Tag: merger

Florida Series III: Parent Company’s Merger Doesn’t Impact Subsidiary’s Noncompete with M.D.

Collier HMA v. Menichello a medical noncompete dispute, considers whether a third party can enforce a noncompete after a merger.  Jettisoning the “changed corporate culture and mode of operation” test, the Florida appeals court applied basic principles of corporate law to determine whether a parent company’s merger necessarily meant its subsidiary merged too and couldn’t enforce a noncompete involving one of its staff doctors.

Halfway through a three-year employment contract between the plaintiff and doctor defendant, the plaintiff’s corporate parent was acquired by another entity.  The plaintiff-doctor employment contract contained a 12-month noncompete and specifically said it was not enforceable by third parties, successors or assignees of the parties.

After the acquisition, the doctor defendant quit and went to work for one of plaintiff’s competitors.  The plaintiff sued the doctor for violating the 12-month noncompete. The doctor defended by stating that the parent company’s merger with another entity made the plaintiff a successor under the law that could not enforce the restrictive covenant.  The trial court agreed and entered summary judgment for the doctor.  The employer appealed.

Held: Reversed.  Plaintiff employer can enforce the doctor’s noncompete.

Reasons:

Under Florida law, S. 542.335(1)(f), Florida Statutes (2012),  an employment contractual provision that authorizes a third-party beneficiary, assignee or successor to enforce a restrictive covenant is valid.

The statute is silent on the meaning of “successor” but case law defines it to mean “a corporation that, through amalgamation, consolidation or other assumption of interests, is vested with the rights and duties of an earlier corporation.”

Here, the plaintiff employer’s status did not change after its parent company’s merger.  Under the law, a parent corporation is a separate and distinct legal entity from its wholly-owned subsidiary.  As a corollary, a parent company cannot exercise rights of its subsidiary.

The subsidiary plaintiff here continued its existence after the merger as the same single member LLC and didn’t sell or transfer its assets to another entity.  Any change in company ownership several tiers up the corporate chain simply didn’t impact the doctor’s employment contract since plaintiff continued to operate and to employ the doctor.  As the lone signer of the employment contract that contained the noncompete, plaintiff could enforce it.

Afterwords:

The Court refused to apply the nebulous “culture and mode of operation” test which looks to the parties’ post-merger conduct (i.e., did the parties act as though the acquiring company was dictating the acquired company subsidiary’s actions?) to decide whether a third-party can enforce a noncompete.  Instead, the Court considered whether the plaintiff continued its operations (it did) in the wake of the parent company’s merger.

Under black-letter corporate law principles, the Court found that the plaintiff’s parent company’s merger had no impact on the plaintiff as “no other entity emerged from the transaction as a successor to [plaintiff].”  Summary judgment for the plaintiff reversed.

 

Third Party Corporation Can Enforce Non-Compete After Stock Purchase

ThyssenKrupp Elevator Corporation v. Hubbard, 2013 WL 3242380 (M.D. Fla 2013) considers whether a company that buys the assets of another can enforce the purchased company’s non-compete agreements. 

The defendant was an elevator salesman for a company that was bought by the plaintiff. an elevator company.  The defendant previously signed a non-disclosure (involving intellectual property), non-solicitation and non-compete provision. 

Soon after plaintiff acquired his employer, defendant resigned and joined one of plaintiff’s competitors. Plaintiff sued, claiming a breach of the restrictive covenants. 

Defendant moved to dismiss on the ground that plaintiff wasn’t a party to the employment contract that contained the restrictive covenants.

The Court denied the motion to dismiss.  Citing a 2008 Florida Federal case (Johnson Controls, Inc. v. Rumore, 2008 WL 203575) and Florida’s Business Corporation Act, the court held that where there was a 100% merger or stock transfer, the surviving company (here, plaintiff) assumed all rights and obligations of the predecessor,  including rights under  the challenged non-compete agreement.  *2, Fla. Stat. § 607.1106 (surviving corporation of a merger shall have all the rights, privileges, immunities and powers, and shall be subject to all the duties and liabilities of the merged corporation). 

Here, in light of plaintiff’s stock purchase of defendant’s former employer, plaintiff was a “surviving corporation” and could sue to enforce defendant’s non-compete  

Take-aways:

A third party can enforce employee restrictive covenants where there is an asset purchase by the third party;

Employees should press for terms in their employment contracts that clarify only their direct employer (and not an acquiring company) can hold them to restrictive covenants.  

Corporate Successor Liability in Illinois: the Rule and Exceptions

Corporate successor liability’s focal point is whether a purchasing corporation (Company 2) is responsible for the purchased corporation’s (Company 1) pre-sale contract obligations. 

It’s an important question because the Company 1 will usually have no assets after the purchase.  Creditors of Company 1 will then try to pin liability on Company 2.

The general rule in Illinois is that a corporation that purchases the assets of another corporation is not responsible for the debts or liabilities of a transferor corporation.  

The rule is designed to protect good faith purchasers from unassumed liability and to maximize the fluidity of corporate assets.  

The four exceptions to this rule are: (1) where there is an express or implied agreement of assumption; (2) where the transaction amounts to a consolidation or merger of the purchaser or seller corporation; (3) where the purchaser is merely a continuation of the seller; and (4) where the transaction is fraudulent – done for the purpose of escaping the seller’s obligations.

The express assumption exception only applies if the plaintiff can produce an agreement where the purchasing corporation agrees to assume the selling corporation’s obligations.

If the agreement is silent, there is no express assumption.  Implied assumption is trickier and requires an examination of the selling and buying corporations’ conduct.  

The merger or consolidation exception applies where the plaintiff demonstrates: (a) continuity of management, personnel, physical location, assets, and business operations; (b) continuity of shareholders; (c) that the seller ceases its business operations quickly after the sale; and (d) the buyer assumes the seller’s liabilities and obligations that are necessary for seamless perpetuation of the seller’s business operations. 

In examining the continuation exception, the court’s focus is whether the purchasing corporation is a reincarnation of the seller corporation and has same or similar management but merely “wears different clothes”. 

The continuity calculus includes whether there is a common identity of officers, directors and shareholders between the selling and purchasing corporations.    

Exact commonality between the selling and purchasing corporations’ management isn’t required for the court to find a continuation.

In assessing whether the fraud exception applies to the general rule of no corporate successor liability, the court looks at multiple factors set forth in the Illinois Fraudulent Transfer Act. 740 ILCS 160/5(b)(1)-(11) including the timing of the transfer from seller to purchaser, whether the seller paid and whether purchaser received adequate consideration, whether the seller became insolvent at or shortly after the transfer, whether the transfer was to an insider (officer, director shareholder of the selling corporation), etc.

Conclusion

To temper the possible harsh results of a corporate transfer wiping out any chance of creditor recovery, I try to put language in a contract saying that if there is a transfer from defendant to another entity during the term of the contract, the defendant promises to both promptly notify my client in writing and make the new, purchasing company aware of the contract and its obligations under it.