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Fizzano Brothers Concrete Products, Inc. v. XLN

May 15, 2009

FIZZANO BROTHERS CONCRETE PRODUCTS, INC.
v.
XLN, INC., SUCCESSOR IN INTEREST TO SYSTEM DEVELOPMENT GROUP, INC.
v.
SHORE CONSULTANTS, LTD., GREGG A. MONTGOMERY, DAVID BINDER AND XLNT SOFTWARE SOLUTIONS, INC.
APPEAL OF: XLNT SOFTWARE SOLUTIONS, INC.



Appeal from the Order entered September 14, 2007, Court of Common Pleas, Delaware County Civil Division at No. 01-11752.

The opinion of the court was delivered by: Donohue, J.

BEFORE: BENDER, DONOHUE and FREEDBERG, JJ.

OPINION

¶ 1 XLNT Software Solutions, Inc. ("XLNT") appeals from the trial court's entry of judgment in favor of Appellee Fizzano Brothers Concrete Products, Inc. ("Fizzano"). The trial court applied the de facto merger doctrine to impose successor liability on XLNT for the debts of a company whose assets XLNT purchased. In so ruling, the trial court excepted this asset sale from the general rule that the purchaser of assets is not liable for the debts of the transferor. Since we conclude that the record in this case does not support a finding that the de facto merger doctrine had any application in this case, we reverse the trial court's order.

¶ 2 In 1991, System Development Group, Inc. ("SDG"), a Pennsylvania corporation owned by Daniel Fritsch ("Fritsch"), Michael Hamlin ("Hamlin"), Phillip Theis and Paul Stehlik, acquired the rights to develop, license and sell "XLN Enterprise Management" accounting and manufacturing software (the "Software"). Notes of Testimony ("N.T."), 10/23/06, at 39-40. In 1999, Fizzano entered into a written contract with SDG whereby SDG agreed to license the Software for use in Fizzano's business. N.T., 10/24/06, at 43.

¶ 3 In April 1999, David Binder ("Binder") and five associates incorporated XLN, Inc. ("XLN") for the purpose of acquiring SDG and the Software. Id. at 79. Pursuant to a stock purchase agreement dated April 19, 2000, SDG agreed to sell and transfer all of its stock and assets to XLN. Defendants' Exhibit 1. In the agreement, XLN was granted a license to develop and market the Software, but ownership of its source code remained in the hands of the former shareholders of SDG until XLN paid the full purchase price. Id. XLN hired Hamlin and Fritsch as employees.

¶ 4 On October 25, 2001, Fizzano filed suit against XLN for breach of contract. Paragraph 3 of Plaintiff's Complaint alleged "XLN, upon information and belief acquired System Development Group, Inc. (hereinafter "System") in June 2000, thereby becoming its successor in interest for purposes of this litigation."

¶ 5 In the third or fourth quarter of 2002, XLN began to experience financial difficulties. Id. at 81-82. Hamlin and Fritsch were both terminated and Binder began efforts to sell the company and/or its assets. Defendants' Exhibit 8. To this end, Binder approached Gregg A. Montgomery ("Montgomery") and Richard Alexander ("Alexander"). In August 2003, Montgomery and Alexander incorporated XLNT and entered into an Asset Purchase Agreement with XLN for $270,000 in cash. Plaintiff's Exhibit 1. Pursuant to the Asset Purchase Agreement, XLN sold most of its assets to XLNT but retained a copy of a derivative version of the Software (called TRex) along with two of its customers, several computer workstations and servers, and various intellectual property rights. Id. In the Asset Purchase Agreement, XLNT disclaimed all liabilities of XLN other than, inter alia, its existing obligations for remediation of problems with a particular customer, Cardinal IG. Id.

¶ 6 In July 2004, Fizzano filed a motion to amend its complaint, which the trial court granted in August 2004. In September 2004, Fizzano filed an amended complaint, adding XLNT (among others) as additional defendants. In September 2006, Fizzano filed a motion for summary judgment against XLN. After XLN failed to respond, the trial court entered judgment in the amount of $114,105 plus attorneys fees against XLN. After a bench trial in October 2006, the trial court entered a verdict against XLNT in the amount of $114,000. In June 2007, the trial court denied XLNT's post-trial motions.

¶ 7 This appeal followed, in which XLNT challenges the trial court's application of the de facto merger doctrine to impose successor liability on XLNT in this case.*fn1 The general rule under Pennsylvania law for corporate sale of assets transactions is as follows: when one company sells all or substantially all of its assets to another company, the latter company is not responsible for the debts of the transferor simply because it acquired the transferor's property. Continental Ins. Co. v. Schneider, Inc., 582 Pa. 591, 599, 873 A.2d 1286, 1291 (2005) (citing Hill v. Trailmobile, Inc., 603 A.2d 602, 605 (1992)); see also 15 William Meade Fletcher, Fletcher Cyclopedia of the Law of Private Corporations § 7122 (perm.ed., rev.vol.2004).

¶ 8 This general rule of non-liability can be overcome if either of five exceptions is established: (1) the purchaser expressly or implicitly agreed to assume liability; (2) the transaction amounted to a consolidation or de facto merger; (3) the purchasing corporation was merely a continuation of the selling corporation; (4) the transaction was fraudulently entered into to escape liability; or (5) the transfer was without adequate consideration and no provisions were made for creditors of the selling corporation. Schneider, 582 Pa. at 599-600, 873 A.2d at 1291; Hill, 603 A.2d at 605; Fletcher, supra, at § 7122.

¶ 9 The second of these exceptions,*fn2 the de facto merger doctrine, proceeds from the basic equitable principle that an entity should not be permitted to escape its obligations to others through sham corporate reorganizations. As this Court has recognized, "where the successor corporation has been established to merely 'continue' the former corporation's operations or to escape the former corporation's liability, our courts have imposed 'successor corporation liability'." Bostick v. Schall's Brakes and Repairs, Inc., 725 A.2d 1232, 1237 (Pa. Super. 1999). Or described more generally:

The exception is designed to prevent a situation whereby the specific purpose of acquiring assets is to place those assets out of reach of the predecessor's creditors. In other words, the purchasing corporation maintains the same or similar management and ownership, but wears a 'new hat.' To allow the predecessor to escape liability by merely changing hats would amount to fraud. Thus, the underlying theory of the exception is that, if a corporation goes ...


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