilitiesthat they may havepreviouslybeIllinois argued that Pennsylvanialaw lieved." How, then, to protect the buyer
should apply, since the buyer was a in an assetsale?
Proceed with caution when assumPennsylvaniacorporation and the asset
purchaseagreement,by its terms, was ing liability. First. exercisegreat care in
governedby Pennsylvanialaw (Pennsyl- drafting clauseson assumptionof liabilvania had by then adopted Ray, which ities. Your buyer should probably never
"all liabilitiesof the seller,"since
would have been favorable to the bro- assume
ker). The first district appellate court an assumptionthat broad would bring
held that the choice of law rules appli- in product liability torts and environcableto torts should apply to determine mental claims that were not in the conwhich state'slaw appliesto successorli- templation of either buyer or sellerand
ability. Sincethe injured plaintiff resided may not becomeapparentuntil decades
in Illinois and the injury occurredin llli- later.
A betterpracticewould be to assume
nois, the Illinois law of successorliability applied. Illinois courts had by then only specified liabilities. Another aprejectedRay, so the buyer was held not proach would be to assumeliabilitiesas
reflectedon an audited balancesheetof
liable.''
ln Ruiz u BlentechCorp,52the seventh the seller (after checkingthe notes to the
circuit held that while Illinois choice of financial statementsfor contingent lialaw ruleswould apply California corpo- bilities).The buyer could also set a time
rate law to interpret an assetpurchase limit for assertionof any of the assumed
agreement between California corpo- liabilitiesagainstthe buyer.
Avoid transferring buyer's stock as
rations, the Illinois rules apply Illinois
tort law to an injury occurringin Illinois payment for the assets.Assuming that
to an Illinois resident,even though the the string of Illinois AppellateCourt deproduct causingthe injury was part of cisionsrejecting Ray are eventuallyfola product line sold from one California lowed by the Illinois Supreme Court,
stock ownershipwill be an essentialelecorporationto another.sr
If tort choice of law rules apply to ment of a defactomerge! and if there is
successorliability cases,then an Illi- no stock given,then there can be no denois corporation doing businessor sell- facto merger.Be aware that giving even
ing products in a state like California a relativelysmallproportion of stock (22
would be subjectto California law, in- percent, as in Fendersonl can be enough
cluding Ray.ln Nelson u Tiffany Indus- to trigger liability.
Distinguish business operations of
tries, lnc,5aa Missouri buyer bought assetsfrom an Illinois sellerin a saleoccur- buyer and seller. Another way to avoid
ring in Illinois. The plaintiff'sinjuriesoc- successorliability is to make the busicurred in Minnesota,but shewas a Cal- nessoperationsof the seller and buyer
ifornia resident and so filed suit there. as different as possible.If a particular
The ninth circuit applied California law plant or product line is likely to generate
as establishedin Ray to the Missouri a claim, do not buy it. In the best case,
buver.and remandedto determineif all there should be no overlao benveenthe
644 | ILLINOIS BAR JOURNAL I DECEilBER 2OOs I VOL.93
directors and officers in the buyer and
sellercorporations.Ideally,management
shouldalso be different.In all likelihood,
the buyerwill want to keepthe sameemployeesand businessname.To the extent
that the product linesand locationof operations are different, the ability to defend againsta defactomergercasewould
be enhanced.
To this end, the buyer should purchasespecificnamed assetsof the seller,
rather than buying "the business" of
the seller.Practitioners,in an effort to
be all-inclusive,sometimesinclude the
term "the business"in the list of assets
to be purchased,but doing so will work
againstthe buyer in avoiding successor
liability.
Buy specific assets, not "the business."Indeed.the bestprotectionagainst
successorliability would be not to buy
"the business"as an ongoingenriry at
all, but rather to buy individual assets
used in the businessas if sold on a liquidation basis. Even Ray requiresthat
there be a continuity of enterprise,so if
the businessoperations(assets,employees,location,businessname,etc.)do not
continue from sellerto buyer,there will
be no successor
liability imposedon the
buyer.tt
Non-Illinois law sometimes applies.
50. 79 Ill App 3d 44,398 NE2d 244 lrsrD 1979).
5 1. Id at 48-49, 398 NE2d at 246-47.
52. 89 F3d 320 lTthcr 1996).
53. Seealso Kramer u \X/eedholtperof Utah, Inc,204
Ill App 3d 469,477,562 NE2d 271,275 (1stD 1990)
(Ra1,not applied to California corporation; rather, IIlinois law applies sincethe injury occurred in lllinois and
the relationship of all the parties is centeredin Illinois).
54. 778 FZd 533 (9th Cir 1985).
55. Id at -534-38. See also Gee u Tenneco. Inc.615
F2d 857 (9th Cir 1980) (Ray applied to Delaware bu.ver
of assets,which included product line injuring California plaintiff). SeeJohn T. Hundlev, Business Expdttsion
Through Asset Acquisition: Some Problems Posed by
Protluct Liabiliry Doctrines, 77 lll B J 492, 492-93
( 1 9 8 9) .
56. This article has not even touched on the federal
law imposing successorliabilitv. which tends to be more
liberal. See, for example, ()olden State Bottling Co,
Inc u NLRB,414 US 168 (1973) (buvermust remedl
seller's unfair labor pract:Lce\John Wiley tt" Sons, Inc u
Liuingston,3T6 US 543 ( 1964) (buyer must collectiveli
bargain with seller's union); Upholster's Intl Union
Pension Fund u Artistic Furniture of Pontiac.920 F2d
I 1 2 3 t T r h C i r 1 9 9 0 )t b u y e r l i a b l ef o r s e l l e r ' ,E R I S A o b ligation to contribute to pension [und); Musikiuamho u
ESSI,Inc,760 F2d740 (7th Cir 1985) (buver liable for
race discrimination claim against seller); Continentdl
Crain Co u PulLman Standarcl, Inc, 690 F Supp 628
(ND lll 1988) (buver liable for RICO claims against
seller); Goldstein u Gardner, 444 F Supp 581 (ND
Ill 1978) {buver liable for securitieslaw 10b-5 claims
against seller).
57. lf the buyer purchasesonly some of the business
assetsof the seller,the buyer is not a corporate successor
and will not be liable for the seller's tt>rrs.Domine lcired
in note 31).
Although Illinois law on successorliability is generally favorable ro buyers,
rememberthat Illinois law does not always apply to Illinois buyers.California
larv will apply to an Illinois buyer if the
sellerproduceda productcausinginjury
in California.Illinois buyersare alsosubjectto the federallaw on successor
liabilit1.,which has special,liberal rules that
imposeliability in labor,ERISA,and discriminationcases.
I)o normal due diligence. Buyers are
r,velladvised to take advantageof the
normal procedures designed for their
protection. Due diligence,long an underrated function, should be emphasized.The buyershouldinsisron gerring
a claimshistory from the sellerfor as far
back as available. Escrows for claims
could be set up. The buyer could negotiate for a right to set-offclaims against
notes,employmentcontracts,non-competition agreements,or other deferred
payments due from the buyer to the
seller.
These classicmethods provide good
protectionfor claimswhich might be asserted against the buyer within a relatively short period of time, but would
probably not work for someof the product liability and environmentalclaimsin
the casesdiscussedin this article,which
came up as many as 50 years after the
acauisitionoccurred.
Consider buying insurance. Ideally,
the seller should stay in existence(as a
target to attract claims) after closing.
Buyers, however, generally lack such
ability to control the sellerafter closing,
and many sellerswill dissolveas soon as
possible.
The buyer could require that the
sellermaintain insurancefor tort claims
following the sale of the business.In
many cases,the seller could obtain a
products liability tail policy for a onetime premium that covers tort claims
occurring after closing.The sellercould
name the buyer as an additional insured on that tail policy, and the buyer
could make receipt of a certificate of
insurance evidencing such coverage a
condition to closing. The buyer should
also verify that its own commercial
liability insurancepolicy would protecr
it againstassertionof successorliability claims. Most policiesprovide such
coverage.
Include an indemnification clause.Finally,the ultimateprotectionfor a buyer
is the indemnificationclausein the asset
purchaseagreement.In the clause,the
seller should indemnify the buyer for
any actions or omissionsof the seller
that take place before closing. There
should be no de minimus basketor time
limitation attachedto the indemnification; while a de minimus basket and a
time limitation are often given with respect to the warranties and representations sectionof the assetpurchaseagreement, they should not apply ro acrions
or omissionsof the seller taking place
beforeclosing.
Relianceon an indemnificationclause,
of course,has its limitations. If the indemnifying party is the seller corporation, the corporation may be dissolved
and out of existence before a claim
arises..sEven if the seller shareholders
join in the indemnification obligation,
they may have died or disappearedby
the time the claim arises.In the end, it is
a questionof the assessment
of the business risks and rewards involved in the
acquisition,which is a judgmentcall for
both attorneyand client.I
58.\n Huschart (cited in note 3l), the defecrive
product lvas manufactured 36,vears before suit, and
the business had been sold 6 times. The courr was
influenced by the long time lapse and the fact that
the original seller had long since dissolved, in holding that the last buyer was not liable under successor
liability.
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