Making New Law, the EDVA Bankruptcy Court Allows a Debtor Corporation to Sue its Own Successor

The Bankruptcy Court of the Eastern District of Virginia recently extended the reach of trustees standing in the shoes of debtor corporations to pursue assets that were transferred to successor entities prior to a bankruptcy petition. Judge Keith L. Phillips of the Richmond Division did not let the lack of prior precedent stand in his way, stating, “Although there appears to be no Virginia case specifically stating that a corporate entity may pursue a successor liability claim against its alleged successor in interest, there is also no case that prohibits such an application of successor liability theory.” This new precedent will be useful to creditors and trustees that seek to recover assets that have been transferred to new, successor entities, leaving behind only liabilities with the previous entity.

In In re: Anderson & Strudwick, Inc., Adv. Proc. No. 14-03175-KLP (E.D. Bkr. Apr. 8, 2015), the bankruptcy trustee, standing in the shoes of the Chapter 7 debtor corporation, asserted a claim for successor liability against Counterclaim Defendants Sterns Agee Group, Inc. and Sterne, Agee & Leach, Inc. (together, “Sterne Agee”). A successor liability claim seeks to tag a new entity with the liability of a previous entity, and it is an exception to the general rule of limited corporate liability. As a practical matter, these fact-intensive claims often appear alongside fraudulent conveyance claims and are frequently invoked by creditors attempting to collect on prior judgments or obligations against entities that have sold their assets in bulk.

According to the trustee’s counterclaim, Stern Agee purchased most, if not all, of the assets from the debtor three years prior to the debtor being put into involuntary bankruptcy. In addition to the asset purchase, Sterne Agee allegedly hired most of the debtor’s employees, including all but one of the debtor’s former directors. All of the debtor’s branch office managers allegedly moved over to similar positions at Sterne Agee. The debtor’s previous president and CEO allegedly became a senior managing director at Sterne Agee, and the majority of the debtor’s sales force also allegedly moved to Sterne Agee. Finally, the trustee alleged that Sterne Agee published a press release stating that it would continue service of the debtor’s customers, and the customers would see no change from their previous experience with the debtor.

Stern Agee’s purchase agreement with the debtor, however, excluded all liabilities of the debtor that were not necessary for the continued operation of the debtor’s business, according to the Counterclaim. This left the debtor with no remaining assets with which to operate its business or pay its remaining liabilities, and this led to the Trustee’s claim for successor liability against Sterne Agee.

Sterne Agee moved to dismiss the trustee’s claim on the grounds that Virginia law did not authorize a claim by a corporation against its own successor entity (normally, successor liability claims are brought by the third-party creditors of the defunct entity). Judge Phillips, after citing the alleged connections described above between the debtor and Sterne Agee, held that these allegations sufficiently stated a claim for successor liability. He then examined whether the debtor could bring such a claim against its own successor entity and concluded that no prior Virginia case law prevented the trustee’s claim. The judge relied upon prior Fourth Circuit precedent in Steyr-Daimler-Puch of Am. Corp. v. Pappas, 852 F.2d 132, 135-36 (4th Cir. 1988) which held that if state law authorizes an alter ego claim by a corporation, then that claim passes into the bankruptcy estate and to the trustee after a petition is filed. Judge Phillips analogized an alter ego claim to a successor liability claim, and finally concluded that the successor liability claim was not specific to any one creditor and any recovery would only benefit the bankruptcy estate (and all creditors). Thus, Judge Phillips allowed the odd situation of a debtor entity asserting a successor liability claim against its own successor.

There will be no appellate review of Judge Phillips’s decision because the parties ultimately settled their claims prior to trial. Thus, the judge’s decision will stand, and it provides a useful tool for creditors and trustee counsel looking to assert successor liability claims involving Virginia state law.