In Smith v Kelley, SJC No. 12759 (Feb. 11, 2020), the Supreme Judicial Court addressed the issue of corporate successor liability, finding an attorney personally liable for the obligations of a professional corporation of which he was the sole officer and shareholder. The Court found that the attorney, who ceased operating the PC on one day and began serving the PC’s clients on the next, was personally liable as a “mere continuation” of the PC. As such, the attorney was personally liable to a judgment creditor of the PC to pay the judgment which had prompted the PC’s windup and dissolution.
Robert Kelley (“Kelley”), the Defendant attorney, was the sole shareholder and officer of a professional corporation, R Kelley-Law, PC (the “PC”), a law firm that at one point employed 15 people. Unbeknownst to Kelley, an associate employed by the PC engaged in a fraudulent mortgage loan scheme to defraud banks that were clients of the firm. He did so by creating a false financial profile and supporting documents for Plaintiff Smith, a mentally ill, functionally illiterate homeless veteran in whose name the associate purchased two properties at inflated prices. The mortgage loans went unpaid, Smith’s credit was ruined, he was unable to rent a home or find work, and he became more depressed and even suicidal.
Smith sued the PC and Kelley individually. The suit led to wholesale layoffs at the PC, leaving only Kelley remaining practicing at the firm. A court eventually found the PC vicariously liable to Smith but found that Kelley, who had no knowledge of the fraudulent scheme, was not liable to Smith.
The day after a judgment for more than $200,000 entered against the PC, Kelley, as sole shareholder of the PC, resigned as officer of the PC and voted to wind up the corporation. Immediately thereafter, Kelley began serving the PC’s clients from the offices of the PC using PC equipment. For a substantial period, he continued using the PC email address and telephone number. He deposited payments made to the PC in his sole proprietorship business accounts.
When it became clear that the PC could not or would not pay Smith and that Kelley had taken over the assets of the PC, Smith brought a claim against Kelley as the successor-in-interest to the PC. When the PC thereafter filed for bankruptcy, the Trustee in the bankruptcy made a claim against Kelley for assets of the PC that he had appropriated. The claim settled with Kelley paying the bankruptcy estate $85,000 in return for a release from the estate. However, the bankruptcy court specifically declined to determine whether the release of Kelley included a release of any potential veil piercing or alter ego claims against Kelley.
In the Superior Court action which followed, the trial court judge rejected Smith’s successor-in-interest claims against Kelley, holding that successor liability was only applicable to corporations and could not be applied where the alleged successor was a natural person.
On appeal, the Supreme Judicial Court noted the general rule that “the liabilities of a corporation are not imposed upon its successor”, but noted at least four exceptions to this principle. Slip op. at 15. The salient one for purposes of the case was the “mere continuation” exception which allows “a creditor to recover from the successor corporation whenever the successor is substantially the same as the predecessor.” Id. at 17. Although no one factor is dispositive, key factors a court will review in performing such an analysis are “the continuity or discontinuity of the ownership, officers, directors, stockholders, management, personnel, assets, and operations of the two entities.” Id. at 17-18.
In this case, the Court noted that “[i]n almost every respect, Kelley’s sole proprietorship mirrored the P.C. that immediately preceded it.” Id. at 19. The Court cited, among other things, the continuity of clients, owner, sole officer, employees, contact information, office space and equipment, concluding that “Kelley’s sole proprietorship amounted to a “reincarnation” of the predecessor professional corporation.” Id. at 19-20.
The Court acknowledged the heightened concern of applying the doctrine of successor liability to an individual, which effectively eviscerates the limitations of liability that come with the corporate form and puts at risk all of Kelley’s assets, whether derived from the PC, the successor sole proprietorship or from any other source. Id. at 20-23.
Notwithstanding this concern, the Court had no problem imposing personal liability on Kelley as a successor in interest, even though the jury had specifically found that he was not individually liable to Smith. Id. at 24-25. The Court concluded that Kelley had put himself in this position by winding up the PC in an effort to avoid liability and then restarting what was essentially the same enterprise. Id. However, noting that imposing successor liability was an equitable remedy, the Court did limit Kelley’s liability to revenues derived from the sole proprietorship and remanded the case with instructions for the trial court to fashion an appropriate remedy including, if necessary, an appropriate payment plan. Id. at 27-28.