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New Developments Relating to New York’s De Facto Merger Doctrine
February 1, 2004

New York courts will not apply the de facto merger doctrine to an asset sale absent continuity of ownership between the seller and purchaser or any successor entity.
by Gregory J. Blasi and LeRoy T. Haynes

New York courts will not apply the de facto merger doctrine to an asset sale absent continuity of ownership between the seller and purchaser or any successor entity.
by Gregory J. Blasi and LeRoy T. Haynes

Recently, the U.S. Court of Appeals for the Second Circuit, in Cargo Partner AG v. Albatrans Inc., ruled that under New York’s “de facto merger” doctrine, a corporation that purchases the assets of another is not liable following the sale for the seller’s contract debts absent “continuity of ownership” between the seller and purchaser or any successor entity.1

Between 1999 and 2001, Chase-Leavitt Inc. (Chase) incurred a debt to Cargo Partner AG (Cargo) of approximately $240,000 for services rendered. Albatrans Inc. (Albatrans) then entered into an agreement with Chase and its sole shareholder, Alison Leavitt, to purchase all of Chase’s assets. In connection with the deal, Chase agreed to provide certain customs brokerage services exclusively to Albatrans until Albatrans acquired an appropriate license. In March 2001, Cargo filed a diversity suit under New York law against Chase and Albatrans asserting that the asset purchase was in essence an acquisition of Chase, because the two companies had merged into a single entity and therefore under New York’s de facto merger doctrine Albatrans was liable for Chase’s debt to Cargo.

Under New York law, there are at least three ways in which a corporation can acquire the business of another. A purchaser can buy the seller’s capital stock, it can buy the seller’s assets, or it can merge with the seller to form a single corporation. Only in the third case, when two corporations merge to become a single entity, is the successor entity automatically liable for the debts of the seller.

Nevertheless, in a transaction involving the sale of assets, New York recognizes four exceptions to the rule that an asset purchaser is not liable for the seller’s debts. These exceptions are: (1) a purchaser who formally assumes a seller’s debts; (2) transactions undertaken to defraud creditors; (3) a purchaser who de facto merged with a seller; and (4) a purchaser that is a mere continuation of a seller.2 A de facto merger occurs when a transaction—although not in the form of a merger—is in substance a consolidation or merger of the seller and purchaser.3 New York’s de facto merger doctrine is meant to detect these transactions in order to prevent companies from procuring all the benefits of a merger—while technically avoiding the merger label—in order to sidestep assuming seller’s liabilities.

Cargo argued that the proper way to determine whether a transaction is a de facto merger is to weigh three factors, which had been set forth in an earlier New York State Appellate case.4 These factors were: (i) cessation of ordinary business and dissolution of the acquired corporation as soon as possible; (ii) assumption by the successor of the liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation; and (iii) continuity of management, personnel, physical location, assets, and general business operation.5 Cargo thus argued that the presence of any of these factors together—or alone—could trigger the de facto merger doctrine.

The court rejected Cargo’s argument and made clear that only the third factor, the presence of continuity of ownership between the predecessor companies and the successor entities, was of any concern when determining whether a merger has occurred.6 The court ruled that the other factors argued by Cargo are only relevant when continuity of ownership is present. The court further stated that only a single ingredient is necessary to find that continuity of ownership exists. This ingredient is the continuation of the selling company within the ownership structure of the purchaser or similar successor entity following the transaction, which is evidenced by the purchaser or successor entity incorporating the seller’s management, personnel, assets, physical location, and/or stockholders.

In simple terms, continuity of ownership exists where following the transaction the seller is no longer a sovereign and independent entity, but instead has become merely a component or joint owner along with the purchaser of a larger successor entity. Given the facts of the case, the court found that the de facto merger doctrine did not apply to the Chase asset purchase because continuity of ownership was not present.

It is clear that New York courts will not apply the de facto merger doctrine to an asset sale absent continuity of ownership between the seller and purchaser or any successor entity. However, if continuity of ownership is present, the transaction may be treated as a de facto merger, thereby exposing the purchaser to the seller’s liabilities, despite the desire of the purchaser to call the transaction by a different name.


Notes

  1. 2003 U.S. App. LEXIS 24692 (2d. Cir. 2003). [Back to reference]
  2. Cargo Partner AG, 2003 U.S. App. LEXIS, at *15-17. [Back to reference]
  3. Schumacher v. Richards Shear Co., 451 N.E.2d 195, 198 (N.Y. 1983). [Back to reference]
  4. See Fitzgerald v. Fahnestock & Co., 286 A.D.2d 573 (N.Y. App. Div. 2001). [Back to reference]
  5. Fitzgerald, 286 A.D. 2d at 573. [Back to reference]
  6. Cargo Partner AG, 2003 U.S. App. LEXIS, at *15-17. [Back to reference]

Reprinted by permission from The M & A Lawyer, Vol. 7, No. 8 (February 2004).


The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.


The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.