In 1997 the Massachusetts Supreme Judicial Court (SJC) adopted the doctrine of “de facto merger” and held a purchaser of assets, but not liabilities, liable for its predecessors’ (seller’s) debts. Cargill, Incorporated v. Beaver Coal & Oil Company, Inc., et al., 424 Mass. 356, 676 N.E.2d 815. In Cargill, the SJC enumerated four factors to be considered in determining whether to characterize an asset sale as a de facto merger. These are:

(1) Continuance of the enterprise of the seller so that there is a continuity of management, personnel, physical location, assets and general business operations;

(2) Continuity of shareholder;

(3) The seller completely ceases its ordinary business operation, liquidates and dissolves as soon as legally and practicably possible;

(4) The purchasing corporation assumes the obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations of the seller corporation.

This decision which recently applied to a purchaser of assets at an Article 9 foreclosure sale. Milliken & Company v. Duro Textiles, LLC, & Others, 451 Mass. 547, 887 N.E.2d 244 (2008). The facts in reasoning of the Court are set out below.

In 1997 a consortion of banks extended a line of secured credit to Old Duro taking a security interest in and mortgage of substantially all of Old Duro’s assets. As part of its business operation, Old Duro purchased materials on credit from Milliken. In December of 2000 Old Duro restructured its bank debt, and at that point, the bank group acquired a 51 percent equity interest in Old Duro.

In December of 2000, Arc I purchased from one member of the bank group a 29 percent interest in the secured debt. In May 2002 Arc II purchased the remaining 71 percent interest in the bank debt and also acquired the 51 percent stock interest from the bank group. At this time, Milliken was owed approximately $8.5 million [Arc I and Arc II were controlled by the same people.] In August 2002 Old Duro filed a Chapter 11 petition which was dismissed in September. In late September Arc I and Arc II formed New Duro, a Delaware LLC with capital of $2,000. On October 18, 2002, the personal property assets of Old Duro were sold at an Article 9 foreclosure sale to New Duro for $26.2 million which was loaned to New Duro by Arc and Arc I, and they received a security interest in all of New Duro’s assets. Old Duro changed its name to Chace Street, Inc. and leased all of its real property to New Duro. Milliken had obtained a judgment against Old Duro and then commenced an action against New Duro on the judgment.

The Court noted New Duro continued the same business, had retained Old Duro’s collective bargaining agreement and certain of the old customer contracts, assumed some of the old equipment leases and paid off some unsecured debt. New Duro retained the old telephone number and the president and chief executive officer of New Duro held those offices under Old Duro.

The Court stated simply that the secured creditors had a right to foreclose on the assets of Old Duro and if those assets had been sold to a third party, the unsecured creditors of Old Duro would have had to look to whatever assets remained at Old Duro. However, in this case, what occurred was not a sale of its assets to a third party but rather a sale of assets to a “reconstituted version of itself” in an effort to maintain its business as a going concern while “shedding its debt obligations to unsecured creditors.” In the view of the Court, all that had occurred in this instance was a mere change of form without a significant change of substance which, unless successor liability was imposed, would result in a single corporation shedding its debt to unsecured creditors and continuing its business operations with the hope of returning to profitability. In the view of the Court, the application of the principle of successor liability “is designed to remedy this fundamental inequity as factual circumstances, such as those represented here, dictate.”

This case poses another problem for the foreclosing secured creditor who seeks to maximize recovery by selling the assets as a “going concern” rather than as “dead assets.” In Milliken since there was a continuation of equity interests, all of the Cargill factors were present. However, if all of the factors of Cargill other than “continuity of shareholder interests” were present, we must be concerned that the result might be the same.