Creditors: What You Should Know About Ohio's Successor Liability Doctrine

A business that dissolves without paying its bills may think it has escaped its obligation to repay creditors. However, under Ohio’s successor liability doctrine, a creditor may seek recovery from a new business that purchased assets from an old business if the new business did not follow proper formalities.

It is important for creditors to know what a business would be liable for under the successor liability doctrine.

Understanding Successor Liability

With a business merger, the general rule is that the successor business assumes all liability of the old business¹. However, sometimes businesses try to avoid liability by simply selling their assets. In that case, the successor business does not assume liability unless one of four exceptions apply:

1. The buyer expressly or implicitly agrees to assume liability
2. The transaction amounts to a de facto consolidation or merger²
3. The buyer corporation is merely a continuation of the seller corporation
4. The transaction is entered into fraudulently for the purpose of escaping liability³

The successor liability doctrine was reviewed in Welco Indus., Inc. v. Applied Cos., 67 Ohio St. 3d 344 (Ohio 1993). The plaintiff argued that the new company was liable for the old company’s debts because it was a mere continuation of the company.

They adopted the traditional “mere continuation” theory. This theory argues that a new company is a mere continuation of an old one when the corporate entity continues after a transaction even if the business operation doesn’t⁴. They did not adopt the product line theory, which states that a successor corporation is only a continuation if it manufactures the same line of products as its predecessor⁵. Nor did they adopt the expanded “mere continuation” theory, which imposes liability when the successor’s business shares many of the same features as the seller’s business⁶.

However, the court in Welco held that none of the exceptions applied to the case. There was no indication of fraudulent intent to escape liability because there was not a lack of good faith or inadequate consideration⁷.

Welco also outlined hallmarks of a de facto merger:

1. The continuation of the previous business activity and corporate personnel
2. A continuity of shareholders resulting from a sale of assets in exchange for stock
3. The immediate or rapid dissolution of the predecessor corporation
4. The assumption by the purchasing corporation of all liabilities and obligations ordinarily necessary to continue the predecessor's business operations⁸

Because there was no transfer of stock or immediate dissolution, the court found that the successor corporation was not a de facto merger⁹. The court also held that there was not a mere continuation because the business structure did not appear to be a reorganization.

Unfortunately, Welco narrowed the application of the successor liability doctrine for creditors under the mere continuation theory. (The other two theories receive broader application.)

Questions All Creditors Should Ask

While Welco made it more difficult to apply the successor liability doctrine, creditors still can bind successor companies to liability if they know what to look for. It is imperative to ask the right questions and make sure that successors followed the proper formalities. If they did not, the creditor should immediately file suit against the successor to reclaim the debt of the acquired business.

Creditors should ask:

• Did the acquiring business expressly disclaim liability in the purchase agreement? If not, then the creditor may be entitled to bind the new business under an implied assumption of liability theory.
• Did the acquiring business expressly assume liability in the purchase agreement? If looking to bind the acquiring business under an implied or express assumption theory, the creditor should obtain a copy of the purchase agreement and thoroughly review what liability the acquiring business agreed to assume.
• What assets did the acquiring business receive? If the business acquired stock, then this should be scrutinized under a de facto merger theory.
• What amount of money did the seller receive? And was this a good faith transaction? If not, then the creditor should seek to bind the acquiring business under the fraud theory of the successor liability doctrine.
• Did the acquiring business also acquire the staff of the seller? Creditors should determine whether the transaction is structured as a disguised reorganization.

Creditors also should be on the lookout for tax liability that may be imposed on the successor business. The successor could be liable for taxes levied according to ORC 5739.01 or ORC 5739.31¹⁰. In order to avoid liability, the successor must withhold a sufficient amount of the purchase money to cover the taxes, interest and penalties due and unpaid until the former owner produces either a:
 

• Receipt from the tax commissioner showing that the taxes, interest and penalties have been paid
• Certificate indicating that no taxes are due¹¹

Successors that do not take these measures certainly will be liable for the acquired company’s debts.

What This Means to Creditors

It is important to ask the right questions to determine whether a creditor may collect on the debt of a business that sold its assets to escape liability. If the creditor sees this avenue of attack, they will be entitled to collect from the acquiring business. Creditors that have a right to recover should take immediate action or risk falling behind the Ohio Board of Tax Appeals or other creditors.


¹ Flaugher v. Cone Automatic Machine Co., 30 Ohio St. 3d 60,62 (Ohio 1987).
² A transaction that has the economic effect of a statutory merger but that is cast in the form of an acquisition or sale of assets or voting stock. See Blacks Law Dictionary 9th Ed.
³ Id.
⁴ Id. at 350.
⁵ Welco at 347.
⁶ Id.
⁷ Id. at 349.
⁸ Id.
⁹ Id.
¹⁰ See ORC 5739.14.
¹¹ Id.; See also http://www.tax.ohio.gov/taq/tabid/6315/Default.aspx?QuestionID=475&AFMID=11354 (“A tax release will be issued by the Department of Taxation after: The business has been sold and the seller has filed the final sales tax return (final return should be sent directly to the Central Office, Tax Release Group, with guaranteed funds); and The department has reviewed the seller's account and found that: (a) All sales tax returns have been filed, (b) all reported tax, interest and penalties have been paid, (c) all filing and reporting requirements have been met.”)