Over the last year as many business owners tried to stay afloat, they found that, even though their revenues dropped, they still had many of the same expenses. This meant going into debt. Even though chapter 11 bankruptcy is an option, many business owners do not want to go through that process for one reason or another. They think they can just start another business under a different name and continue as if nothing happened. Are they home-free? Not necessarily.
Here is an example. ABC Company makes pencils. The company has two shareholders, Sean and Pete. ABC has been buying the erasers from Red Round Company. At the end of November 2020, ABC owed Red Round $ 250,000. Rather than filing for bankruptcy, in January 2021, Sean and Pete decided to change the name of the business to 123, LLC, with Sean and Pete still as the owners. While they moved their operations to another part of town, 123 had the same phone number and, if someone went onto the ABC website, they would be redirected to the 123 website.
Unfortunately, for Sean and Pete, in the middle of January, when Leslie, the owner of Red Round, called ABC to find out when she was going to get paid, the person who answered the phone said “This is 123, may I help you?” The first thing Leslie did was to look at her phone, thinking she misdialed. Seeing that she called the right number, she asked what happened to ABC. The person who answered the phone told Leslie that ABC went out of business due to Covid. Leslie, being pretty sophisticated, got off the phone and immediately called her attorney, Chuck.
At first, Leslie was upset, thinking that Red Round was going to have to write off $ 250,000. However, Chuck told Leslie that 123 might be liable to Red Round for the debt of ABC under either successor liability or de factor merger.
Either of those could mean that 123 might be liable for the debts of ABC. Generally, Courts look at the following factors in deciding whether the new company is responsible for the debts of the old company: (1) continuation of the business of what the old company did; (2) whether the new company has the same shareholders as the old company, (3) whether the old company stopped its ordinary business operations, liquidates, and dissolves as soon as legally and practically possible; and, (4) the new company assumes the obligations of the old company ordinarily necessary for the uninterrupted continuation of normal business operations.
Let’s look at the Sean and Pete side of the coin. If they wanted to continue to make and sell pencils how could they do that without being liable for the debts of ABC? The best way is to sell the business through an asset purchase agreement. The key is going to be that the sale has to be an arm’s length transaction and for fair value.
The bottom line is if your company is in financial trouble; make sure you speak with your lawyer to discuss your options.