The following is a case update written by Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal. Ret.), a member of the ad hoc group of the California Lawyers Association’s (CLA) Business Law Section, analyzing a recent decision of interest:
The Eighth Circuit ruled that a competitor’s purchase of a coffee roasting company’s assets at a private foreclosure sale held by the secured lender does not create successor liability even when the buyer retained most of the employees at the same business location, including some management personnel. Ronnoco Coffee, LLC v. Westfeldt Brothers, Inc., 939 F.3d 914 (8th Cir. 9/19/2019). To view the full opinion, click here.
FACTS: U.S. Roasterie, Inc. (USR), an established coffee roasting company, ran into financial difficulties in 2014, including running up a multi-million dollar unsecured debt to its principal coffee supplier, Westfeldt Brothers, Inc. (Westfeldt). When its primary lender, Great Western Bank (GWB), declined to extend maturing secured loans in late 2014, USR defaulted and GWB conducted a private foreclosure sale of its collateral, essentially all the assets of USR including the raw coffee supplied by Westfeldt and other suppliers, to Ronnoco Coffee, a competitor. The private sale was memorialized by an agreement which expressly provided that Ronnoco did not assume USR liabilities or obligations. The facts were undisputed that the sale was held in a commercially reasonable manner and at a commercially reasonable price.
Apparently based on diversity (the opinion is silent on this issue), Ronnoco commenced a declaratory relief action in Missouri district court, seeking a finding that it was not liable to Westfeldt for USR’s debt. Westfeldt counterclaimed based on successor liability, unjust enrichment, and other claims. Based on facts not relevant to this summary, the district court applied Iowa law to the successor liability and unjust enrichment claims and Louisiana law to the claims sounding in tort. It ultimately granted summary judgment in favor of Ronnoco on all claims. The crux of its ruling was that the general rule of almost all jurisdictions applied here: except for some well-recognized exceptions “where one company sells or otherwise transfers all its assets to another company, the latter is not liable for the debts and liabilities of the transferor.” 15 Fletcher Cyclopedia of Corporations § 7122, at 229-30 (2017 rev. ed.). It found the foreclosure and asset sale were bona fide business transactions. Westfeldt appealed to the Eighth Circuit, which affirmed.
Reasoning: The Eighth Circuit found that the choice of law questions intertwined with the district court’s ruling need not be decided, since both Iowa and Louisiana law would have produced the same result, as would have almost every other state. The general rule it followed is universally recognized, as are, on the whole, the well-recognized exceptions. Those exceptions are (1) where the transaction includes an express or implied agreement to assume liabilities, (2) it involves a de facto merger or consolidation, (3) the transaction was fraudulent, or (4) where the asset purchaser is a “mere continuation” of the seller. Fletcher, Id. at 240. Westfeldt’s arguments centered on the mere continuation and fraud exceptions.
The court rejected the mere continuation and fraud assertions, relying on the test for such developed by the caselaw, another universal test: “In determining whether one corporation is a continuation of another, the test is whether there is a continuation of the corporate entity of the transferor – not whether there is a continuation of the transferor’s business operation.” Westfeldt had presented no evidence that the transaction here was anything other than arm’s length or that the corporate entity survived the sale. Moreover, the court held there is nothing inherently wrongful or fraudulent in purchasing assets at a foreclosure sale, free from encumbrances, rather than directly from USR, especially when there is no prejudice to trade debt such as Westfeldt. The evidence demonstrated the foreclosure sale was fairly conducted and that the commercially reasonable price paid for the assets did not satisfy USR’s entire debt to GWB. The demonstrated insolvency of USR meant that in any circumstance general unsecured debt was unlikely to be paid in full, if at all.
Ronnoco conducting its business in the same location with many of the same employees, including USR management personnel for limited periods of time, also was not construed to be continuation, where the ownership of the successor entity was distinct from USR’s ownership. Nothing prohibited Ronnoco from exercising sound business practices to maximize the profits it might realize from buying the assets of one of its competitors which ran into financial difficulty.
Westfeldt’s unjust enrichment and tort claims also failed because it could not prove the required elements of the claims.
Author’s Comment: This case demonstrates the historic difficulty creditors have experienced when trying to pin successor liability on an entity which acquires the assets of a going concern. The reason for the challenge is often easily identifiable: almost overnight a new business entity begins running exactly the same business operation with the same employees and assets at the same place as one which owed substantial debts to trade creditors. A suspicion that something is not “on the up and up” is foreseeable. However, a disgruntled creditor must overcome the universally accepted general rule that there is no successor liability, by showing more than a mere acquisition of going concern assets. It must be able to prove the underlying ownership of the entities is the same or that some collusion on price or procedure occurred. It does not matter whether the sale of assets took place directly between the companies or through a foreclosure sale by a secured lender unless the default was fabricated, the procedure unfair, or the price paid was not commercially reasonable. In a circumstance such as here, where the secured lender took a haircut, showing collusion will be a substantial burden and the creditor is unlikely to succeed.
Before a stiffed trade creditor initiates costly litigation in an attempt to hang liability on the successor entity, it should be very certain it can prove collusion or fraud. Otherwise, it will just exacerbate its financial shortfall by spending attorney’s fees on pointless litigation.
These materials were written by members of the California Lawyers Association Business Law Section for the Commercial Finance Newsletter, published weekly on Westlaw. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further distributed without the consent of Thomson Reuters.