When a company or entrepreneur buys the producing assets of another firm, they may be taking on liabilities they never figured on.
Increasingly, courts are saying that the new owners may have to respond to damage claims filed by persons hurt by products turned out by the company that sold off its assets. Not long ago, such an obligation would have been unthinkable. The way the courts have changed the law illustrates how judges shape and amend precepts as society's idea of justice changes.
A corporation is a legal entity. When a new owner takes control of its stock, the corporation continues to exist, with the same legal obligations it had before the stock sale. The sale of assets is merely considered a property transaction. But that works better in theory than in practice, for if the corporation sells virtually all its assets and then distributes the proceeds from the sale, nothing much remains but an empty shell. And empty shells are not choice defendants in damage suits.
So, the courts began to build in exceptions to the rule that a sale of assets did not include the transfer of liability from the selling corporation. Liability transferred with the stock sale if the sales contract said it did. But other traditional exceptions were essentially designed to avoid fraud and to combat deals that were mere "paper transactions," with the "new" owner being nothing more than a continuation of the old owner. Those exceptions were designed to protect minority stockholders and the companies owed money by the "old" owners.
Only in the past decade have courts begun to worry about the plight of someone with a product liability claim against a company that sold off its assets. The first case to do something for such a plaintiff involved an unusual situation. The company in question -- a manufacturer of drying ovens used by commercial printers -- was owned entirely by one man. When he died, his estate sold the firm's assets to a group of its employes, who continued to use an almost identical name (adding only Inc.) and turn out the same product line at the same plant, using the same laborers and supervisors. In that case, the U.S. Court of Appeals in Boston ruled in 1974 that a jury cannot find that the new ownership is a "mere continuation" of the old. The ruling approved an award of damages to two employes of a printing company who were injured by a drying system made by the manufacturer under its original owner. Because the transaction by the deceased owner's estate had been a real one, and the new ownership group did not include anyone with a financial stake in the operation before the asset sale, that ruling represented a considerable expansion of the old exception.
The ruling was based on the appellate judges' reading of a New Hampshire law. Since then, Michigan, Alabama, and Wisconsin have adopted the same approach, applying it to situations where the after-sale operation was not quite as close to the predecessor as it had been in the drying-ovens situation. The Michigan Supreme Court, for instance, considered only whether the before and after operations had the same key ownership personnel, not whether the assembly line labor force remained intact.
But in 1977, the California Supreme Court decided that rather than trying to widen the old exceptions, it makes more sense simply to create a new one expressly for product liability suits against successor companies.
The California justices ruled that when a sale involves basically all of the assets of the selling company, and when the buyer trades on the goodwill of the selling company by continuing to turn out similar products and sell them under a similar name, then the new owner also is liable for defects in merchandise sold by the previous management. New Jersey and Pennsylvania later adopted the California approach. Two months ago, the Washington State Supreme Court decided to go along with the trend, too. "This narrowly drawn rule strikes a fair balance among the competing considerations of products liability and corporate acquisitions," Justice Fred H. Dore explained.
Cutting through the rhetoric, the judges fashioned the new law because the old rule seemed unfair. Without sticking the buyer of the assets with the liability, there would be no entity to pay damages the accident victim deserved, they reasoned. And they took as a given a public policy decision that the burden of injuries caused by defective products should not be borne by the accident victim, but by society as a whole, through higher prices charged to offset the extra liability.
But the judges built some business reasoning into the decisions, too. The new owner is trading on the goodwill of the predecessor, they noted, and that goodwill goes hand-in-glove with compensating those who suffered from a product defect. And they reasoned, as the Boston judges put it, that "the successor knows the product, is as able to calculate the risk of defects as the predecessor, is in position to insure therefore and reflect such cost in sale negotiations, and is the only entity capable of improving the quality of the product."
The changes wrought in the sale-of-assets rules, without any action by the state legislatures, are not unique. The courts in the U.S. have the power they do precisely because they are responsive to changing social attitudes. But they serve to remind business executives that they manage in an era of change, and yesterday's precepts may not apply today.