Bench & Bar of Minnesota is the official publication of the Minnesota State Bar Association.

The Magically Disappearing Defendant: Successor Liability under Minnesota Law

Successor liability is more difficult to establish under Minnesota law than under Title VII and the standard for doing so has been subject to considerable give and take between Minnesota’s courts and legislature. Transfers of intangible assets without consideration pose significant risks that successor liability will attach.

What would you do in the following situation? Suppose you represent the plaintiff in a suit against Steve’s Lemonade House, Inc. After you serve the complaint, Steve’s Lemonade House goes out of business rather than defend the suit. Then, sometime later, you discover a new company called Steve’s Lemonade Hut which is using the assumed name Steve’s Lemonade House, Inc. You suspect that the same shareholders may control the new company and it may be doing the same business with the same employees for the same customers in the same location as the first business. As Steve’s carries on as it did before (albeit with a new set of corporate paperwork), your client is left with a valid claim or default judgment against the first entity, which is likely insolvent. Whatever is a lawyer to do?

This conundrum implicates successor liability, a doctrine in which the competing interests of allowing injured parties to find recourse for their injuries and protecting the limited liability businesses form collide.1 Given the realities of today’s “Great Recession,” issues of successor liability are likely to come up with increasing frequency. Accordingly, a review of the development of successor liability under Minnesota law and the current state of the law is in order, as is a warning about the potential liabilities that one can incur transferring intangible assets without consideration.

Development of Successor Liability

Two cases illustrate the initial development of successor liability in Minnesota. An early, rather quaint example of the Minnesota Supreme Court addressing the issue is Fena v. Peppers Fruit Co.2 In that 1931 case, a Minnesota partnership purchased two carloads of grapes from a sole proprietor in California. Upon delivery, half the grapes were spoiled. When the partners brought suit, they discovered that subsequent to the sale, the sole proprietor transferred all the assets of his business to Peppers Fruit Company (Peppers Co.), an entity he formed prior to the sale. In exchange for the assets of his sole proprietorship, the sole proprietor received almost all of the stock in Peppers Co. The company argued that the plaintiffs’ dispute was with the now insolvent sole proprietorship, not Peppers Co.

The court held that Peppers Co. was liable for the debt of the sole proprietorship. As it happened, Peppers Co. had expressly assumed those liabilities by contract. However, the court noted that there was a separate, independent basis for its decision: the new company was doing the same business under the same name with the same management. The court thus suggested that trial courts should look beyond a business form at the facts to see if the new business is simply a reincarnation of the first. If so, successor liability could attach.

Forty-two years later, in J.F. Anderson Lumber Co. v. Myers,3 the Minnesota Supreme Court again addressed successor liability, this time formulating a common law rule. J.F. Anderson involved a construction dispute. One of the parties to the action was the builder, Richard T. Leekley, Inc., a corporation held and managed by Mr. Leekley and his wife, Mrs. Leekley. After a trial in which Richard T. Leekley, Inc. was found liable, but before judgment was entered, the company transferred all of its tangible assets, for consideration, to a new company called Leekley’s, Inc. Mr. and Mrs. Leekley owned and managed the new entity. The Leekleys admitted that the reason for their transfer of assets was to create a new company without the liabilities of the first.

The plaintiff in J.F. Anderson argued that although there was consideration for the transfer of the tangible assets from one company to the second, there was no consideration for the transfer of the intangible assets, which included the good will associated with the reputation of the Leekleys. Although the trial court accepted this argument and entered judgment against Leekley, Inc., the supreme court rejected it on factual grounds, holding that there was no transfer of intangible assets. The court then reasoned that because there was consideration for the transfer of assets, there was no successor liability. The court went on to say, however, that “if, in the proper case there is an asset transferred without consideration labeled good will,” that could be the basis for successor liability.4 As we will see, after J.F. Anderson, plaintiffs in some circumstances have used the transfer of intangible assets without consideration to attach successor liability.

In J.F. Anderson, the court went on to articulate four exceptions to the general rule that when one company transfers all of its assets to another, there is no liability for the first company’s debts. The court declared that a successor company is only liable for the debts of its predecessor:

(1) where the purchaser expressly or impliedly agrees to assume such debts; (2) where the transaction amounts to a consolidation or merger of the corporation; (3) where the purchasing corporation is merely a continuation of the selling corporation; and (4) where the transaction is entered into fraudulently in order to escape liability for such debts.5

The court then noted that the alternative basis for the holding in Fena—the continuation of business, name and management—standing alone, was insufficient for the attachment of successor liability. With the abandonment of Fena’s broad holding, the general rule of no successor liability with the four exceptions became the law. However, the legislature soon stepped in.

Limited Liability Contentious

The limited liability business form has a contentious history in American law.6 As Professor Matheson recalled, limited liability has been both condemned (by Thomas Cooper) as “a mode of swindling … and a fraud on the honest and confiding part of the public” and lauded (by President Butler of Columbia University) as “the greatest single discovery of modern times.” Butler went on to say that “even steam and electricity are far less important than the limited liability corporation, and they would be reduced to comparative impotence without it.”7 These two competing views of limited liability can be seen in Minnesota through legislative attempts to narrow successor liability following J.F. Anderson and cases in which courts have pushed back on those restrictions when necessary to punish corporate gamesmanship or relieve a meritorious plaintiff.

In 1981, the Minnesota legislature promulgated a statute which appeared to attempt to narrow the holding in J.F. Anderson by eliminating the common law exceptions it created. In relevant part, the statute provided:

The transferee is liable for the debts, obligations, and liabilities of the transferor only to the extent provided in the contract or agreement between the transferee and the transferor or to the extent provided by this chapter or other statutes of this state.8

This statute provided that the only exceptions to the general rule of no successor liability are those provided by statute or contract rather than common law. This is significant because the mere continuation and de facto merger exceptions articulated in J.F. Anderson were based in common law. Nevertheless, in subsequent cases, courts interpreted this statute as setting forth a general rule which was subject to the common law exceptions articulated in J.F. Anderson rather than an attempt to eliminate those exceptions. For example, in Niccum v. Hydra Tool Corp.,9 the Minnesota Supreme Court addressed an attempt to expand the mere continuation exception. In refusing to do so, the court stated that Minn. Stat. §302A.661, subd. 4 (1981) reflected a legislative intent to restrict further expansion of successor liability rather than eliminate the common law exceptions.10

In 2003, the Minnesota Supreme Court again narrowed the scope of successor liability under Minnesota law in Johns v. Harborage I, Ltd.11 The plaintiff, an employee of Gators bar, brought sexual harassment claims against several entities which ran Gators. She obtained a judgment against Harborage I, Ltd. at trial. However, at the time of the judgment, the assets of Harborage I, Ltd. had been liquidated and Gators had been sold to another company, Jillian’s Entertainment Corporation (Jillian’s). Jillian’s took over Gators and operated it exactly as it had been operated in the past.

After the plaintiff learned of these events, she amended her complaint to add Jillian’s as a defendant on a successor liability theory and subsequently moved for summary judgment. The district court granted her motion but the court of appeals reversed. The supreme court found that Jillian’s was not a successor under Minnesota state law, but that it was a successor under federal Title VII common law.12

In considering whether Jillian’s was a successor under Minnesota law, the court cited J.F. Anderson for the narrow proposition that “when one corporation transfers its assets to another, the receiving corporation is not responsible for the debts of the transferor unless it agrees to assume these debts.”13 This language, which reads like Minn. Stat. §302A.661, subd. 4. (1981), is a narrower proposition than J.F. Anderson had been cited for in the past. The court then reasoned that Jillian’s could not be held liable under Minnesota law because, “Jillian’s carefully defined the liabilities it would assume, and debts such as Johns’ judgments were not among them.” That was the end of the analysis with respect to Minnesota law.

In 2006, with Niccum and other cases continuing to rely on the common law successor liability exceptions in J.F. Anderson, and the narrow opinion in Johns raising doubt about their continued application, the legislature amended Minn. Stat. §302A.661, subd. 4. The amendment added the following two sentences to the text of subdivision four:

A disposition of all or substantially all of a corporation’s property and assets under this section is not considered to be a merger or a de facto merger pursuant to this chapter or otherwise. The transferee shall not be liable solely because it is deemed to be a continuation of the transferor.14

The 2006 Reporter’s Notes state that the amendments are intended to address “confusion” in the law and confirm that there are no common law successor liability exceptions. This amendment makes even more explicit the legislature’s intent to restrict exceptions to the successor liability rule to those provided by statute or contract.

Mere Continuation

Although both the “mere continuation” and “de facto merger” exceptions referenced in J.F. Anderson were eliminated by the 2006 amendments to Minn. Stat. §302A.661, at least one case addressing the mere continuation exception deserves attention. Huray v. Fournier Programming, Inc.15 is an example of a case in which the transfer of an intangible asset gave rise to successor liability. In Huray, a group of manufacturing companies owed the plaintiff Huray a debt. Two weeks before going out of business, the majority shareholders of these businesses formed a new company. The new company then purchased the tangible assets of the first two companies and continued to perform the exact same business for the same customers. The new company continued to use certain software which had been licensed, at great expense, by the first companies.

Huray argued that the new company was a mere continuation of the first companies. Relying on the language in J.F. Anderson regarding the transfer of good will, Huray argued that because the new company continued to use the software of the first company, a transfer of intangible assets had occurred without consideration. The court of appeals agreed. The court reasoned that because of this transfer, the almost total continuation of shareholders, and the fact that the new company was performing the same work for the same customers in the same location, the new company was a successor under the mere continuation exception. Although the mere continuation exception is no longer viable, Huray remains an example of the potential liabilities that exist when intangible assets are transferred from one company to another without consideration.

Fraudulent Transfer

The fraudulent transfer exception to the general rule against successor liability remains viable today.16 Although the J.F. Anderson court did not expressly state that the Uniform Fraudulent Transfer Act (“UFTA”), Minn. Stat. §513.41 et seq., should be used for purposes of analyzing fraudulent transfer successor liability, courts have assumed that it should be.17 The UFTA is a broad, remedial statute, designed to achieve speedy relief for creditors.18 It protects those defrauded through a transaction entered into with actual intent to defraud a creditor. The UFTA sets forth a nonexclusive list of 11 factors, also known as “badges of fraud,” which are used to analyze whether a particular transfer was entered into with such actual intent to defraud a current or future creditor.19 The UFTA also protects creditors defrauded by transactions in which the debtor “did not receive reasonably equivalent value for the transfer” and either the debtor’s remaining assets were unreasonably small or the debtor became insolvent.20

In Sweeter v. Power Industries, Inc.,21 the plaintiff relied on the UFTA and a used transfer of intangible assets to attach liability to a successor company. Sweeter had an employment claim against his former employer, Power Industries. Power Industries was owned and operated by a sole shareholder. During discovery, Power Industries went out of business and the sole shareholder relinquished the franchise which he used to run the business. Immediately afterwards, Power Industries’ sole shareholder’s mother assumed the franchise, formed a new corporation called Paradigm Industries, Inc., and immediately began running the business as it had been run before. The sole shareholder of Power Industries then became the general manager of Paradigm Industries.

Meanwhile, at trial on his employment claim, Sweeter won a judgment against Power Industries. He subsequently garnished funds he believed were owed to Power Industries, and the funds were paid into the district court. The court held that Paradigm Industries was a successor to Power Industries pursuant to the fraudulent transfer exception. Like Huray, Sweeter was able to use the transfer of an intangible asset—this time a franchise—to attach successor liability.

Schwartz v. Virtucom, Inc.22 is yet another case in which intangible assets were used to attach liability to a successor company. Schwartz had a contract dispute with Virtucom. Schwartz sued and Virtucom went out of business. Schwartz obtained a default judgment. Subsequently, Schwartz learned that the majority shareholder and chairman of the board of Virtucom had moved to New York and was operating a company called St. Regis Ventures (St. Regis). St. Regis used the assumed name Virtucom Group, Inc. and engaged in a business similar to Virtucom’s, for similar clients.

At trial, Schwartz established that Virtucom transferred its name, logo, domain names, and customer contacts to St. Regis without consideration. St. Regis was held to be the successor to Virtucom based on both the fraudulent transfer and mere continuation exceptions.23 The court of appeals upheld the result on fraudulent transfer grounds and the Minnesota Supreme Court denied review. As in Huray and Sweeter, the transfer of intangible assets without consideration gave rise to successor liability.

Successor Liability Today

In light of the foregoing, let us return to our hypothetical involving Steve’s Lemonade Hut. Even if Steve’s Lemonade Hut did not expressly assume the liabilities of Steve’s Lemonade House, a plaintiff could use the fraudulent transfer exception to attempt to attach successor liability. Even if no tangible assets were transferred between the two companies, if such a plaintiff finds intangible assets transferred without consideration from Steve’s Lemonade House to Steve’s Lemonade Hut—like a lemonade stand franchise or computer software licenses—they could draw on the reasoning in Huray, Sweeter, and Schwartz to attach successor liability.

On the other hand, attorneys advising their business clients on successor liability issues should make known the risks associated with the transfer of intangible assets without consideration. Those transfers remain fraught with danger for the unwary defendant. Lastly, it should be noted that defendants, like those in J.F. Anderson, who forthrightly state that they have formed a new company to create an entity without the debts of the first, and who pay consideration for at least some of the acquired assets, seem to fair far better in these cases. Given the current state of Minnesota law, defendants who avoid gamesmanship and explain their intentions should thus be able to avoid successor liability.

David E. Schlesinger is an employment litigator in the Minneapolis office of Nichols Kaster, PLLP, where he represents employees in both individual and collective actions. He was plaintiffs’ counsel in Schwartz v. Virtucom, a case discussed in the article.

The author acknowledges with thanks the guidance of Jeffrey P. Anderson, plaintiff’s counsel in Sweeter v. Power Industries, for whom he worked as a law clerk early in his career. “Jeffrey taught me a great deal about successor liability and the practice of law in general,” says the author.

1 The general rule against successor liability and the exceptions “reflect an attempt to balance the need to protect corporate creditors with the need to respect the separation of corporate entities.” Huray v. Fournier Programming, Inc. C9-02-1852, 2003 WL 21151772, at *3 n.3 (Minn. App. 05/20/03), citing Victoria Braucher, et al., Fletcher Cyclopedia of the Law of Private Corporations §7122 (perm. ed. rev. vol. 1999).
2 239 N.W. 898 (Minn. 1931).
3 206 N.W.2d 365 (Minn. 1973).
4 Id. at 369.
5 Id. at 368-69.
6 John H. Matheson, “The Limits of Business Limited Liability: Entity Veil Piercing and Successor Liability Doctrines,” 31 Wm. Mitchell L. Rev. 411, 418-19 (2004).
7 Id.
8 Minn. Stat. §302A.661, subd. 4. (1981).
9 438 N.W.2d 96 (Minn. 1989).
10 Id. at 99.
11 664 N.W.2d 291, 297 (Minn. 2003).
12 The federal Title VII common law of successor liability is beyond the scope of this article. Suffice it to say, however, that this common law contains broader protections for injured parties than currently exist under Minnesota law. See generally Lieb v. Georgia Pacific Corp., 925 F.2d 240, 247 (8th Cir. 1991) (describing factors considered in analyzing successor liability under federal Title VII common law).
13 Id. at 297.
14 Minn. Stat. §302A.661, subd. 4 (2006).
15 Huray v. Fournier Programming, Inc., supra, n. 1.
16 See Minn. Stat. §302A.661, subd. 4, Reporter’s Notes 2006.
17 See Sweeter v. Power Industries, A-05-2466, 2006 WL 2865329 (Minn. App. 10/10/06); Schwartz v. Virtucom, 08-1059, 2009 WL 1311816 (Minn. App.), rev. denied (07/22/09).
18 See In re Butler, 522 N.W.2d 226, 234 (Minn. 1996) (discussing the “comprehensive” definition of transfer); Lind v. O.N. Johnson Co., 282 N.W.2d 661, 667 (Minn. 1938) (“The whole purpose of the enactment is aimed at the dishonest debtor and seeks to provide an orderly, efficient and speedy remedy to the creditor.”); In re Minn. Breast Implant Lit., 36 F.Supp.2d 863, 881 (D. Minn. 1998) (the UFTA is to be construed broadly).
19 See Minn. Stat. §513.44(b) (2009).
20 See Minn. Stat. §513.44(a).
21 Sweeter v. Power Industries, Inc., supra, n. 17. 22 Schwartz v. Virtucom, Inc., A08-1059, 2009 WL 1311816 (Minn. App.), rev. denied (07/22/09).
23 The facts of Schwartz occurred prior to the 2006 amendment to Minn. Stat. §302A.661, subd. 4, which eliminated the mere continuation exception.

One Comment

  1. Charles Leekley
    Dec 13, 2011

    I remember having been told of this case by my now deceased Mother Marian Leekley.

    Richard T. Leekley Inc. was contracted by the owner of Dairy Queen restaraunts to renovate his home in the suburbs West of Minneapolis. Richard T. Leekley having been somewhat new to the building business utilized the credit of one of his suppliers to begin the renovation. Like many builders Richard Leekley gave terms to the client. After the completion of the project the client failed to make payment due to Richard Leekley, Inc. claiming discrepencies in the work. This is a very common practice among savy businessmen and has claimed countless numbers of contractors in the State of Minnesota. Many a home has been built on the “good will” of their contractors. Many of these contractors have gotton stiffed.

    Richard T. Leekley sued the client for a contruction lien on the property only to have the case eventually thrown out of court by the then acting Attorney General Hubert Humphrey who just happened to be an friend and associate of the client.

    Based on this experience Richard Leekley construction company required a 10 and 10 contract to on any and all projects be paid in increments throughout the contruction process.

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