Purchasing a Corporation in Maryland? “Mere Continuation” Rule Just Became Clearer

The Maryland Court of Appeals (the “Court”), the state’s highest court, in Phillip Martin, v. TWP Enterprises Inc. (No. 1855, Sept. Term, 2014, decided Feb. 24, 2016, Leahy, J.) addressed what it identified as the third exception to the general rule that a corporation which purchases assets is not responsible for the liabilities of the selling corporation.  That exception provides, under common law, that the purchasing corporation is a “mere continuation” of the selling corporation and is therefore liable for the liabilities of the selling corporation.  The Court’s holding approved and reiterated two new factors to analyze under the “mere continuation” exception.

Best & Brady Components, LLC (“B&B”) was a lumber manufacturing company that opened for business in March of 2010.  Phillip Martin (“Martin”) was a minority owner and assumed management of B&B’s daily operations under a two-year employment contract.  B&B was never profitable, and ran out of cash.  TWP Enterprises, Inc., (“TWP”) bought B&B’s assets. Martin sought compensation under his employment contract from B&B and TWP.   A default judgment was entered against B&B.  Martin pursued TWP for satisfaction of the judgment.  Martin claimed that TWP was a mere continuation of B&B and, therefore, liable under the “mere continuation” exception to the general rule that successor corporations do not assume the liabilities of selling corporations. The circuit court disagreed, finding that TWP was not a mere continuation of B&B and, therefore, was not liable for the default judgment against B&B.

The Court stated that the function of the “mere continuation” exception is to prevent corporations from purchasing assets solely for the purpose of placing those assets out of the reach of the predecessor’s creditors.  In this case, it examined two new factors to weigh in the “mere continuation” analysis: the purpose of the asset sale and the adequacy of [its] consideration.

The facts at the trial court level indicated that TWP continued in the business of B&B, for a time doing business under that name.  Its former owner became an employee of TWP, but not an owner of that corporation. TWP continued to provide administrative support to B&B. TWP relied on independent salesmen, of which Martin was one, in carrying on its business.  Some of B&B’s former employees worked for TWP.  TWP sold to some of the same clients as B&B.  TWP continued to use the same software as B&B and the same sales reporting format.  Martin, who had an independent business, continued to be a vendor to TWP.

TWP argued at the trial level that TWP was not a mere continuation of B&B.  Martin argued that because TWP continued operating B&B after the purchase from the same location, with the same employees, under the same trade name, that TWP was a mere continuation of B&B and assumed the liabilities of B&B, including the default judgment entered against it.

The trial judge believed the “mere continuation” exception did not apply because (1) there was no evidence that the [asset sale and purchase] transaction was for the purpose of avoiding liability to Martin; (2) TWP provided B&B adequate consideration in the asset purchase; and (3) while there was substantial overlap in management, control, and ownership, this overlap was not determinative because historically overlap had always existed between B&B and TWP.  Martin appealed the trial judge’s ruling.

The Court stated the general rule that “a corporation which acquires the assets of another corporation is not liable for the debts and liabilities of the predecessor corporation”.  Baltimore Luggage Co. v. Holtzman, 80 Md. App. 282 (1989).  It stated that the rule has applied when asset transfers were made in good faith for fair consideration, to foreclose actions for damages for breach of contract.

Four exceptions to the general rule that a predecessor corporation’s debts and liabilities do not become the obligation of a successor corporation are enumerated in the Court’s opinion: (1) there is an expressed or implied assumption of liability as codified, in the case of the former, in Maryland Code Corporations and Associations (“C&A”), § 3-115(c)(1) (1975, 2007 Repl. Vol.) and, in the case of the latter, in Isle of Thye Land Co. v. Whisman, 262 Md. 682 (1971).; (2) the transaction amounts to a consolidation or merger as codified in C&A §3-114(f)(1); (3) the purchasing corporation is a mere continuation of the selling corporation; or (4) the transaction is entered into fraudulently to escape liability for debts as codified in C&A §3-114(f)(1)

The third exception has not been codified in Maryland.  The Court’s opinion recites that it is “designed to prevent a situation whereby the specific purpose of acquiring assets is to place those assets out of reach of the predecessor’s creditors.”  In Maryland, only three cases had addressed the “mere continuation” exception to the general rule against successor liability:  the seminal case, Baltimore Luggage, Nissen Corporation v. Miller, 323 Md. 613 (1991), and Academy of IRM v. LVI Environmental Services, Inc., 344 Md. 434 (1997).  In none of those cases did the Court conclude that the successor corporation was a mere continuation of the predecessor corporation.

The trial court found that the purpose of B&B’s sale of assets to TWP was not to place the assets beyond Martin’s reach, but rather to “salvage . . . a failing business,” and, therefore, the “mere continuation” exception did not apply.  This “purpose” test was added by virtue of the Academy of IRM opinion.

Baltimore Luggage, Nissen, and Academy of IRM, when taken together, contain analysis of the following factors: (1) change in ownership and management, (2) continued existence of the selling corporation, (3) adequacy of consideration, (4) transfer of any “instrumental” employees from the predecessor to the successor, and (5) purpose of the asset sale.  In all three cases, the courts assessed the adequacy of consideration as a factor and consistently found the exception did not apply where consideration was adequate, although none of the cited cases relied solely on the adequacy of consideration in their conclusions.

In the case before it, and in reviewing the new factors of “purpose” and “adequacy of consideration”, the Court stated that even though Martin managed B&B’s sales, the company had difficulty completing orders on time. A loan from TWP senior employees and a subsidiary could not overcome B&B’s cash flow problems. Martin had actively opposed B&B’s bankruptcy and eventually consented to the asset sale to TWP.  If B&B had filed for bankruptcy rather than sell its assets, Martin likely would never have received the approximately $300,000 that TWP paid him as a trade creditor as part of the asset purchase.  All of these factors highlighted the fact that the purpose of the asset sale was not to escape creditors, and particularly any obligation to Martin, but to attempt to salvage B&B.  Moreover, the consideration involved in the transaction was adequate.

Considering all of the factors of the case, and particularly the factors of purpose and adequacy of consideration, the holding of the trial court that TWP was not a “mere continuation” of B&B was affirmed.  TWP was not responsible for the liabilities of B&B.

The Martin decision points out that the importance of the new factors it examines.  It also points out the necessity of corporate transactional documents containing clear statements of purpose and consideration in asset purpose transactions.

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