Business Law: The De Facto Merger Doctrine

As a general rule, a corporation does not assume a predecessor’s liability by purchasing assets, unless “(1) it expressly or impliedly assumed the predecessor's tort liability, (2) there was a consolidation or merger of seller and purchaser, (3) the purchasing corporation was a mere continuation of the selling corporation, or (4) the transaction is entered into fraudulently to escape such obligations.” Schumacher v. Richards Shear Co., 59 N.Y.2d 239, 245 (1983). Although generally cited for setting forth New York’s “de facto merger” doctrine, in Schumacher the Court of Appeals actually found that a de facto merger had not occurred but that the successor corporation was nonetheless liable for failure to warn because it continued to service machine in question and touted its expertise.

An example a case where the court found a de facto merger is Matter of AT&S Transp., LLC v. Odyssey Logistics & Tech. Corp., 22 A.D.3d 750, 753 (2d Dep't 2005), where the Second Department explained that:

substantially all of the assets of Rely and Acquisition Corp. were purchased or licensed by Odyssey. The real property of the predecessor corporation was transferred or assumed by Odyssey. Odyssey offered employment to its predecessor's employees, hired two of its predecessor's management personnel, assumed the contracts of independent contractors, agreed to honor the predecessor's customer service contracts, and received the predecessor's business insurance policy. Moreover, pursuant to the transfer agreement, Rely could no longer use its trade name and the transaction was deemed a liquidation of Rely. Furthermore, upon liquidation, the shares of Odyssey stock were to be distributed to Rely's preferred stockholders. The fact that Rely did not immediately liquidate is not dispositive. So long as the acquired corporation is shorn of its assets and has become, in essence, a shell, legal dissolution is not necessary before a finding of a de facto merger will be made.

In 2006, the Court of Appeals declined to add a fifth exception to the De Facto Merger doctrine, the “products line” exception, whereby continuation of the same product line, by itself, exposed a successor corporation to liability. Semenetz v. Sherling & Walden, Inc., 7 N.Y.3d 194, 818 N.Y.S.2d 819 (2006). The one New York State decision to interpret Semenetz thus far makes clear that Semenetz did not change the fact that “the policies that guide an assessment of successor liability include the concept that a successor that effectively takes over a company in its entirety should carry the predecessor's liabilities as a concomitant to the benefits it derives from the goodwill purchased, and the desire to ensure that a source remains to pay for the victim's injuries." Morales v. City of New York, 18 Misc. 3d 686, 688 (Kings County, 2007)

Morales went on to explain that “the hallmarks of a de facto merger are the continuity of ownership; cessation of ordinary business and dissolution of the predecessor as soon as possible; assumption by the successor of the liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation; and a continuity of the management, personnel, physical location, assets, and general business operation. These factors are analyzed in a flexible manner that disregards mere questions of form and asks whether, in substance, it was the intent of the successor to absorb and continue the operation of the predecessor. Policy considerations dictate that, at least in the context of tort liability, courts have flexibility in determining whether a transaction constitutes a de facto merger." Morales, 18 Misc. 3d 686, 690-691; But see Employee Rels. Assocs. v. Xperius, Inc., 196 Misc. 2d 485 (Monroe County, 2003)(courts have been more flexible in finding de facto merger for the purpose of Tort liability than Contract, and in contracts at least, continuity of interest is a strict requirement). Although multiple factors are considered, the key factors (generally described as necessary requirements) are: (1) continuity of ownership, which can be shown by any “indicia of control over or continuing benefit from the sold assets;” and (2) cessation of the predecessor corporation’s business. Morales, 8 Misc. 3d, 691.