Case Law Update: Successor Liability for a Law Firm

Posted Wednesday, July 26, 2017 by Christopher L. Thayer

The Washington State Court of Appeals (Division I) recently found the owner of a law firm operating as a sole proprietorship liable for debts incurred by his predecessor Limited Liability Company in Columbia Bank v. Invicta Law Group and Mark Jordan, (No. 73915-8-I)(2017).

In 1999, Jordan formed Invicta Law Group, PLLC (“PLLC”) and was the sole member and manager. In February 2012, the PLLC borrowed $165,000 from Columbia Bank. The PLLC executed several loan documents including a commercial promissory note (note), loan agreement, and security agreement. Jordan signed all three loan documents as manager of the PLLC. Jordan also signed the loan agreement individually as guarantor.

On September 30, 2013, Jordan (personally) filed for voluntary Chapter 7 bankruptcy. On January 2, 2014, the bankruptcy court discharged Jordan's personal guaranty on the loan agreement. On the same day he filed for bankruptcy, Jordan also ceased operating as the PLLC. The PLLC did not file for bankruptcy. When Jordan filed for personal bankruptcy, the PLLC also stopped making payments on the loan to Columbia Bank.

The day after filing bankruptcy, Jordan began operating a law practice as a sole proprietorship under the name Mark V. Jordan. Jordan owned, operated and controlled the sole proprietorship.

Jordan continued his individual law practice, using the same name, website, signage, telephone number, offices, insurance, employees, equipment, and representing the same clients. Jordan continued to use the full name Invicta Law Group, PLLC in new client engagement letters for nearly 6 months. Jordan also continued under the same contracts as the PLLC including office lease agreement, subtenant agreements, existing client agreements (did not have clients sign new agreements), and malpractice insurance. Jordan continued representing the same clients the PLLC had represented at the time the PLLC ceased operation. No clients left the PLLC due to its change in legal structure. Indeed, Jordan did not tell the clients until months later.

Columbia Bank sued Jordan on a claim of successor liability. The trial court awarded judgment against Jordan in favor of Columbia Bank, which, including attorney’s fees and costs, exceeded $400,000. Jordan appealed. The Court of Appeals noted:

Washington follows the general rule that "a corporation purchasing the assets of another corporation does not become liable for the debts and liabilities of the selling corporation." Cambridge Townhomes. LLC v. Pacific Star Roofing, Inc., 166 Wn.2d 475, 481-82, 209 P.3d 863 (2009). The rationale for this rule is a "bona fide purchaser who gives adequate consideration and who lacks notice of prior claims against the property acquires no liability for those claims." Hall v. Armstrong Cork. Inc., 103 Wn.2d 258, 262, 692 P.2d 787 (1984)). There are, however, exceptions to this general rule. A successor may be held liable for the debts of a predecessor, where:

(1) there is an express or implied agreement for the purchaser to assume liability; "(2) the purchase is a de facto merger or consolidation; (3) the purchaser is a mere continuation of the seller; or (4) the transfer of assets is for the fraudulent purpose of escaping liability.

Cambridge, 166 Wn.2d at 482 (quoting Hall, 103 Wn.2d at 262).

The trial court found Jordan liable under the "mere continuation" exception to the general rule. Washington courts rely on several factors to determine whether a successor business is a mere continuation of a seller. These include: (1) a common identity between the officers, directors, and stockholders of the selling and purchasing companies, and (2) the sufficiency of the consideration running to the seller corporation in light of the assets being sold.

The objective of the court when considering these factors is to determine whether the "purchaser represents merely a new hat for the seller." Cambridge, 166 Wn.2d at 482. The particular form of the business entity is not determinative. Therefore, for the first factor, where a sole proprietorship is involved, while there can be no continuation of officers, directors, or shareholders, the court will consider "the continuity of individuals in control of the business as satisfying this factor." Cambridge, 166 Wn.2d at 482-83.

The Court further reasoned:

[T]he evidence of the "mere continuation" between the PLLC and Jordan's sole proprietorship goes beyond that identified as sufficient in Cambridge. Here, the sole proprietorship: (1) operated at the same location as the PLLC, it had the same offices, space, signage, telephone number, and address, (2) operated under the same lease as the PLLC, and between September 30, 2013, and February 2015 continued to hold itself out to the landlord as the PLLC, (3) used the same office equipment, furniture, and inventory, (4) used the same contact information as the PLLC including the same phone number, e-mail address, fax number, letterhead, and website, (5) used the same employees, (6) held itself out to its current and new subtenants as the PLLC including entering a new sublease agreement on October 31, 2013, under the name of the PLLC, and … held itself out to its malpractice insurance carrier as the PLLC for over a year….

The Court likely felt compelled to find Jordan personally liable under a theory of successor liability based upon the unique facts of this case. Most significantly, Jordan’s sole proprietorship did not pay anything for the “assets” it acquired from the PLLC. If Jordan had paid any reasonable sum for the assets acquired (known as “consideration” in this context), we believe it is likely a court would have had a hard time finding him liable under a theory of successor liability – even under these fairly egregious facts. If you have questions about successor liability (and how to avoid it or prove it), please feel free to contact Chris Thayer at 206-805-1494 or at CThayer@PivotalLawGroup.com.

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