Massachusetts Supreme Judicial Court, Robert Smith vs. Robert E. Kelley, SJC-12759

Corporation

Professional Corporation

Corporate Successor Liability

When the Successor Is A Sole Proprietorship?

Successor Liability

Equitable Remedy

Successor in Interest

Continuity of Individuals in Control of the Business

Doctrine of Piercing the Corporate Veil

Alter Ego or Veil-Piercing Theory

Declaratory Judgment

Equitable Claim to Reach and Apply Kelley's Assets

Judgment, Preclusive Effect.

Collateral Estoppel

 

 

The instant case concerns a final judgment that was entered four years ago against a professional corporation, RKelley-Law, P.C. (the P.C.), for the fraudulent activity of one of its associates. The associate defrauded the plaintiff, Robert Smith, in a mortgage scam. The defendant in this case, Robert Kelley, was at all times the sole shareholder and officer of the P.C. The day after the entry of final judgment against the P.C., the defendant voted to wind up the corporation. That same day, he began operating his law practice as a sole proprietorship. Not long thereafter, the P.C. was placed into bankruptcy proceedings. The P.C. now has no assets, and the plaintiff seeks to recover from the defendant personally. For the reasons discussed infra, we conclude that, in the very unique circumstances of this case, the plaintiff may pursue successor liability against the defendant's sole proprietorship, as it was a mere continuation of the former professional corporation.

 

(…) The P.C., against which the final judgment was entered, had been formed by Kelley in or around 2003. The practice primarily involved real estate conveyances. At the height of the practice, the P.C. employed twelve to fifteen employees. At all times, Kelley was the sole shareholder, president, treasurer, secretary, and director of the P.C. Additionally, he served as the P.C.'s registered agent in Massachusetts.

 

(…) The day after final judgment was entered against the P.C. on Smith's claims, Kelley resigned from his officer positions in the P.C. and voted to wind up the corporation. Pursuant to the vote, Kelley decided to "consult with a bankruptcy lawyer on whether to file dissolution papers or bankruptcy." At the same time, Kelley opened a sole proprietorship called Law Office of R. Emmett Kelley (the sole proprietorship). Pursuant to the wind-up vote, Kelley had existing clients of the P.C. amend their fee agreements to bill all future work to the sole proprietorship, instead of the P.C. The sole proprietorship operated out of the same office as the P.C., used the same e-mail address, and utilized very similar letterhead.

 

The specific terms of the vote were as follows:

"That R. Kelley Law, P.C. would cease operations effective immediately; that the sole stockholder shall direct a plan to wind up the corporation; that a list of all assets be compiled; that existing clients be contacted and asked to amend any ongoing fee agreements and be billed for all future work to the Law Offices of R. Emmet Kelley; to establish a new account in the law office of Robert E. Kelley, D/B/A Law Offices Of R. Emmett Kelley, new [tax identification number]; file a final tax return for R. Kelley-Law, P.C.; apportion ongoing expenses to the two law firms during the wind-up process; prepare an agreement to sell any assets to the Law Offices of Robert E Kelley at their fair market value; consult with bankruptcy lawyer on whether to file dissolution papers or bankruptcy; and to do all things necessary to wind up corporation."

 

Approximately three months after final judgment was entered against the P.C., on April 4, 2016, the Federal District Court judge issued an execution against the P.C. for $255,728 plus interest. Smith made a demand upon the P.C., but the P.C. failed to remit any money to him. On July 18, 2016, Smith brought the instant suit against Kelley in the Superior Court, seeking a declaratory judgment that Kelley was personally liable for the P.C.'s liabilities as a successor in interest to the P.C. Smith also brought an equitable claim to reach and apply Kelley's assets to satisfy the final judgment entered against the P.C.

 

Bankruptcy proceedings. On May 19, 2017, the P.C. filed a voluntary petition for relief under Chapter 7 of the United States Bankruptcy Code, 11 U.S.C. §§ 301 et seq. (2012). A trustee was appointed. During the course of discovery in the bankruptcy proceedings, the trustee determined that the P.C. had direct claims against Kelley. Specifically, Kelley had taken equipment, inventory, and supplies from the P.C. without paying for them. Moreover, receivables owed to the P.C. had been deposited into Kelley's account, rather than the account of the P.C. The trustee calculated the total value of the direct claims that the P.C. could assert against Kelley at $74,000. Kelley offered to purchase the claims from the bankruptcy estate for $85,000.

 

(…) b. Successor liability. Having determined that the prior litigation does not foreclose Smith from seeking to impose personal liability on Kelley, we turn to the question whether Kelley's sole proprietorship may be held liable for the final judgment entered against the P.C. as a successor in interest. We conclude that in the narrow factual circumstances of this case, it may.

 

As a general rule of corporate law, the liabilities of a corporation are not imposed upon its successor. See Milliken & Co. v. Duro Textiles, LLC, 451 Mass. 547, 556 (2008). This principle is no less applicable to professional corporations, which are afforded the same protections against liability as corporations formed under G. L. c. 156D. See G. L. c. 156A, § 6 (a). See also 63 Am. Jur. 2d Products Liability § 117 (1997) ("The traditional rule of corporate successor liability and the exceptions to the rule are generally applied regardless of whether the predecessor or successor organization was a corporation or some other form of business organization"); Graham v. James, 144 F.3d 229, 240 (2d Cir. 1998).

 

While we respect the integrity of corporate structures, we nonetheless find it troubling "that by merely changing its form, without significantly changing its substance, a single corporation can wholly shed its debts to unsecured creditors, continue its business operations with an eye toward returning to profitability, and have no further obligation to pay such creditors." Milliken & Co., 451 Mass. at 561. The application of the doctrine of successor liability is "designed to remedy this fundamental inequity." Id. The "essence" of this doctrine is that, "under principles of equity, a court will consider a transaction according to its real nature, looking through its form to its substance and intent." Id. at 560. If the entity remains essentially the same, despite a formalistic change of name or of corporate form, successor liability may be imposed.

 

Successor liability is triggered, inter alia, when a successor entity is a mere continuation of its predecessor.

 

There are four exceptions to the general rule of limited corporate liability that fall within the doctrine of successor liability. A successor in interest may be held responsible for the liabilities of its predecessor where "(1) the successor expressly or impliedly assumes liability of the predecessor, (2) the transaction is a de facto merger or consolidation, (3) the successor is a mere continuation of the predecessor, or (4) the "mere continuation" exception of successor liability "reinforces the policy of protecting rights of a creditor by allowing a creditor to recover from the successor corporation whenever the successor is substantially the same as the predecessor". 15 W.M. Fletcher, Cyclopedia of Corporations § 7124.10, at 321 (rev. 2017). To determine whether the exception applies, we examine the continuity or discontinuity of the ownership, officers, directors, stockholders, management, personnel, assets, and operations of the two entities. See Cargill, Inc. v. Beaver Coal & Oil Co., 424 Mass. 356, 359 (1997) (focusing on de facto merger exception, but articulating factors relevant to mere continuation analysis, including continuity of management, personnel, physical location, assets, and general business operations); McCarthy v. Litton Indus., Inc., 410 Mass. 15, 23 (1991); Columbia State Bank v. Invicta Law Group PLLC, 199 Wash. App. 306, 312-314 (2017) (discussing relevant factors in finding mere continuation of law firm from professional corporation to sole proprietorship, such as continuity of business, clients, leadership, and location). We emphasize that "no single factor is dispositive, and the facts of each case must be examined independently." Milliken & Co., 451 Mass. at 558. Ultimately, however, our focus is on "whether one company has become another for the purpose of eliminating its corporate debt." Id. at 556.

 

Kelley urges this court to analyze the degree of continuity between the P.C. and the sole proprietorship based on the characteristics of the P.C. over the course of its lifetime. As Kelley notes, the P.C. at one point employed twelve to fifteen employees, while the sole proprietorship employed just one. At all times, however, Kelley was the sole shareholder, officer, and director of the P.C. Crucially, the leadership structure of the P.C. and Kelley's sole proprietorship were functionally identical -- while the sole proprietorship does not have officers, directors, or shareholders, Kelley has operated at the helm of both entities, with his wife serving as an office assistant or manager. See Cambridge Townhomes, LLC v. Pacific Star Roofing, Inc., 166 Wash. 2d 475, 482-483 (2009) ("Though there is no continuation of officers, directors, or shareholders where a sole proprietorship is involved, we can consider the continuity of individuals in control of the business as satisfying this factor, which at any rate is not a rigid requirement for finding successor liability").

 

In almost every respect, Kelley's sole proprietorship mirrored the P.C. that immediately preceded it. Prior to dissolution, it was effectively a one-person P.C., and after dissolution, it was effectively a one-person sole proprietorship. Kelley continued to receive legal fees from clients of the P.C., and legal fees due the P.C were paid to the sole proprietorship. The client fee agreements of the P.C. that preceded its dissolution date were also rolled over to the sole proprietorship, as though nothing had changed. Kelley also took the equipment, inventory, and supplies from the P.C. for use in the sole proprietorship without paying for them. Both entities used the same e-mail address, the same physical address, the same IOLTA account with the same name, and the same health insurance with the same named employer, and paid the same creditors and vendors. Kelley did "eventually" use a different telephone number for the sole proprietorship from the one he had used for the P.C., although it is not clear when this change occurred. In sum, the evidence appears overwhelming that Kelley's sole proprietorship amounted to a "reincarnation" of the predecessor professional corporation. Bud Antle, Inc. v. Eastern Foods, Inc., 758 F.2d 1451, 1458 (11th Cir. 1985). All that had changed was the label.

 

Having examined the similarities between the predecessor entity and the successor entity, we consider whether successor liability is nonetheless unavailable because the successor entity is a sole proprietorship. Had Kelley dissolved the P.C. in favor of another corporate form that limited personal liability, such as a successor professional corporation or a limited liability company, we would have little difficulty in finding the successor entity liable. The only issue is whether a different set of rules applies when the successor is a sole proprietorship. For the reasons discussed infra, we conclude that successor liability may apply to sole proprietorships even though they expose their proprietors to personal liability.
This exposure is an additional concern that must be taken into account, especially when considering the equities at the damages stage, but we ultimately conclude that successor liability is justified where the sole proprietorship is a mere continuation of its predecessor and the purpose of the change is to eliminate the debt.

 

(…) The court explained that successor liability "exists in equity to protect creditors from debtors that attempt to change corporate form, sell off their assets, or merge with another company in an attempt to avoid their debts." Moreover, and as we have also discussed, the mere continuation theory of liability prevents a company from escaping liability by "transferring all of the company's assets and continuing business in another form." The fact that the successor was a sole proprietorship did not change the court's analysis of successor liability.

 

(…) Despite these concerns, we nonetheless conclude that the doctrine of successor liability should be extended here, where the record plainly reflects that the purpose of dissolving the P.C. and establishing the sole proprietorship was to avoid payment of the liabilities at issue.

 

At bottom, successor liability is an equitable remedy aimed at fairness and justice. Milliken & Co., 451 Mass. at 560. As we have previous said, focusing on the substance and intent of a transaction, rather than its form, is at "the essence" of the doctrine of successor liability.

 

(…) Rather, the P.C. was vicariously liable. As the P.C. was essentially continued to Kelley's personal benefit, the revenues generated by the continuing practice should be used to pay the debt, not Kelley's other assets. To the extent possible, such a distinction should be preserved. Drawing that line here best achieves equity in the instant case.

 

In light of our conclusion that Smith is entitled to recover under the doctrine of successor liability, we need not address the availability or merits of Smith's theory of recovery as to piercing the corporate veil (fn. 15 p. 36).

 

 

 

(Massachusetts Supreme Judicial Court, February 11, 2020, Robert Smith vs. Robert E. Kelley, SJC-12759)

 

California Court of Appeal (Third Appellate District), North Valley Mall v. Longs Drug Stores, Docket C079281, Certified for Publication

Contract (alteration): Corporation: Merger: De facto merger: (Corporate veil): Reverse triangular merger: Transfer of corporate stock: Creditors and shareholders: Assignment:

At issue in this case is whether the court should “go behind” the form of a corporate reorganization in order to alter contractual obligations, when the corporation utilized the type of reorganization it used in order to avoid altering its contractual obligations. The type of reorganization used in this case is a common one, and is referred to as a reverse triangular merger (A reverse triangular merger is one in which an acquiring corporation forms a new subsidiary, which is merged into the surviving corporation. In this case a survivor corporation, North Valley Mall, LLC, merged with Longs Drug Stores, Inc., the surviving corporation, by sale of its stock but with retention of its legal title to the property at issue). The usefulness of such a merger is to leave the target corporation intact as a subsidiary of the acquiring corporation where the target corporation has contracts or assets that are not easily assignable.

We conclude that where the form of reorganization was not chosen to disadvantage creditors or shareholders, we will not ignore the form of reorganization chosen by the corporation. We will affirm the judgment.

Corporations “ ‘have an identity apart from that of the owners.’ ” (Kraft, Inc. v. County of Orange (1990) 219 Cal.App.3d 1104, 1109.) Therefore, “the transfer of corporate stock is not deemed a transfer of the real property of a legal entity because the separate legal entity still owns the property.” (Ibid.) However, a traditional merger--one in which two or more corporations merge, one survives and the others disappear--results in the transfer of the assets of each disappearing corporation to the surviving corporation. (Marsh’s Cal. Corp. Law, (4th ed. 2013) Corporate Reorganizations § 19.10[C], p. 19-103; Phillips v. Cooper Laboratories (1989) 215 Cal.App.3d 1648, 1660.)

The transaction between CVS and Longs was a reverse triangular merger, sometimes referred to as a triangular phantom merger. This form of reorganization is used when the target corporation, in this case Longs, has licenses, permits, or property which is impossible or highly burdensome to attempt to transfer. (Marsh’s Cal. Corp. Law, supra, § 19.01[H], p. 19-18.) In a reverse triangular merger, the acquiring corporation (CVS) forms a new subsidiary, which is merged into the target corporation (Longs) so that the target corporation is a surviving corporation that continues to own its assets. (Ibid.) Here, CVS acquired all of the issued and outstanding shares of Longs. To effectuate the stock acquisition, CVS formed a subsidiary called Blue MergerSub Corp., which merged with and into Longs, with Longs being the surviving corporation. Longs became a wholly owned subsidiary of CVS, and was converted to a limited liability company named Longs Drug Stores, LLC. Longs remains vested with legal title to the property at issue.

There Was No Sale or Lease of the Property.

(…) Courts usually describe reverse triangular mergers as similar to stock acquisitions because they do not work an assignment of contractual obligations from the target to the acquiring parent company.

(…) “The intention of the parties as expressed in the contract is the source of contractual rights and duties. A court must ascertain and give effect to this intention by determining what the parties meant by the words they used.” (Pacific Gas & Elec. Co. v. G. W. Thomas Drayage & Rigging Co. (1968) 69 Cal.2d 33, 38, fn. omitted.) In this case, the plain language of the agreement specifies that the trigger for removing the CAM charge cap is the “sale or lease of any portion of the subject property to any third person . . . .” When the agreement was made, Longs was a corporation. A plaintiff who chooses to deal with a corporation must have known “that shares of stock therein might be owned by different stockholders and are subject to assignment to others in the ordinary course of business.” (Ser-Bye Corp. v. C.P.&G. Markets, Inc. (1947) 78 Cal.App.2d 915, 920, superseded by statute on another point, as stated in In re Alberto (2002) 102 Cal.App.4th 421, 430, fn. 4.)

(…) The Further Agreement indicates that the parties intended the CAM cap to be lifted if the corporate real property was sold or leased. We cannot interpret this language to include a sale of corporate stock. NVM asks us to conclude that even if the property at issue was never sold or leased by Longs, we should look behind the reverse triangular merger and conclude that it was a de facto merger, resulting in the transfer of the property to CVS. We decline to do so.

(…) Some courts have concluded that reverse triangular mergers do not effect a de facto merger unless they are structured to disadvantage creditors or shareholders. (In re McKesson HBOC, Inc. Securities Litigation (N.D. Cal. 2000) 126 F.Supp.2d 1248, 1277; Binder v. Bristol-Myers Squibb, Co. (N.D. Ill. 2001) 184 F.Supp.2d 762, 769-770.) There is no evidence this transaction was structured as a reverse triangular merger for either of these purposes.

(…) We will not interfere with the reasonable economic expectations of the parties to these reorganizations where there is no effort to disadvantage creditors or shareholders.

Secondary authorities: Gutterman et al., Cal. Transactions Forms (2018) Business Entities, § 12:8.; Marsh’s Cal. Corp. Law, (4th ed. 2013) Corporate Reorganizations.

(California Court of Appeal (Third Appellate District), Sept. 25, 2018, North Valley Mall v. Longs Drug Stores, Docket C079281, Acting P.J. Blease, Certified for Publication)

Un contrat entre deux entreprises liées à un centre commercial prévoyait un versement périodique dû par la société A. en faveur de la société B. au titre de la participation à l’entretien du centre commercial. La participation ne pouvait pas dépasser un montant déterminé, cette limite maximale n’étant plus applicable en cas de vente ou de mise en location des actifs de la société A.

Ultérieurement, par le biais d’une « reverse triangular merger », une société tierce est fondée dans le seul but de reprendre le capital-actions de A. Dite société a donc repris ce capital social, A. restant propriétaire de ses actifs (sa forme juridique a toutefois été modifiée, le management remplacé, et les locaux de la direction transférés).

Constatant cette réorganisation, B. demande à A. et à sa nouvelle société-mère une participation à l’entretien du centre commercial d’un montant supérieur au maximum contractuel précité. A. s’y oppose. D’où la présente procédure. B. invoque la théorie juridique de la fusion de fait (« de facto merger »). Elle considère qu’il convient de regarder au-delà du type de fusion choisi et de prendre en compte ici une « fusion de fait » impliquant une situation contemplée par le contrat entre A. et B., soit le transfert des actifs qui permet de juger comme nulle la clause de valeur maximale de la participation à l’entretien du centre commercial.

En l’espèce, la cour rejette la théorie de la fusion de fait, et considère qu’au moment de contracter au sujet de la question de la participation des frais du centre commercial, l’intention des parties était d’abolir la limite supérieure de ces frais uniquement en cas de transfert ou de location des actifs, et non en cas de transfert de la propriété des actions de la société, ledit transfert n’impliquant aucune modification s’agissant de la propriété des actifs, qui restent en main de la même société : seul l’actionnariat change, dans le cadre d’une « reverse triangular merger » (la forme juridique de l’entreprise a elle aussi été modifiée, ce qui n’est pas relevant ici dans la mesure où c’est bien la forme sociale (peu importe laquelle) qui détient encore et toujours ses propres actifs, avant et après les opérations d’acquisition). La cour serait prête à juger autrement, et à appliquer la théorie « de facto merger », si des parties utilisaient le montage de « reverse triangular merger » pour porter préjudice aux droits des créanciers ou des actionnaires sociaux, ce qui n’est pas le cas en l’espèce.