Understanding Corporation Asset Transfer and Assumption of Debt in California

Corporation Asset Transfer and The Assumption of Debt

A potential problem in the sale or transfer of substantially all of a corporation’s assets is whether the purchaser has assumed the corporation’s liabilities.  When transferring corporate assets you need to be aware that you may in fact assume the liabilities of the selling corporation depending on the way such assets are transferred.  

In California, the general rule is that when a corporation sells or transfers its principal assets to a successor corporation, the successor corporation is not liable for the former corporation’s debts and liabilities.  However, there are exceptions to this rule.  Liability will transfer to a successor corporation under the following circumstances:

Circumstances for Liability Transfer to a Successor Corporation

1. Express or Implied Transfer to a Successor Corporation
   The successor corporation expressly or impliedly agrees to assume the liability of the former corporation. A successor corporation agrees to assume the liability of the former corporation upon the transfer of asset by way of agreement.  The assumption of liability should be clearly set forth in the asset purchase agreement.
2. Consolidation or Merger with a New Corporation
   The transfer between a former corporation and a new corporation in a consolidation or merger.  Where a corporation merges with another corporation the surviving corporation will be subject to all of the rights and assets of the disappearing corporation and is subject to all of its debts and liabilities in the same manner as if the surviving corporation had itself incurred them.
3. Continuation of the Former Corporation
   The new corporation is a continuation of the former corporation.  Where a new corporation acquires the former corporation’s assets for inadequate consideration, has practically the same shareholders and management as the former corporation, and carries on the same business (even under a new name), the new corporation may be regarded as a mere continuation of the former corporation.  In such circumstances, the new corporation is essentially the same entity as the former corporation and may be held liable for the former corporation’s obligations.  
4. Asset Transfer to Avoid Debt or Liability
   The asset transfer from the former corporation to the successor corporation was made for the purpose of avoiding a debt or other liability.  Where a former corporation fraudulently transfers its assets to a successor corporation for little to no consideration and the purpose of the transfer is to avoid certain debts or liabilities.

Exceptions: Liability Non-Transfer in Corporation Asset Transfer

On the other hand, liability does not transfer from a former corporation to a successor corporation under the following circumstances.

1. Good Faith Consideration by a Bona Fide Purchaser  
   Where a transfer of assets is made in good faith by a former corporation to a new corporation and for sufficient consideration, and the former corporation is left with sufficient assets with which to pay the debts of the former corporation, the new corporation will not be liable for the obligations of the former corporation and the creditors of the former corporation cannot collect its debts from the new corporation.  However, if there are recorded or perfected liens against the assets, the new corporation will take the assets subject to whatever debts or claims are secured thereby.

In conclusion, if you are planning on acquiring the assets of another corporation, it is recommended that you have an attorney assist you through the process to avoid any potential unwanted liability.