Consider the following scenario:
Two brothers own and operate a heating and ventilation company called “Brother’s Heating & Cooling, Inc.” Each of the brothers owns half the stock of the company. Over the years, many family members of the two brothers work for the company.
Two years ago, the company started to accumulate excessive debt. The company is unable to generate enough revenue or take on more debt to pay its obligations.
The brothers see the writing on the wall. They form a new Illinois corporation called “Two Brother’s HVAC, Inc.” The brothers decide that one of their cousins and one of their spouses will be the two shareholders of the new company. The brothers remain in control of the new company’s day-to-day operations. The new company offers essentially the same services, in the same geographic area, and uses many of their same assets, including business contacts.
Brother’s Heating & Cooling’s largest creditor is a parts supplier. The supplier wants to recover its accounts receivable. The supplier only did business with Brother’s Heating & Cooling.
Question: Does the supplier have a claim against Two Brothers’ HVAC?
The short answer is “yes.” But, that does not end the inquiry because having “a claim” does not guarantee a favorable outcome for a supplier. A survey of Illinois’ corporate successor liability doctrine will inform the supplier’s next steps.
Generally, a corporation that purchases the assets of another corporation is
not liable for the debts or liabilities of the transferor corporation.
Vernon v. Schuster, 179 Ill.2d 338 (Ill. 1997). This general rule is intended to (1) “protect bonafide purchasers from unassumed liability” and (2) “maximize the fluidity of corporate assets”
Id. at 345.
Illinois courts have recognized that this general rule can have very harsh results for the creditors of the selling/transferring corporation. The courts have developed the following four exceptions to the general rule of successor corporate nonliability:
- where there is an express or implied agreement of assumption;
- where the transaction amounts to a consolidation or merger of the purchaser or seller corporation;
- where the purchaser is merely a continuation of the seller; or
- where the transaction is for the fraudulent purpose of escaping liability for the seller’s obligations.
Id. at 345. The purpose of these exceptions is to prevent a corporation that has breached a contract to “avoid liability through corporate transformation in form only.”
Gray v. Mundelein College, 296 Ill.App.3d 795, 808 (1st Dist. 1998).
For the sake of brevity, we will focus on the “mere continuation” exception (exception #3 above). This exception applies when the purchasing or successor corporation is “merely a continuation or reincarnation of the selling corporation.”
Workforce Solutions v. Urban Services of America, Inc., 2012 IL App (1st) 111410, ¶87.
In evaluating the “mere continuation” exception, the most important consideration is the common identities of the decision makers and owners between the original and successor corporations. Illinois courts, however, do not require complete identity between the owners of the former and successor corporations.
Id.
Other factors a court may consider under the mere continuation exception include (1) the adequacy of consideration paid for the assets, (2) if the same personnel and employees are employed by the successor corporation, (3) the similarity in name and identify, and (4) whether the successor is holding itself out as the continuation of the predecessor.
With these guideposts in mind, let’s return to the above scenario and specifically address the question: “What are the supplier’s chances of recovering its account receivable from Two Brothers’ HVAC?”
Given the facts (limited as they are), there is a good chance the supplier will be able to use the “mere continuation” exception to trace its accounts receivable from Brother’s Heating & Cooling to Two Brothers’ HVAC.
The most important consideration in the “mere continuation” exception is the common identities of decision makers and owners. The facts tell us that the two entities have different ownership. Brother’s Heating & Cooling is owned equally between the two brothers. Two Brothers’ HVAC, on the other hand, is owned by a cousin and the spouse of one of the brothers.
This distinction will likely not protect Two Brothers’ HVAC because the two brothers are still involved in the business operations. One important fact will be how the profits are distributed out of Two Brothers’ HVAC. Given the facts, it would not be surprising to learn that the two brothers take all the profits in the form of salary.
There are other facts that suggest that Two Brothers’ HVAC is a mere continuation of Brother’s Heating & Cooling. Both companies offer the same services, in the same geographic area and use the same assets. These facts will certainly help the supplier make the necessary connections to support its claim of mere continuation.
Whether your business is struggling to pay its creditors or frustrated by an inability to collect a business debt, the lawyers at Lavelle Law are ready, willing, and able to represent you and your company. If you would like more information about this topic contact Brian Massimino at 312-332-7555 or
[email protected] for a free consultation.
