ERISA successorship test properly applied to find that “interest” was transferred between predecessor and successor companies

A federal district court properly applied the multifactor ERISA successorship test to find that an “interest” had been transferred within the meaning of Federal Rules of Civil Procedure 25(c) between a predecessor company and two successor companies, according to the U.S. Court of Appeals in Chicago (CA-7). The appellate court concluded that the facts adopted by the district court, including that the successors retained most of the predecessor’s employees, that all entities operated out of the same location, and that there was substantial overlap in customer lists, among other facts, created a clear picture of notice and continuity, satisfying the ERISA test. Thus, the successor companies could be substituted as judgment debtors in a lawsuit to recover delinquent pension fund contributions.

In the years preceding its closure, a predecessor business entity was in arrears on pension fund payments to a union. After a joint arbitration board issued an award in favor of the union, the union filed suit to compel enforcement of the award under the Labor Management Relations Act and ERISA. In order to enforce the award, the union’s trustee sought to discover the predecessor’s assets. During his deposition, the owner of the predecessor company admitted that his son knew more about the company’s assets and operations than he did. The son was deposed and revealed his sole ownership of two companies that were established contemporaneously with the predecessor company’s closing. One successor company primarily serviced lawn irrigation systems, while the other successor company’s sole business was leasing equipment that it purchased from the predecessor company to the other successor company.

The trustee moved to impose judgment against the successor companies as successors. After a magistrate judge denied the trustee’s motion for lack of a procedural mechanism through which to substitute the parties as judgment debtors, the trustee filed a motion under Federal Rules of Civil Procedure Rule 25(c). The magistrate found the companies were successors under ERISA and that Rule 25(c) provided an appropriate procedure to enable substitution of the successor companies for the predecessor company. Adopting the magistrate’s recommendation, the district court granted the trustee’s motion to substitute. It determined that the successor companies failed to rebut the magistrate’s key findings: that the son exercised control over all entities; that one of the successor companies hired five out of six former predecessor company employees; that all entities operated out of the son’s home; that there was substantial overlap in customer lists; and that the timing of the predecessor company’s closure and the incorporation of the successor company that primarily serviced lawn irrigation systems suggested its intention to take over the predecessor company’s operations.

ERISA’s successorship test

On appeal, the successor companies asserted that the district court’s factual findings fell short of satisfying ERISA’s successorship test. Specifically, they refuted that the son had notice of the predecessor company’s liability and rejected factual findings that contributed to the substantial continuity determination. As an initial matter, the Seventh Circuit reviewed de novo the district court’s finding of substantial continuity. Rule 25(c) allows the substitution of parties if an “interest” is transferred, but it relies on other substantive law to define “interest.” Normally, a corporation purchasing the assets of another corporation does not assume the obligations of the transferor. However, an exception has developed in the context of ERISA actions to recover delinquent pension fund contributions.

The successor companies asserted that only a substantial transfer of assets can trigger substitution under Rule 25(c), and because one of the successor companies acquired only six pieces of equipment from the predecessor company and the other successor company acquired no assets directly from the predecessor company, no interest was transferred. However, the appellate court observed that a formal purchase of assets is not required to establish successorship liability in the ERISA context. Specifically, the ERISA test allows a plaintiff to proceed against the subsequent purchaser of the violator’s business, even if it is a true sale, provided that two conditions are satisfied: (1) the successor had notice of the claim before the acquisition; and (2) there is substantial continuity of operation of the business before and after the sale. The district court relied on this test to determine that an “interest” was transferred from the predecessor company to the successor companies, justifying the Rule 25(c) substitution.

Notice and substantial continuity

The appellate court observed that there was plenty of evidence to allow a fact finder to imply that the successor companies had knowledge of the claim before acquisition to satisfy the notice requirement—the leadership positions of the owner’s son in each company, his relationship to the predecessor company’s owner, and the son’s ownership of the property on which all of the companies operated were located. Thus, the district court did not clearly err by adopting these factual findings and concluding that notice of the predecessor company’s delinquency existed.

Similarly, the appellate court found a continuity of business. Here, the successors’ contention regarding the district court’s substantial continuity finding relied on viewing them as isolated entities. Thus, one of the successor companies asserted that it never purchased any of the predecessor company’s assets, while the other successor companies contended that its purchase of the predecessor company’s assets was merely part of a piecemeal sale, insufficient to establish continuity. However, the appellate court found that the purported independence of these entities was contradicted by the facts adopted by the district court, which, taken as a whole, showed that the three companies had similar leadership, employees, customers, office space, equipment, and services.

As to the leadership issue, the appellate court rejected the successor companies’ claim that the son was never an officer of the predecessor company. The district court had based its decision about the son’s leadership on tax returns, company credit cards in the son’s name, and the father’s depositions concerning the son’s involvement in the predecessor company. The appellate court found that this evidence did not support a conclusion that the district court had clearly erred in finding that the son had leadership positions in each company. Thus, this assertion and other assertions as to the unrelated nature of the entities (i.e., that one of the successor companies did not conduct the same business as the predecessor company and that the equipment transfer from the predecessor company to the other successor company was a piecemeal sale of assets) were artificial distinctions that did not mask the substantial interrelatedness of the companies. The appellate court found that it was clear that the successor companies had taken on every aspect of the predecessor company’s former business, and, based on available facts, there was nothing to suggest that the district court had improperly concluded that there was substantial continuity between the three companies.

The appellate court affirmed the district court’s rulings.

Source: Sullivan v Running Waters Irrigation, Inc. (CA-7).

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