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Startups – Don’t Make this Mistake!

Happy Friday!

A few months back I wrote a post titled Business Startups: Don’t make these mistakes.

I discussed a recent case that highlighted mistakes that business startups can make – including, shutting down a business, then starting a new one just to avoid debts/creditors.

Generally speaking, that doesn’t work!

A May 3rd Cour of appeals decision reiterates this point – and it provides a good explanation of the legal doctrine that holds a successor business entity “liable” for the debts of its predecessor company – we call this legal doctrine the “mere continuation” doctrine.

You can check out the case of Commonwealth Land Title Insurance Co v Metro Title Corp and Metro Equity Services

I. Facts

  • plaintiff filed a lawsuit against Metro Title and Metro Equity Services, asserting that
  • (1) Metro Title formed Metro Equity for the purpose of fraudulently transferring their assets to avoid collection on the  May 2012 default judgment, and
  • (2) Metro Equity was liable for the judgment as a mere continuation of Metro Title under a successor-liability theory.
  • Metro Equity acknowledged that its owner was the owner of Metro Title and Metro Equity, it argued that Metro Equity was not a mere continuation of Metro Title because Metro Equity did not engage in the same business or customer base as Metro Title and Metro Equity did not purchase any of Metro Title’s stock or liabilities.
  • The Trial Court held that Metro was a mere continuation and found it liable. The Court of Appeals affirmed.

II. “MERE CONTINUATION”

The Court stated the law:

“Michigan follows the traditional rule of successor liability. Foster [v Cone-Blanchard Machine Co], 460 Mich [696] at 702[; 597 NW2d 506 (1999)]. Under that rule, the nature of the transaction determines the potential liability of predecessor and successor corporations. Id. “If the acquisition is accomplished by merger, with shares of stock serving as consideration, the successor generally assumes all its predecessor’s liabilities. However, where the purchase is accomplished by an exchange of cash for assets, the successor is not liable for its predecessor’s liabilities unless one of five narrow exceptions applies.” Id. The five exceptions are: (1) an express or implied assumption of liability; (2) de facto -3- consolidation or merger; (3) fraud; (4) transfer lacking in good faith or consideration; or (5) where the transferee corporation was a mere continuation or reincarnation of the old corporation. Id. at 702.”

The Court held that the mere continuation doctrine was applicable in commercial transactions such as this one – and affirmed the trial court’s ruling finding successor liability.

Lesson:

Start up businesses – take advantage of your limited liability protection, but do not think you can avoid your debts simply by starting up a new business entity that is a mere continuation of one you dissolved.

e-mail: Jeshua@dwlawpc.com

www.dwlawpc.com

twitter: @JeshuaTLauka

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