Successor Liability

Generally, the purchaser of assets does not assume the liabilities of the seller.  Successor liability, however, is an exception to the general rule. Under the successor-liability doctrine, the IRS may seek to recover unpaid taxes from a “successor”—often a purchaser of corporate assets.

Successor liability is generally determined under state law, although some courts have bolstered state law with a purported federal common law of successor liability.

When does Successor Liability Apply?

In most jurisdictions, successor liability imposes liability in the following circumstances:

• when the buyer or successor expressly assumes the liabilities;
• when the transaction amounts to a de facto merger;
• when the successor is a mere continuation of the seller corporation (e.g., the buyer continues essentially the same operations or product line of the seller); and
• when the transaction is entered into fraudulently to escape liability.

Express Assumption of Liabilities

Where a buyer expressly assumes the seller’s liabilities, the buyer succeeds to those liabilities and is liable for their payment under the successor-liability doctrine.  Unless the scope of an express assumption provision is at issue, most successor liability cases do not involve disputes under the express-assumption prong because liability is typically clear.

De Facto Merger and Mere Continuation

Where a taxpayer ceases to do business, a second or successor corporation may become liable for the taxes if the second corporation is the mere continuation of the taxpayer or the predecessor and successor underwent a def factor merger.

The interrelated concepts of de facto merger and mere continuation consider such factors as continuity of management, personnel, location, assets, and operations.

Where a taxpayer ceases to do business, a second or successor corporation may become liable for the taxes of the taxpayer if the second corporation is the mere continuation of the taxpayer.

To determine whether a de facto merger or mere continuation exists, courts have generally looked to whether:

• the second corporation continues the business or performs the same functions as the taxpayer;
• the taxpayer’s employees become the employees of the second corporation;
• the taxpayer and the second corporation are owned or controlled by the same individual or individuals;
• the successor’s business activities are carried out in the same location;
• less than full consideration is paid for the transferred assets; and
• the business relationships remain relatively static.

Fraudulent Transfers to Escape Liability

Successor liability may also apply where a taxpayer engages in a transaction fraudulently with the purpose of escaping liability.  Courts have looked to a number of factors to determine whether a taxpayer has engaged in a fraudulent transfer intending to escape liability, including the following factors:

• the transfer or obligation was to an insider;
• the debtor retained possession or control of the property transferred after the transfer;
• the transfer or obligation was disclosed or concealed;
• before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit;
• the transfer was of substantially all the debtor’s assets;
• the debtor absconded;
• the debtor removed or concealed assets;
• the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred;
• the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;
• the transfer occurred shortly before or shortly after a substantial debt was incurred; and
• the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.

Have a question? Contact Jason Freeman, Freeman Law.