The “Successors and Assigns” Provision and Successor Liability

[Update: Go here for the June 15, 2013 post about my article It’s Time to Get Rid of the “Successors and Assigns” Provision.]

The shortcomings of traditional contract language come in varying degrees of subtlety. At the unsubtle end of the spectrum is the “successors and assigns” provision. It’s utterly standard, but it’s also, um, problematic.

I tackled the “successors and assigns” provision in this 2006 post, and I thought that was that, but recently it resurfaced. First, a reader asked me what I thought of this 2008 post by Alan Sklover and whether its advice applied in an M&A context. On looking at it, I recalled that I had posted a comment to it, and that Al and I had exchanged comments to my post.

Then I noticed that Brian Rogers had included a “successors and assigns” provision in the sample contract for the sale of goods that he offered to the gods of crowdsourced contracts. In a comment to his post about his contract (here), I asked Brian why he had included a “successors and assigns” provision. He replied as follows:

As to the successors and assigns clause, my concern is the situation Robert Sonenthal describes in his comment to the post you linked to — that a purchaser in an asset sale (in which the Buyer in this contract for the sale of goods is selling its business) might leave behind a contract that benefits my client (which is the Seller in this contract for the sale of goods). I’ll have to keep noodling on that (and researching). Any thoughts from you or others would be quite welcome.

Here’s the bulk of Robert’s comment:

Let me suggest a possible purpose for the “successors and assigns” clause – a variation on #1: To assure that, if either party sells all or substantially all of its assets (or merges into another firm), the asset sale (or merger agreement) will include a clause specifically committing the purchaser (or successor-in-interest) to continue performing the contract.

And Al Sklover makes the same point in his post:

Any employer could decide to sell its assets, divvy up the sale proceeds, and then simply go out of legal existence. Any employer could find other ways, too, to deny you what you have been promised, and have earned. The key to preventing this is simple: make sure you have a “successors-and-assigns clause” in your agreement. Otherwise, all you’ve worked so hard for could be lost, without a chance of getting it back.

So the notion is that a “successors and assigns” provision could help you if the other party sells its assets and excludes from that deal its contract with you. But it’s clear that a “successors and assigns” provision would be of no help.

Consider the following (citations omitted) from Asset Acquisitions: Assuming and Avoiding Liabilities, an article by Byron F. Egan in the Winter 2012 Penn State Law Review (PDF here):

Until about 35 years ago, the general (and well-settled) rule of successor liability was that “where 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. This rule was derived in the corporate world of contracts between commercial equals, where both parties were knowledgeable and had access to sophisticated advice. Two justifications historically have been given for the rule. First, it “accords with the fundamental principle of justice and fairness, under which the law imposes responsibility for one’s own acts and not for the totally independent acts of others.” The second justification is based on the bona fide purchaser doctrine, which holds that a purchaser who gives adequate consideration and who has no knowledge of claims against the item purchased, buys the item free of those claims.

More recently, however, the theory of successor liability has evolved and expanded as the result of a series of clashes between conflicting policies. This is a recurring theme throughout the successor liability cases, as the benefits attendant to a corporation’s ability to sell its assets in an unrestricted manner are balanced against other policies, such as the availability of other remedies to the injured party, and who can best bear the cost of protecting persons in the same situation as the plaintiff.

Byron’s article goes on to discuss “nine different theories under which one or more types of a predecessor’s liabilities could be imposed upon a successor.” But none of those nine theories relies on the “successors and assigns” provision.

So there’s nothing to support the notion that the “successors and assigns” provision can help you if you’re left stranded when the other party to a contract sells its assets. Anything that suggests otherwise will just create confusion. If on the other hand I’m the one who’s mistaken, I’ll happily eat crow.

Note that in the case of a merger, the surviving entity acquires all the liabilities of the target, so there’s no risk of being left high and dry.

Posted in Selected Provisions | 4 Comments

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  • http://twitter.com/IPDraughts Mark Anderson

    Ken, not sure about eating crow, but here is a good way to eat rook: http://www.youtube.com/watch?v=gvm6mN-LSbE

    I agree with your conclusions. The wording of these clauses gives a clue to their peculiarity. Why “assigns” and not “assignees”, and why “inure”? The clause seems to be preserved in aspic.

    Surely if the objective is to impose an obligation on a party to ensure that any assignee is bound, there should be a direct obligation on that party to do so (eg “X shall ensure…”), rather than have the indirect language (“shall be binding on”) that is typically seen? This indirect language looks kind-of like an automatic transfer of a property interest, which doesn’t make sense in this context under English law.

    • http://www.theContractsGuy.net Brian Rogers

      Mark: I like your solution.

  • Dennis

    Ken,
    As an Insurance Investigator with 35 years of experience, I find your comments regarding “successors and assigns” on point. There is, however, one other purpose for using the phrase, that being to commit fraud. The clause provides a gateway for transferring income and assets into a private LLC from, for example, a retirement investment account, especially in a relationship where commingled funds are utilized. The accounts are typically self-directed, so no fiduciary standard is require to be met by the service provider, the investors are shareholders, and considered Class 2 investors. When the money is directed into the account and becomes commingled, the service provider now owns the investor’s money. The regulatory agency typically only requires a Level 3 audit, and by law the Plan Sponsor is not allowed to audit the service provider. These minimum audit requirements create a caustic example of “zero risk” for the service provider, which opens the door for potential investor fraud.