Successor Liability: a New Corporation is Not an Escape Route

Successor Liability: a New Corporation is Not an Escape Route

Jan 30, 2017

A debtor business entity cannot shed its obligations by dissolving and reforming as a new and separate business. If the new business is a “mere continuation,” the debts will attach to the new company, but holding the owners liable for the debt is a more difficult issue, requiring a creative approach to maximize the chances of success.

United States District Court Judge Anthony Trenga considered the possible liability of a successor entity and its principles individually when the owners of Bluemont Capital Advisors responded to a civil judgment by dissolving Bluemont and starting a newly formed LLC for the sole apparent purpose of avoiding the debts of the first entity. The case is Charles Schwab & Co. v. WS Wealth Mgmt, LLC.

As of 2011, Bluemont Capital Advisors, LLC was in the business of providing investment advice for its customers. Schwab managed the stock portfolios for Bluemont’s customers. In 2011, a Schwab investment advisor left Schwab and went to work for Bluemont. When he began soliciting Schwab clients for the benefit of Bluemont, Schwab terminated its relationship with Bluemont and brought a claim for tortuously interfering with its business. That claim was arbitrated, resulting in a $311,294.50 judgment in favor of Schwab.

The Schwab judgment rendered Bluemont insolvent. Thereafter, Bluemont’s principals – Mark Stys, Carolyn Stys and Jonathan Wagner – formed WS Wealth Management, LLC. Within a month, WS was managing all but three of the accounts formerly managed by Bluemont. Schwab then sued WS under the theory of successor liability.

Judge Trenga relied on the 1992 case of Harris v. T.I. Inc. in noting that Virginia courts recognize successor liability in only limited circumstances. Among these are businesses that are a “mere continuation” of the prior business and “de facto merger.” Trenga had little difficulty in concluding that Bluemont’s principals’ pattern of conduct established a valid claim for successor liability because its members “clearly engaged in a series of transactions designed to thwart Schwab’s ability to collect its judgment from Bluemont.” “As a practical matter,” wrote Trenga, “and certainly from the clients’ perspective, little, if anything, had changed other than the name of Bluemont had changed to WS Wealth.”

From the perspective of Schwab, the critical question was the liability of Stys, Stys and Wagner, since that would be the best or, perhaps, only source of collection of the full business debt. Schwab argued that the members of WS should be liable for the underlying debt because they owed fiduciary duties to the creditor once the debtor company (Bluemont) entered the “zone of insolvency.” Trenga rejected this creative argument, ruling “based on the text and structure of the Virginia Limited Liability Company Act, that Schwab did not have standing to sue any of the members of either Bluemont or WS Wealth for breach of fiduciary duty.”

Judge Trenga’s December 2, 2016 ruling will probably force WS Wealth out of business and will likely ruin Stys, Stys and Wagner professionally, but the underlying debt might remain elusive. Sometimes the Virginia statutory structure leaves a wrong without a remedy. A better theory for Schwab to secure the personal obligation of the owners may have been Fraudulent Conveyance, because the transfer of the assets from Bluemont to WS Wealth was clearly intended to “delay, hinder or defraud” creditors, as defined in the Fraudulent Conveyance Statute. Under this theory, it is conceivable that any diminution in the amount recovered, as well as the costs and fees incurred because of the wrongful transfer, could have been recouped from the company owners.