The plaintiff obtained a breach of contract judgment against the developer defendant (Company 1) who transferred the building twice after the judgment date. The second building transfer was to a third-party (Company 3) who ostensibly had no relation to Company 1. The sale from Company 1 went through another entity – Company 2 – that was unrelated to Company 1.
Plaintiff alleged that Company 1 and Company 3 combined to thwart plaintiff’s collection efforts and sought the turnover of the building so plaintiff could sell it and use the proceeds to pay down the judgment. The trial court granted the turnover motion on the basis that Company 3 was the “continuation” of Company 1 in light of the common personnel between the companies. The appeals court reversed though. It found that further evidence was needed on the continuation exception but hinted that the fraud exception might apply instead to wipe out the Company 1-to Company 2- to Company 3 property transfer.
On remand, the trial court found that the fraud exception (successor can be liable for predecessor debts where they fraudulently collude to avoid predecessor’s debts) indeed applied and found the transfer of the building to Company 3 was a sham transfer and again ordered Company 3 to turn the building over to the plaintiff. Company 3 appealed.
The appeals court affirmed the trial court’s judgment and in doing so, provided a useful summary of the principles that govern when one business entity can be held responsible for another entity’s debts.
In Illinois, a corporation that purchases the assets of another corporation is generally not liable for the debts or liabilities of the transferor corporation. The rule’s purpose is to protect good faith purchasers from unassumed liability and seeks to foster the fluidity of corporate assets.
The “fraudulent purpose” exception to the rule of no successor liability applies where a transaction is consummated for the fraudulent purpose of escaping liability for the seller’s obligations.
The “mere continuation” exception to the nonsuccessor liability rule requires a showing that the successor entity “maintains the same or similar management and ownership, but merely wears different clothes.” The test is not whether the seller’s business operation continues in the purchaser, but whether the seller’s corporate entity continues in the purchaser.
The key continuation question is always identity of ownership: does the “before” company and “after” company have the same officers, directors, and stockholders?
In Advocate Financial, the factual oddity here concerned Company 2 – the intermediary. It was unclear whether Company 2 abetted Company 1 in its efforts to shake the plaintiff creditor. The court affirmed the trial court’s factual finding that Company 2 was a straw purchaser from Company 1.
The court focused on the abbreviated time span between the two transfers – Company 2 sold to Company 3 within days of buying the building from Company 1 – in finding that Company 2 was a straw purchaser. The court also pointed to evidence at trial that Company 1 was negotiating the ultimate transfer to Company 3 before the sale to Company 2 was even complete.
Taken together, the court agreed with the trial court that the two transfers (Company 1 to Company 2; Company 2 to Company 3) constituted an integrated, “pre-arranged” attempt to wipe out Company 1’s judgment debt to plaintiff.
Afterwords: This case illustrates that a court will scrutinize property transfers that utilize middle-men that only hold the property for a short period of times (read: for only a few days).
Where successive property transfers occur within a compressed time window and the ultimate corporate buyer has substantial overlap (in terms of management personnel) with the first corporate seller, a court can void the transaction and deem it as part of a fraudulent effort to evade one of the first seller’s creditors.