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)
