Like people, all businesses have baggage. For new or small business owners, constantly carrying corporate debt can be overwhelming. When it becomes too much, owners might consider scrapping their indebted entity and transferring its assets to a new one to avoid paying creditors. Not surprisingly, Iowa courts see through these transfers and will hold the new entity liable for the old entity’s debts if certain conditions exist.
These conditions were discussed in a July 2018 Iowa Court of Appeals case, Tu Ha v. CMP Tactical Lazer Tag, 2018 WL 3471599 (Iowa Ct. App. July 18, 2018). The question in that case was whether AKA Tactical Laser Tag, LLC, and Escape Chambers, LLC, two downtown Des Moines businesses, could be held liable for a workers’ compensation judgment against CMP Tactical Lazer Tag. The employee suffering the injury alleged that AKA and Escape Chambers should be liable too, as AKA, Escape Chambers, and CMP are all really the same entity. This is called the “mere continuation” exception to the principle of successor liability.
The principle of successor liability is straightforward. It states that when a corporation purchases the assets of another corporation, that corporation assumes no liability for the transferring corporation’s debts and liabilities. Exceptions generally arise in four circumstances, when:
- The buying corporation agrees to be held liable;
- The two corporations consolidate or merge;
- The buyer is a “mere continuation” of the seller;
- The transaction amounts to fraud.
The “mere continuation” exception applies when the purchasing corporation has the same owners and management of the selling corporation. The key element is common shareholders, officers, and directors. While the Iowa Court of Appeals did not find common owners and management amongst the entities above, Tu Ha v. CMP Tactical Lazer Tag provides a good refresher on the consequences of a new business being deemed a “mere continuation” of a former business in Iowa.
The takeaway: when a small business owner transfers assets from one entity to another, s/he should consider whether that new entity is really a “mere continuation” of the prior that is obligated to pay the prior’s debts. The business owner need not have a fraudulent intent for the exception to apply. When in doubt, business owners should contact their corporate attorney.
The material in this blog is not intended, nor should it be construed or relied upon, as legal advice. Please consult with an attorney if specific legal information is needed.