Corporations can be like cartoon villains; attorneys for the creditor-plaintiff are like Scooby Doo and the Gang. Just like the villain who tries to avoid detection by masquerading as a ghastly ghoul, so too will corporations seek to avoid their debts and liabilities by donning a new coat and holding themselves out as a different corporation. In these instances, the liabilities and debts of a predecessor corporation may transfer to its successor.
In Illinois, as well as most other jurisdictions, the general rule is that one corporation’s purchase of another corporation’s assets does not also transfer the debts and liabilities to the purchaser corporation.1 However, as is often the case, rules have exceptions; and this general rule is no different. Four exceptions exist which, if proven, transfer liability to a corporation that purchases another corporation’s assets. The four exceptions, as set forth by the Illinois Supreme Court, are found: (1) where there is an express or implied agreement or assumption of liabilities; (2) where the transaction amounts to a consolidation or merger; (3) where the purchaser is merely a continuation of the seller; or (4) where the transaction is a fraud to escape liability.2
The second and third exceptions to the general rule — commonly referred to as the “de facto merger” and “mere continuation” exceptions — have been the subject of numerous appellate opinions. As the case law shows, these two exceptions can be confusingly similar. This article will set forth an account of the case law discussing these two exceptions, whether and how Illinois courts distinguish these exceptions, and the elements and factors that courts look to identify a well plead and/or proven cause of action under either of these two exceptions.
The De Facto Merger Exception The leading Illinois case discussing the de facto merger exception is Hernandez v. Johnson Press Corp.3 In Hernandez, the plaintiff was injured while operating an allegedly defective punch press, and sued the corporation that created the punch press and that corporation’s successor. Under the de facto merger exception, Hernandez argued that the successor was liable for the punch press maker’s torts. While affirming summary judgment in favor of the successor, the Hernandez court, by reference to case law from foreign jurisdictions, identified the criteria for establishing a de facto merger.
First, to prove de facto merger one must show that there is a continuation of the seller corporation such that there is a continuity of management, personnel, physical location, assets and general business operations; second, the seller and purchaser must have a continuity of shareholders resulting from the purchase of the seller’s assets through use of the purchaser’s stock; third, the seller corporation winds down its business, liquidates, and dissolves as quickly as possible; and last, the purchaser assumes the liabilities and obligations of the seller so that the seller’s business continues without interruption.4
Hernandez left the question open as to whether Illinois would adopt the above four prong test. Likewise, Hernandez described the four prongs as criteria, rather than elements. Since that time, however, Illinois courts have expressly applied Hernandez’s four prong test and have stated that each of the prongs is an element which must be proven to recover under the de facto merger exception.5
The Continuity Element Illinois case law analyzing claims for successor liability under the de facto merger exception all require a finding of continuity. It appears that plaintiffs most frequently fail to prove the continuity of ownership between the former and successor corporation. This is a fatal flaw in a plaintiff’s case and may lead to an award of summary judgment to the defendant.
Consider Myers v. Putzmeister and Kaleta v. Whittaker Corp. In each of those cases, the plaintiffs failed to show that the seller continued as the owner of the purchaser. In Myers, no shareholders of the predecessor ever held shares of the successor corporation6; in Kaleta, the predecessor obtained shares of the successor company, but only of a de minimus nature consistent with an employee stock plan.7 This acquisition of the successor’s shares was not significant or controlling enough to meet the continuity of ownership element.
While the other elements of the claim are equally necessary, case law shows that successor liability claims most frequently fail for the lack of common ownership between the predecexssor and successor. In fact, Illinois courts have held that continuity of shareholders is the most important element of a successor liability claim and provide the “ultimate justification for allowing liabilities to carry over to the successor.”8
As such, courts have devoted much of their analysis on this element. This in turn has created confusion between the de facto merger exception and the mere continuation exception.
Confusion Like the de facto merger exception, the mere continuation theory also requires a finding of continuity of stock ownership.9 This led the Second District of the Illinois Appellate Court to opine that the de facto merger and mere continuation exceptions are inseparable.10 While both exceptions focus on continuity of ownership, the two are distinguishable. Nilsson v. Cont’l Mach. Mfg. Co, d, succinctly clarified the distinctions between the two exceptions.. That court stated that the de facto merger exception applied when two existing corporation combined to form a single successor, and the mere continuation exception applied where a corporate reorganization took place so that the old corporation simply “put on a new coat.”11 While the quantum of proof overlaps for the two exceptions, it is clear that they are distinct. The Illinois Supreme Court recognized as much in Vernon v. Schuster when it maintained the delineation of these two exceptions.12
Mere Continuation Exception The rationale behind the mere continuation exception is that a change in form without a change in substance should not absolve a corporation of its liabilities.13 In contrast to the de facto merger exception, a cause of action under the mere continuation exception will not be measured against an element-based test. Rather, the test is whether the purchaser corporation is a continuation of the corporate entity of the seller.14 To be a continuation of the seller, there must be an identity of ownership between the predecessor and successor corporations.15 While the continuity of ownership element is required, it is unclear what other facts must be established to show a continuation of the corporate entity. Similarly courts have had to address what relationship and what percentage of ownership constitutes an identity of ownership between the predecessor and successor corporations.
Establishing Identity of Common Ownership Several recent Illinois cases have clarified what is necessary to establish an identity of ownership. Importantly, Illinois courts have not required complete identity between the seller’s and purchaser’s shareholders.16 In fact, if the predecessor’s owner’s spouse now owns the successor corporation, identity of ownership may be established. Park v. Towson & Alexander, Inc. is one such case. There, the husband and wife each owned half of the predecessor corporation, but the wife was the sole owner of the successor corporation.17 Even with this difference in ownership, the court still found enough identity of ownership to establish successor liability under the mere continuation theory.18 In another scenario, plaintiff established identity of ownership as a matter of law by showing the sole shareholder of the successor corporation became the chief executive of the successor and caused that corporation to issue a controlling eighty percent interest to his wife.19
No bright line test exists to establish identity of ownership, nor is any exact percentage of ownership per se enough to create such an identity. Rather, it appears Illinois courts employ a more flexible approach that examines the commonality of the control of ownership instead of looking to the names on the stock certificates.
Factors Showing a Mere Continuation No Illinois case clearly sets forth the factors that should be assessed to determine if one corporation is a mere continuation of its predecessor. Nonetheless, recent case law allows readers to glean certain factual circumstances that courts find relevant in determining the application of the mere continuation exception. For instance, after finding an identity of ownership, one appellate court noted that the successor corporation conducted business from the same address, used the same phone number and bank accounts, had the same employees, used the same bank accounts, and even used the predecessor’s professional license.20
These facts lead that court to find the successor was in truth the dissolved corporation just wearing a new coat.21
Since no exclusive list of factors guides Illinois courts’ analysis, courts have seemed willing to examine all the commonalities between the predecessor and alleged successor corporation. Accordingly, some courts have highlighted commonality in management and physical location.22 Also, courts have found the commingling of different corporation’s account and the uninterrupted continuation of the predecessor’s business as dispositive. 23 Still, other courts looked for similarities in the equipment, supplies, and customers used by corporations.24 Courts have even been persuaded by the continued use of the same motto by two corporations.25
There appears to be no limitation on the circumstances courts will consider in finding that one entity is the mere continuation of the other. Instead, the courts have adopted a fact intensive, case-by-case approach to determine whether the old entity has merely guised itself in new clothes. In applying this exception, courts continue to exalt substance over form.
Conclusion A plaintiff’s attorney should be mindful that the wind-down and dissolution of a corporation does not always extinguish all hopes of collecting on the debts owed by the dissolved entity. If prior to dissolution the assets of a corporation were sold or transferred, liability may transfer to the purchaser of those assets. Before involving any successors in the litigation, a plaintiff would do well to be aware of the exceptions to the general rule against successor liability. Ultimately, if a cause of action under successor liability is pursued, plaintiff should consider whether the cause of action is best pursued under the stringent de facto merger exception or the more broad mere continuation exception.
1 Vernon v. Schuster, 179 Ill. 2d 338, 345 (Ill. 1997)
3 Hernandez v. Johnson Press Corp., 70 Ill.App. 3d 664, 668 (1st Dist. 1979).
5 Gray v. Mundelein Coll., 296 Ill. App. 3d 795, 808 (1st Dist. 1998) (citing Kaleta v. Whittaker Corp., 221 Ill. App. 3d 705 (1st Dist. 1991)); Myers v. Putzmeister, Inc., 232 Ill. App. 3d 419 (1st Dist. 1992).
6 Myers, 232 Ill. App. 3d at 424.
7 Kaleta, 221 Ill. App. 3d at 709-10.
8 Manh Hung Nguyen v. Johnson Mach. & Press Corp., 104 Ill. App.3d 1141, 1148-49 (1st Dist. 1982)
9 Dearborn Maple Venture, LLC v. SCI Illinois Services, Inc., 2012 IL App (1st) 103513 ¶38.
10 Green v. Firestone Tire & Rubber Co., 122 Ill. App. 3d 204, 210 (2d Dist. 1984).
11 Nilsson v.Continental Mach. Mfg. Co., 251 Ill. App. 3d 415, 418 (2d Dist. 1993).
12 Vernon v. Schuster, 179 Ill. 2d at 345.
13 d. (quoting Baltimore Luggage Co. v. Holtzman, 80 Md. App. 282, 290 (Ct. Sp. App 1989)).
14 Id. at 1176.
16 Dearborn Maple Venture, LLC, 2012 IL App (1st) 103513 ¶38.
17 Park v. Townson & Alexander, Inc., 287 Ill. App. 3d 772, 775 (3rd Dist. 1997).
19 Steel Co. v. Morgan Marshall Indus., Inc., 278 Ill. App. 3d 241, 249 (1st Dist. 1996).
20 Hoppa v. Schermerhorn & Co., 259 Ill. App. 3d 61, 66 (1st Dist. 1994).
22 Dearborn Maple Venture, LLC v. SCI Illinois Services, Inc., 2012 IL App (1st) 103513 ¶39.
23 Clayton v. Planet Travel Holdings, Inc., 2013 IL App (4th) 120717, ¶¶ 41-42.
24 Steel Co., 278 Ill. App. 3d at 249.
25 Park, 287 Ill. App. 3d at 775.
Patrick R. Boland graduated from the University of Illinois at Urbana-Champaign. After establishing a career as a teacher, Patrick attended The John Marshall Law School. Patrick currently practices general civil and commercial litigation as an attorney with Momkus McCluskey, LLC in Lisle, Illinois.