In a recent decision underscoring the significance of choice of law in determining successor liability, a California federal district court dismissed a purported class action against Bank of America (“BofA”), holding that, under Delaware law, by acquiring substantially all of Countrywide’s assets, BofA did not assume Countrywide’s liabilities. See Maine State Retirement System v. Countrywide Financial Corp., No. 10-CV-0302, 2011 WL 1765509 (C.D. Cal. Apr. 20, 2011). In contrast, in April 2010, a New York trial court applying New York law had come to a different result in MBIA Insurance Corp. v. Countrywide Home Loans, No. 602825/08 (N.Y. Co. Apr. 27, 2010), finding that a de facto factor merger had occurred.  


In January 2010, the plaintiffs filed in California federal court a putative class action on behalf of all holders of certain mortgage-backed securities issued in 427 public offerings between January 2005 and November 2007. Named plaintiffs included several employee benefit and pension organizations, with the Iowa Public Employees’ Retirement System appointed as lead plaintiff. The complaint alleged that Countrywide Financial Corporation (“CFC”), Countrywide Securities Corporation, Countrywide Home Loans (“CHL”), and Countrywide Capital Markets (collectively, “Countrywide”) made materially false or misleading statements or omissions regarding loan origination practices in their public offering documents. Plaintiffs also named BofA and NB Holdings Corporation (“NB Holdings”) as defendants, contending that they were liable for Countrywide’s actions under a theory of de facto merger. Under the de facto merger doctrine, a widely recognized exception to the rule of successor non-liability, a purchaser is liable for all of a seller’s debts by operation of law, just as in a merger. In December 2010, plaintiffs amended their complaint to avoid standing and statute of limitations issues by reducing the offerings at issue from 427 to 14 that were made between October 2005 and December 2006.

Between 2005 and 2007, Countrywide — primarily through its subsidiary CHL — allegedly originated or purchased a total of approximately $1.4 trillion in mortgage loans. In July 2008, CFC merged into a wholly owned BofA subsidiary, Red Oak Merger Corporation (“Red Oak”), in a stock-for-stock merger that was approved as fair by the Delaware Supreme Court. Red Oak was renamed CFC and remained a subsidiary of BofA. In November 2008, “substantially all” of Countrywide’s assets, along with “certain of Countrywide’s debt securities and related guarantees,” were allegedly transferred to BofA. Plaintiffs argued that the November 2008 asset transfer, in conjunction with the July 2008 subsidiary merger, constituted a de facto merger — an exception to the general rule of successor liability that when one company sells or transfers all of its assets to another, the second entity does not become liable for the debts and liabilities of the transferor — and thus BofA was on the hook for Countrywide’s liabilities.  

The plaintiffs further alleged that NB Holdings, a wholly owned subsidiary of BofA, was one of the shell entities used to effectuate the BofA-CFC merger. In July 2008, CHL completed the sale of substantially all of its assets to NB Holdings and the plaintiffs contend that NB Holdings is thus a successor in interest as well.  

In support of the de facto merger argument, the amended complaint asserted that the Countrywide brand was retired shortly after the merger, that the CFC’s former website now redirects the user to the BofA website, and that “many of the same locations, employees, assets and business operations” continue now under the BofA brand. The plaintiffs noted that CFC ceased filing its own financial statements at the time of the asset transfer and that its assets and liabilities are now included in BofA’s financial statements. They also alleged that BofA had assumed CFC’s liabilities, having paid to resolve other litigation arising from misconduct such as predatory lending allegedly committed by CFC.

The Court’s Decision

The court first addressed the choice of law issue, analyzing whether the law of Delaware, CFC’s state of incorporation, or the law of California, the forum state and CFC headquarters prior to the merger, applied. Under the Erie doctrine and Ninth Circuit law, the court explained, the choice of law rules of the forum state determine which state law applies. The court thus applied California’s “governmental interest” test, determining first whether a true conflict exists and then analyzing the two jurisdictions’ competing interest in having its law applied.

The court found that a conflict exists between Delaware and California law on the issue of successor liability. Although both recognize de facto merger, Delaware courts apply the doctrine far more narrowly, requiring intent to defraud. The court explained that “[b]ecause Delaware respects a corporation’s ability to structure transactions to its advantage, so long as the statutes governing such transactions are fully complied with, Delaware is reluctant to find an asset sale is a de facto merger in the absence of fraud.” In fact, the court noted, some treatises go so far as to conclude that Delaware has rejected the de facto merger doctrine. In contrast, California is more willing to find de facto merger “if the court concludes — notwithstanding the structure of the transaction — that an asset sale produces the same result as a merger.” As long as the other indicia of a merger are present, California does not require an allegation of fraud or intent to harm to find that successor liability exists.

Next, the court concluded that Delaware had a greater interest in having its law applied. According to Section 302 of the Restatement (Second) of Conflict of Laws, issues involving the rights and liabilities of a corporation — such as mergers, reorganizations, and matters that may affect the interests of the corporation’s creditors — are determined by the law of the state of incorporation.

The court turned to analyzing whether the amended complaint adequately pled that a de facto merger occurred. Delaware courts consider the following factors when determining whether a de facto merger has been adequately alleged: (1) whether adequate consideration was received and held by the transferor corporation in exchange for the assets that were transferred; (2) whether the asset transfer complied with the statute governing such an asset sale; (3) whether creditors or stockholders were injured by a failure to comply with the statute governing an asset sale; and (4) whether the sale was designed to disadvantage shareholders or creditors.

The court found that the complaint failed adequately to allege any of these factors and, thus, failed to demonstrate a de facto merger under Delaware law. Specifically, the complaint failed to allege that the asset sale failed to comply with any relevant statute governing such sale; indeed, the July 2008 subsidiary merger between Red Oak and CFC had already been reviewed by the Delaware courts and found to be fair. Further, Delaware law allows parties to choose whatever reorganization structure they wish — whether asset sale or merger — as long as they follow the statutory guidelines, as BofA did here. The court noted that contemporaneous public Securities and Exchange Commission (SEC) filings demonstrate that BofA acquired CFC’s assets in exchange for valuable consideration totaling billions of dollars; it explained that CFC has retained that consideration and that CFC’s creditors can look to BofA to satisfy those obligations that the bank has expressly assumed. In addition, the complaint failed to allege that the November 2008 asset sale was designed to disadvantage stockholders or creditors.

In dismissing BofA and NB Holdings from the lawsuit, the court wrote that “[p]laintiffs’ attempt to characterize two separate, legal transactions as one combined fraudulent transaction must fail under Delaware law. Delaware respects the independent legal significance of transactions, even when under common ownership and control, as long as they comply with statutory authority.”

The New York Decision

In the earlier New York action MBIA Insurance Corp. v. Countrywide Home Loans, No. 602825/08 (N.Y. Co. April 27, 2010) , MBIA — which had provided credit enhancement for 17 second-lien mortgage securitizations originated by Countrywide — brought suit against Countrywide for its purported misrepresentations in connection therewith. MBIA also bought claims against BofA on a successor liability theory. The court applied New York law and held that the complaint sufficiently alleged that BofA was vicariously liable for Countrywide’s actions under New York’s de facto merger doctrine. Unlike Delaware, New York does not require an allegation of fraud to find a de facto merger; instead, the doctrine applies when an acquiring coproration has effectively merged with the acquired corporation.

New York courts analyze four main factors to determine whether a de facto merger has occurred: continuity of ownership; cessation of ordinary business and dissolution of the acquired corporation as soon as possible; assumption by the successor of liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation; and continuity of management, personnel, physical location, assets, and general business operation. These factors are analyzed in a manner that “disregards mere questions of form and asks whether, in substance, it was the intent of the succesor to absorb and continue the operation of the predecessor.” In MBIA Insurance Corp., the court held that MBIA sufficiently alleged each of these four factors under New York law; accordingly, BofA could not be dismissed from the lawsuit on a theory of successor non-liability.