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Commercial Division Allows Successor Liability Claims to Proceed on “Mere Continuation” Theory

A corporation that acquires the assets of another is generally not liable for the pre-existing liabilities of the acquired corporation.  However, as the Commercial Division’s recent decision in 47 East 34th Street (NY), L.P. v. BridgeStreet Worldwide, Inc.[i] demonstrates, there is an exception to this rule when the successor is deemed to be a mere continuation of the acquired corporation.  In 47 East 34th Street, Justice Andrew Borrok relied on the mere continuation doctrine to deny a motion to dismiss claims asserted against a successor guarantor to a lease that had acquired the assets of the original guarantor through a consensual foreclosure.

Background

The dispute in 47 East 34th Street arose from a tenant’s unauthorized use of residential units for short-term corporate housing.  BridgeStreet leased 110 residential apartment units from Plaintiff 47 East 34th Street (NY), LP (“47 East”) in 2012 (the “Lease”).  Since 2009, the building had been receiving tax abatements under Section 421-a of the New York Real Property Tax Law, and continued to do so during the term of the Lease.[ii]  One condition of those tax abatements was that the units in the building could not be rented for periods of less than six months.[iii]  Accordingly, the Lease required BridgeStreet to impose a minimum term of six months on any leases for units in the building.

BridgeStreet’s obligations under the lease were guaranteed by its parent company, Defendant BridgeStreet Worldwide (“Worldwide”).  The Guaranty provided that the guarantor’s obligation would not be modified by, among other things, modification or amendment of the Lease, the transfer of any or all membership interest in BridgeStreet, or by the assumption of the Lease by any other person.[iv]

In 2013, Defendant Domus BWW Funding, LLC (“Domus”), a subsidiary of Defendant Versa Capital Management, LLC (“Versa”), purchased debt that Worldwide owed to Credit Suisse.[v]  The debt went into default.  After a forbearance agreement failed to result in resolution of the default, Domus began a consensual foreclosure of Worldwide in late 2013.  Through the foreclosure process, Worldwide transferred all of its domestic and foreign assets to Domus on March 3, 2014.[vi]  The following day, Domus dissolved Worldwide as an entity under Delaware law.[vii]

Later in 2014, the New York State Office of the Attorney General (“AG”) began an investigation into the building’s Section 421-a tax abatement, based on allegations that BridgeStreet was operating a “hotel” due to its practice of leasing units for terms of less than six months.[viii]  As a result of the ultimate findings of the AG’s investigation, 47 East agreed to repay all of the taxes that had been abated under the 421-a program, resulting in payments of nearly $4.5 million to the City of New York.[ix]

After agreeing to repay these taxes, 47 East sought indemnification and reimbursement from Versa, Domus, and certain individuals for BridgeStreet’s violation of the Lease.  In July 2019, the Court granted 47 East’s motion for summary judgment regarding liability for all damages stemming from the breach of the Lease.[x]  The decision of that motion left open the question whether Domus and Versa (collectively, the “Versa Parties”) were liable for the judgment under theories of successor liability, fraudulent conveyance, and alter ego.  The Versa Parties filed a motion to dismiss the claims against them, and 47 East sought summary judgment on the issues of successor liability.  These competing motions related to the Versa Parties’ liability were the subject of Justice Borrok’s recent decision.[xi]

Successor Liability

47 East put forward two theories of successor liability under which it argued that the Versa Parties were liable for the breach of the Lease: de facto merger and mere continuation.  The Commercial Division rejected the de facto merger theory, but allowed the mere continuation theory to proceed.

Turning first to 47 East’s argument that Domus’s foreclosure of Worldwide resulted in a de facto merger, Justice Borrok looked to the First Department’s decision in Tap Holdings, LLC v. Orix Financial Corp.[xii] According to Tap Holdings, “the question whether a de facto merger exists is analyzed in a flexible manner that disregards mere questions of form and asks whether, in substance, it was the intent of the successor to absorb and continue the operation of the predecessor.”[xiii]  However, Justice Borrok noted that in Tap Holdings, the predecessor owners had acquired equity in the successor company.  More broadly, the court observed that the de facto merger doctrine requires continuity of ownership, which “requires a showing that the shareholders of the predecessor corporation became direct or indirect shareholders of the successor corporation.”[xiv]  That did not occur during the foreclosure of Worldwide.  Although Domus acquired voting and ownership rights, this did not show continuity of ownership “in the absence of proof that shareholders of the predecessor corporation became shareholders of the successor corporation.”[xv]  Given the absence of evidence of continuity of ownership, the Commercial Division granted the Versa Parties’ motion to dismiss with respect to liability based on the de facto merger theory.

Justice Borrok then examined 47 East’s mere continuation theory of liability.  Under a mere continuation theory, the Court said, “a plaintiff must establish that the acquiring corporation has obtained the business location, employees, management, and good will of the acquired corporation.”[xvi] Regarding the intent behind the transfer of assets, the Court noted that Worldwide had sent a letter to customers informing them that BridgeStreet’s assets would be transferred to Domus “which plans to continue BridgeStreet’s operations following this transaction,” and further that “we look forward to continuing to provide our services to you in the future under the new ownership.”[xvii]  Justice Borrok further noted conflicting evidence regarding the location of the businesses and the degree of continuity in management.[xviii]  Given the evidence of Worldwide’s and Domus’s intent to continue operations after the foreclosure, the Court denied the Versa Parties’ motion to dismiss, but faced with factual disputes regarding the location and continuity between the companies, the Court concluded that summary judgment was precluded at this stage.[xix]

Fraudulent Conveyance

In addition to the successor liability theories, 47 East alleged that the Versa Parties “acquired [Worldwide’s] assets for less than fair consideration through a rigged consensual foreclosure” in violation of New York Debtor and Creditor Law §§ 273 and 276.[xx]  47 East also claimed that the transaction left Worldwide insolvent and unable to cover its obligations, including those owed to 47 East under the Guaranty.

Section 273 provides that a transaction that renders a party insolvent and is incurred without fair consideration is fraudulent as to the insolvent party’s creditors, without regard to the debtor’s actual intent.[xxi]  Section 276 provides that a transaction is fraudulent if it is made with the actual intent to hinder, delay, or defraud present or future creditors.[xxii]

Justice Borrok determined that 47 East’s allegations were sufficient to state a cause of action under section 273, but not section 276, because the alleged facts could support a finding that Domus acquired Worldwide’s assets for less than fair consideration, but could not establish fraudulent intent behind the transactions.[xxiii]

Alter Ego

As a final basis for imposing liability on the Versa Parties, 47 East asserted alter ego liability based on the Versa Parties’ alleged domination and control of Worldwide and BridgeStreet.[xxiv] The Court noted that “complete domination and control” is a necessary, but not sufficient condition for piercing a corporate veil.  Beyond mere domination and control, “[t]he party seeking to pierce the corporate veil must establish that the owners, through their domination, abused the privilege of doing business in the corporate form to perpetrate a wrong or injustice against that party.”[xxv]  Justice Borrok pointed to 47 East’s allegations that the Versa Parties used their domination of Worldwide to render Worldwide unable to satisfy its obligations to 47 East under the Guaranty.  These allegations were sufficient to state a claim for alter ego liability.[xxvi]

Conclusion

The Commercial Division’s ruling in 47 East 34th Street provides a reminder that, although a corporation that acquires the assets of another is generally not liable for the pre-existing liability of the acquired corporation, courts will make exceptions to this rule in cases where the successor corporation is not a truly distinct entity or did not acquire the assets for fair value.   

 

[i] 47 E. 34th St. (NY), LP v. BridgeStreet Worldwide, Inc., No. 653057/2016, 2019 BL 433881 (Sup. Ct. N.Y. County Nov. 6, 2019).

[ii] Id. at *3-4.

[iii] Id. at *4 (citing 28 R.C.N.Y. § 6-01(c)).

[iv] Id. at *2-3.

[v] Id. at *3.

[vi] Id.

[vii] Id.

[viii] Id. at *4.

[ix] Id.

[x] Id.

[xi] 47 East also brought claims for tortious interference, fraudulent concealment, and fraudulent and/or negligent misrepresentation, which were dismissed.  See id. at *11-13.

[xii] Id. at *8 (citing Tap Holdings, LLC v. Orix Fin. Grp., 109 A.D.3d 167, 970 N.Y.S.2d 178 (1st Dep’t 2013)).

[xiii] Id. at *9 (citing Tap Holdings, 109 A.D.3d at 176).

[xiv] Id.

[xv] Id.

[xvi] Id.

[xvii] Id. at *10.

[xviii] Id.

[xix] Id.

[xx] Id. at *11.

[xxi] Id. at *11 (quoting N.Y. Debt. & Cred. Law § 273).

[xxii] Id. (quoting N.Y. Debt. & Cred. Law § 276).

[xxiii] Id.

[xxiv] Id. at *13-14.

[xxv] Id. at *13.

[xxvi] Id. at *14.