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The Trouble with Asset Transfers
In Warne Investments v. Higgins, the Arizona
Court of Appeals held a new business and its
owner liable for the debt of a company that
transferred assets to the new entity
Bridge IT, Inc., was an Arizona corporation
founded in 1995 by Sandra Higgins and her
husband to provide technology services to
businesses. Higgins was Bridge IT’s
president, majority shareholder and
principle employee. At its high point,
Bridge IT had 12 employees and annual sales
of $2 million.
Warne Investments entered into a contract
with Bridge IT that called for Bridge IT to
develop a website for Warne. A contract
dispute arose and, in August 2001, Warne
sued Bridge IT. Defending against Warne’s
lawsuit proved to be a major distraction for
Higgins; business declined drastically, and
she hired a manager to run the company.
The case, which went to trial in December
2002, resulted in multiple awards to Warne
totaling more than $155,000. In an attempt
to collect on the ensuing judgments, Warne
garnished Bridge IT’s bank account,
essentially putting the company out of
business.
In July 2002 – after Warne filed its lawsuit
and before the case went to trial – Higgins
created another corporation, Bridge Info
Tech. (Due to the similarity of names, we
will refer to Bridge IT as the “old company”
and Bridge Info Tech as the “new company.”)
The newly created corporation was inactive
until the summer of 2003. At that time,
Higgins stopped working for the old company.
The similarities between the old and new
companies didn’t end with the names:
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The new company leased office space near the
old company.
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The old and new companies provided the same
services and sold the same products.
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The old and new companies had at least five
significant clients in common.
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The old and new companies were owned and
managed by the same people and benefited
from the owners’ skills, knowledge and
market contacts.
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When the new company began operating, it
bought some of the old company’s office
equipment.
Holding judgments against the insolvent,
inactive old company, Warne filed suit in
July 2004 against Higgins and the new
company. Warne was victorious again, getting
judgments against the new company and
against Higgins personally, equaling the
$155,000 that the old company had been
ordered to pay.
The judgment against the new company was
based on the Uniform Fraudulent Transfers
Act (UFTA) and the doctrine of successor
liability. The judgment against Higgins was
based on the successor liability and trust
fund doctrines.
Successor Liability. In Arizona, the general
rule is that when a corporation sells or
transfers its principal assets to a
successor corporation, the successor
corporation is not liable for the former
corporation’s debts and liabilities.
While that may appear to be a huge escape
route for the owner of a troubled company,
the rule is subject to various exceptions.
Legal responsibility transfers to the
successor corporation if any of these
conditions is met:
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the successor corporation expressly or
impliedly agrees to assume the liabilities
of the predecessor corporation; or
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the transaction between the two corporations
amounts to a consolidation or merger; or
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the successor is a mere continuation or
reincarnation of the predecessor; or
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clear and convincing evidence shows that the
transfer of assets from the predecessor to
the successor was for the fraudulent purpose
of escaping a debt or liability.
In the appeal by Higgins and the new company
of the trial court’s verdict against them,
the Arizona Court of Appeals found that
there was sufficient evidence to support the
jury’s conclusion that Bridge Info Tech (the
new company) was a mere continuation of, and
a successor to, Bridge IT. The mere
continuation theory of successor liability
requires proof of “substantial similarity in
the ownership and control” of the two
businesses, and the failure by the successor
business to pay reasonable value to the
predecessor business for the assets
transferred.
In addition to observing the similarities
between the two companies, as noted above,
the Court of Appeals examined the adequacy
of the value paid for the assets
transferred. The Court acknowledged the
finding of Warne’s expert witness that the
old company’s value as a going concern was
transferred to the new company, which used
that value to quickly become a going concern
itself. Higgins’ position was further
weakened by the fact that the new company
did not pay the old company for the transfer
of any assets other than about $2,200 for
office equipment. The old company’s
intangible assets (e.g., goodwill, customer
contacts, and the knowledge and skills of
the owners and employees) were transferred
to the new company without any compensation,
further rendering the old company incapable
of meeting its obligation to Warne.
It should be noted that the availability of
intangible assets, such as good will, for
transfer and the value, if any, of this type
of asset is case-specific and largely
dictated by the type of business involved.
In Warne, the Court recognized that this
successful service business had, but was not
paid for, valuable customer loyalty assets
that simply followed the owner and key
employees. The result: The new company was
liable for the prior judgments Warne
obtained against old company.
Trust Fund Doctrine. As for Higgins’
personal liability for the entire obligation
owed to Warne, a discussion of the trust
fund doctrine may be useful. The doctrine is
meant to ensure that all creditors’ claims
against an insolvent corporation are
satisfied before any stockholders receive
anything. In this case, liability under the
trust fund doctrine required evidence that:
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corporate assets were transferred to
Higgins,
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the transfer occurred while the corporation
was insolvent, and
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the transfer gave Higgins preferential
treatment over other creditors.
The Court of Appeals found that all of those
conditions were met, making Higgins
generally liable under the trust fund
doctrine. However, the Court declined to
impose personal liability on Higgins on
either successor liability or fraudulent
transfer grounds.
Lesson Learned. Sandra Higgins chose a path
that the owners of many other troubled
businesses have tried to follow – i.e., to
limit the recourse of the creditors of
Company A by transferring its assets,
ownership, employees, operations, processes,
customer relationships, etc., to a new,
unblemished Company B, without the payment
of adequate value for the assets
transferred.
The exceptions to the doctrine of successor
liability noted above illustrate (a) how
difficult it is for a successor corporation
to properly structure a transfer of assets
so as to avoid the debts and obligations of
its predecessor and (b) the readiness of the
courts to punish sham transfers from a
predecessor to its successor. •
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