By David M. Stevens

A business that purchases the assets of another entity is often concerned about whether it will be held liable for the seller's debts, including any claims involving employees. In a recent case, Maryland's Court of Special Appeals examined the standard to be applied in determining whether such liability will be imposed. Let's take a closer look at this interesting case.

Background

Phillip Martin was a minority owner who helped found lumber manufacturer Best & Brady Components, LLC, with the aid of TWP Enterprises, a lumber and hardware retailer. At the time Best & Brady was formed, Martin signed an offer letter guaranteeing his employment for a 2-year period. Best & Brady quickly proved to be unprofitable, however, and the company was unable to pay Martin's salary for the full 2 years.

Best & Brady's assets were eventually purchased by TWP, whose employees had performed various administrative functions for Best & Brady during its brief period of operations. As part of the asset sale, TWP purchased Best & Brady's equipment, contracts, and customer lists and agreed to assume certain liabilities specified in the asset purchase agreement. Following the asset sale, TWP continued to operate Best & Brady and, for a time, did business under the "Best & Brady" name.

Martin sued Best & Brady for the unpaid balance of his wages as well as penalty damages under the Maryland Wage Payment and Collection Act (WPCA). His lawsuit also named TWP as a defendant, on the theory that it was liable for the wages he was owed because it was a successor to Best & Brady.

After a default judgment was entered against Best & Brady, a trial was held on TWP's alleged successor liability. The trial court concluded that TWP wasn't liable for Martin's unpaid wages. He appealed that decision.

Decision on appeal

The principal issue on appeal was the method of analysis used by the trial court to evaluate Martin's claim of successor liability. The opinion rendered by the Maryland Court of Special Appeals offers valuable insights about the standard that will be applied when an individual seeks to impose liability on a company for the debts of its predecessor.

The court began its analysis by recognizing that a corporation that acquires the assets of another corporation generally is not liable for the predecessor's debts. Maryland courts have recognized four exceptions to that general rule.

The first three exceptions are relatively straightforward: Liability will be imposed on a successor if it is provided for by an agreement between the entities, if the transaction amounts to a merger, or if the transaction is shown to have been made fraudulently for the purpose of escaping liability. The fourth exception applies when the purchasing corporation is a "mere continuation" of the selling corporation.

Given the sizable exposure that can result from a successor being compelled to satisfy the debts of its predecessor, the analysis used to determine when a successor will be deemed a "mere continuation" is a matter of substantial concern.

Significantly, the court of special appeals rejected Martin's argument that a continuation of management and ownership from one entity to the other is sufficient to impose successor liability. The court instead found that courts must consider additional factors.

Specifically, the court held that the adequacy of the consideration (or remuneration) given in return for the transaction is a proper factor in determining successor liability. The court indicated that payment representing the fair market value of the assets purchased will be a strong factor against imposition of successor liability.

The court also held that the purpose of the asset sale should be analyzed, with any finding that the transaction was undertaken for the purpose of placing assets outside the reach of the predecessor's creditors weighing strongly in favor of a finding of successor liability.

Having clarified the proper analysis to be applied, the court of special appeals concluded that the trial court correctly found that TWP was not liable for Martin's unpaid wages as a successor of Best & Brady. Martin v. TWP Enterprises, Inc. (Sept. Term 2014, No. 1855).

Bottom line

Employers that purchase the assets of another company should be aware of the mechanisms available under Maryland law for imposing liability for debts previously incurred by the seller, including liability for unpaid wages. The risk of liability is greater when the purchaser continues the seller's line of business and retains its key employees or when there is commonality of ownership between the selling and purchasing entities.

If you are considering such a transaction, you would be wise to consult with legal counsel to ensure that the purchase is properly structured to minimize the likelihood that it will give rise to successor liability.

David Stevens, editor of Maryland Employment Law Letter, can be contacted at dstevens@wtplaw.com or 443-263-8250.