It is an article of faith that a company seeking to acquire a business without being saddled with its liabilities does so by acquiring assets: “Most jurisdictions, including Massachusetts, follow the traditional corporate law principle that the liabilities of a selling predecessor corporation are not imposed upon the successor corporation which purchases its assets …,” as in Milliken & Co. v. Duro Textiles, 451 Mass. 547, 556, 887 N.E.2d 244, 254 (2008). As a general proposition, that works. There are, however, exceptions to the general rule, including one known as the de facto merger.

The de facto merger concept is one with fuzzy boundaries, aimed at the transaction which results in the purchaser essentially stepping into the shoes of the selling business. But in most asset acquisitions, the buyer continues the seller's business to some extent, so the trick is to figure out when the continuity is so great that the buyer could be held accountable for the seller's liabilities. To make that determination, courts weigh several specified factors. However, “no single factor is necessary or sufficient to establish a de facto merger,” as in Cargill v. Beaver Coal & Oil, 424 Mass. 356, 360, (1997). That is to say, the absence of any one factor will not preclude a finding of de facto merger, and the presence of some amount of each factor would not compel a finding of de facto merger.

The factors considered in the analysis are whether:

• There is a continuation of the enterprise of the seller corporation, so that there is continuity of management, personnel, physical location, assets, and general business operations;
• There is a continuity of shareholders, which results from the purchasing corporation paying for the acquired assets with shares of its own stock;
• The seller corporation ceases its ordinary business operations, liquidates, and dissolves as soon as legally and practically possible; and
• The purchasing corporation assumes those obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations of the seller corporation.

Whether the transaction is used to defeat creditors' claims is also a consideration.

There has been some elasticity layered into these factors. For example, while the doctrine originally applied to transactions where shares were exchanged for assets, the shareholder component can now be met where the seller's shareholders paid to acquire their shares in the buyer. Furthermore, a small percentage of ownership in the acquiring entity may be enough to satisfy the shareholder factor, as in United States v. General Battery, 423 F.3d 294, 306-307 (3d Cir. 2005) (4.5 percent held to be enough). Formal dissolution of the predecessor is not required to establish the discontinuation of the prior business. Factors that indicate a continuation of the predecessor's business include whether the successor entity continued the general business of the predecessor, used some of the same personnel to continue the business, and acquired assets from the predecessor (including customer lists) to continue the business. See also, Lanee Great Plastic v. Handmade Bow, No. SUCV200705245, 2010 WL 6650330, at *5 (Mass. Super. Ct. Dec. 26, 2010). Satisfaction of the fourth prong, assuming obligations necessary for business continuation, does not require taking on all obligations of the predecessor—only those necessary to continue business uninterrupted.

Recent decisions have held that the asset acquisition must be extensive in order for the de facto merger doctrine to apply. “Successor liability depends on a transfer of all, or substantially all, assets from predecessor to successor,” as in Premier Capital v. KMZ, 464 Mass 467, 475, 984 N.E.2d 286, 292 (2013). In Milliken, however, the predecessor retained its real estate assets, which represented nearly 25 percent of the pre-transaction value of the predecessor and continued in business to operate the real estate. This did not preclude the court from finding a de facto merger. The buyer, however, acquired all of the sellers operating assets, which may account for finding a de facto merger, notwithstanding seller retaining significant assets.

Assessing the likelihood that a transaction will be deemed a de facto merger can be particularly difficult where the principal assets of the predecessor are intangible, such as a service entity or a business for which the principal assets are intellectual property. Take, for example, a financial consulting firm whose principal assets are goodwill and client relationships. If a separate consulting firm hires the principals of such a firm, and thereby obtains access to its client base and goodwill, and the consulting firm from whom the principals are recruited discontinues its business, what may seem like nothing more than hiring some new employees may take on the appearance of a de facto merger.

Determining whether there has been a de facto merger is a fact-intensive exercise. As the Cargill court noted, “each case must be decided on its specific facts and circumstances.” Because of the ad hoc nature of the de facto merger analysis, and its fact-driven character, it will at times be difficult to predict when a transaction will present the risk of successor liability.

Gary S. Matsko practices in the business law and litigation areas at Davis Malm & D'Agostine, representing individuals and business entities in civil litigation and before regulatory agencies, including the Securities and Exchange Commission. Matsko has litigated cases involving claims arising from business sales and acquisitions, securities claims, employment disputes, shareholder disputes, environmental matters and other business litigation.