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Court Denies Dismissal Motion Finding Issues of Fact as to The Application of The de facto Merger Doctrine

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  • Posted on: Apr 8 2019

As a general rule, a corporation that acquires the assets of another company is not liable for the liabilities of its predecessor. Schumacher v. Richards Shear Co., 59 N.Y.2d 239, 245(1983). As with many rules, there is an exception. In this instance, the de facto merger doctrine. Under the doctrine, “[a] corporation may be held liable for the torts of its predecessor if (1) it expressly or impliedly assumed the predecessor’s tort liability, (2) there was a consolidation or merger of seller and purchaser, (3) the purchasing corporation was a mere continuation of the selling corporation, or (4) the transaction is entered into fraudulently to escape such obligations.” Id.

Courts apply the de facto merger doctrine “when the acquiring corporation has not purchased another corporation merely for the purpose of holding it as a subsidiary, but rather has effectively merged with the acquired corporation.” Fitzgerald v. Fahnestock & Co., 286 A.D.2d 573, 574 (1st Dept. 2001).  Courts look for certain “hallmarks” of a de facto merger to determine whether the doctrine applies.  These include: “continuity of ownership; cessation of ordinary business and dissolution of the acquired corporation as soon as possible; assumption by the successor of the liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation; and, continuity of management, personnel, physical location, assets and general business operation.” Id. See also Sweatland v. Park Corp., 181 A.D.2d 243, 245-246 (4th Dept. 1992).

Notably, “[n]ot all of these elements are necessary to find a de facto merger.” Fitzgerald, 286 A.D.2d at 574-75.  Courts will look to the substance of the transaction to determine “whether the acquiring corporation was seeking to obtain for itself intangible assets such as good will, trademarks, patents, customer lists and the right to use the acquired corporation’s name.” Id. at 575. See also Wensing v. Paris Indus., 158 A.D.2d 164 (3d Dept. 1990). The concept upon which the doctrine is based is “that a successor that effectively takes over a company in its entirety should carry the predecessor’s liabilities as a concomitant to the benefits it derives from the good will purchased.” Grant-Howard Assocs. v. General Housewares Corp., 63 N.Y.2d 291, 296 (1984).

In Atkins v. Ovation Risk Planners, Inc., 2019 N.Y. Slip Op. 30815(U) (Sup. Ct. N.Y. County Mar. 27, 2019) (here), Justice Arlene P. Bluth of the Supreme Court, New York County, considered these rules in denying a motion to dismiss and granting a motion to amend a complaint.

Atkins v. Ovation Risk Planners, Inc.

Background

Plaintiffs Arthur Atkins (“Arthur”) and Stefanii Ruta-Atkins (collectively, “Atkins”) are the successor trustees of a trust established by Arthur’s mother (the “Trust”). The Trust is comprised of two adjacent properties; one is located at 1038 Eastern Parkway, Brooklyn and the other is at 1040 Eastern Parkway, Brooklyn.

Atkins maintained homeowner’s insurance on the properties through Castlepoint Insurance Company. The policy had been purchased by Arthur’s mother prior to her death in 2012. John W. Dolan Jr.’s insurance company (“Dolan”) brokered the policy for Arthur’s mother.

Upon the death of Arthur’s mother, plaintiffs became successor trustees and renewed the insurance policies Arthur’s mother had purchased through Dolan. Plaintiffs alleged that they contacted Dolan to request that the polices be changed to indicate that plaintiff “Arthur Atkins as Successor Trustee” be named as an insured. Plaintiffs claimed that Dolan incorrectly listed the named insured as Arthur Atkins in his individual capacity as opposed to his capacity as successor trustee. Additionally, plaintiffs claimed that Dolan failed to indicate on the insurance policy that plaintiffs lived at the 1040 Eastern Parkway property, not the 1038 Eastern Parkway property.

In 2014, M&R Insurance Company (“M&R”) bought Dolan’s book of business, thereby becoming plaintiffs’ insurance broker. M&R did not correct the deficiencies Dolan purportedly made to plaintiffs’ insurance policy.

Also in 2014, Atkins was sued for the personal injuries that occurred on the 1038 Eastern Parkway property. Atkins put in a claim with Castlepoint, which denied coverage, claiming that plaintiffs were not named in the 2014 policy as “insureds,” Castlepoint did not insure properties owned by trusts, and at the time of the incident, 1038 Eastern Parkway was not plaintiffs’ “residence premises.” As a result, plaintiffs lacked insurance coverage.

In 2017, M&R entered into a Business Transition Installment Purchase Agreement with defendant Ovation Risk Planners, Inc. (“Ovation”). In the agreement, Ovation agreed to purchase M&R’s book of business, thereby taking over M&R’s clients. The agreement obligated M&R to transfer all of its records related to customers over to Ovation. Pursuant to the agreement, Ovation has the “exclusive right to solicit and offer customers insurance products.”

Plaintiffs commenced the action against M&R and Ovation in connection with the alleged mistakes made by M&R in failing to make the necessary changes to plaintiffs’ insurance policy. Plaintiffs alleged that Ovation should be held responsible for M&R’s negligence through the theory of successor liability.

Ovation moved to dismiss the complaint, claiming that it could not be liable for any negligence committed by M&R because Ovation is a corporation unrelated to M&R. According to Ovation, the only dealing between the two companies was the 2017 transaction in which Ovation bought a client list from M&R.

The Court’s Decision

The Court denied the motion to dismiss. The Court held that there were issues of fact as to whether the de facto merger doctrine applied. The Court found that by the transaction “Ovation purchased almost all of M&R’s assets including those necessary for the uninterrupted continuation of M&R’s business.” Slip Op. at *4.  The Court observed that the Business Transition Installment Purchase Agreement confirmed “that Ovation purchased the entirety of M&R’s client list” as well as “the good will of the business as a going concern, which included but [was] not limited to any and all transferable rights to all intellectual property ….” Id. According to the agreement, M&R’s intellectual property included “M&R’s phone numbers, email addresses, and website.” Id. As further evidence of a de facto merger, noted the Court, “the agreement explicitly state[d] this was done ‘In an effort to maximize retention of renewing policies and maintain continuity for existing client base.’” Id. at **4-5. The Court further observed that Ovation’s homepage advised visitors that Ovation was formerly known as M&R Insurance. Id. at *5. “Thus,” the Court concluded, “the evidence suggests that Ovation could have been set up to be a continuation of M&R, which can constitute a de facto merger.” Such evidence, the Court held, was “enough to defeat the motion to dismiss.” Id.

In denying the motion, the Court rejected Ovation’s evidence that there was no de facto merger. That evidence – an email sent by plaintiffs to Mary Montemarano, one of the individuals who signed the Transition Agreement between Ovation and M&R, and whose email signature said “M&R Insurance Agency” after execution of the agreement – was “not enough to grant the motion to dismiss.” Id.

In light of the reasoning used to deny the motion to dismiss, the Court granted the cross-motion to amend.

Takeaway

Practitioners are taught that they should not elevate form over substance. Atkins is an example of this teaching. As discussed above, the Atkins Court looked at the various “hallmarks” of a de facto merger and concluded that many of them were present. Thus, rather than rely on the form, the Court looked to the substance of the deal to conclude that the transaction was “set up” for Ovation “to be a continuation of M&R.” Although the Court denied the motion to dismiss, its analysis of the evidence shows the importance of examining the substance of transactions. After all, the point of the de facto merger doctrine is to elevate substance over form.

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