When Will Vicarious Liability Be Imposed on a Lender That Took Over the Business and Management of a Borrower to Effect a Liquidation?
July 27, 2004
Michael Weissman - Chicago
In Cardinal Fastener & Specialty Co. v. Progress Bank, 67 Fed.App. 343 (6th Cir. 2003) a secured creditor escaped a claim of successor liability asserted by an unsecured creditor of the borrower. The claim was asserted because the secured creditor had taken over the financial management of the borrower with the ultimate objective of liquidating the borrower.
Allied Nut & Bolt Co. (Allied) borrowed $2 million from Progress Bank (Progress) secured by a blanket lien on Allied’s assets. One of Allied’s unsecured vendors was Cardinal Fastener & Specialty Co. (Cardinal). In 1999, Allied experienced financial distress and could not pay an open account of $87,403.88 due Cardinal. By the end of 1999, Allied’s financial position had undergone further financial deterioration and Allied did the following: (1) surrendered its assets to Progress for liquidation and (2) continued in business for about two months but yielded management of its financial affairs to Progress. Subsequently, Allied’s business was liquidated and the assets were sold to another company, House of Threads.
Not having been paid, Cardinal filed suit in an Ohio state court against Progress Bank, Allied, Allied’s principals and House of Threads to recover its unpaid debt of $87,403.88. The complaint alleged theories of corporate successor liability, lender control liability, fraud and conspiracy to commit fraud. Allied failed to answer the complaint, resulting in a default judgment against Allied. Then Cardinal voluntarily dismissed Allied’s principals and House of Threads, leaving only Progress Bank as an active defendant. Progress Bank successfully removed the case to the U.S. District Court for the Northern District of Ohio. The District Court held that Progress Bank was not liable to Cardinal and dismissed all claims against Progress Bank.
Cardinal appealed to the U.S. Court of Appeals for the Sixth Circuit, arguing that the District Court failed to follow applicable state law with respect to Cardinal’s claim against Progress Bank, i.e., that the bank should be held liable to Cardinal on a theory of successor liability. Citing Dawejko v. Jorgenson Steel Co., 290 Pa. Super. 15, 434 A.2d 106 (Pa. Super. 1981), Cardinal argued that Progress Bank should be found liable for Allied’s debt to Cardinal if any of the following situations were present:
“(1) the purchaser expressly or impliedly agrees to assume such obligation;
(2) the transaction amounts to a consolidation or merger;
(3) the purchasing corporation is merely a continuation of the selling corporation; …
(4) the transaction is fraudulently entered into to escape liability[;]…
[(5)] …the transfer was without adequate consideration and provisions were not made for creditors of the transferor.”
Id. at 107.
The Sixth Circuit rejected Cardinal’s argument for the simple reason that, unlike in Dawejko, Progress Bank did not “acquire” all or substantially all of the assets of Allied for the purpose of competing in Allied’s industrial sphere. Furthermore, the Sixth Circuit noted that Progress Bank was not in the business of manufacturing or providing screws, nuts and bolts, but was instead a lending organization to which Allied was indebted and to which Allied failed to make required loan repayments. The Sixth Circuit also pointed out that Progress Bank merely oversaw the liquidation of Allied to protect its investment and minimize further depletion of that corporation’s assets.
Based on the foregoing, the Sixth Circuit held that Progress Bank did not, either expressly or by implication, assume Allied’s obligation to Cardinal, and clearly did not merge its banking business with Allied’s manufacturing activities or alter its own functions to “continue” as a participant in the nuts and bolts industry. Therefore, any transaction or transfer that took place was not an effort to escape liability or defraud other creditors, but rather merely an attempt to protect the bank’s secured interest.
What’s the point?
Lenders that take the steps that Progress did clearly run the risk of vicarious liability. Perhaps what saved Progress was the fact that the clearly understood objective was a liquidation of the business rather than a continuation and the fact that the liquidation was accomplished through a sale to a third party rather than a piecemeal sale of assets that extended over an extended time period. n
For more information e-mail Michael L. Weissman at
michael.weissman@hklaw.com or call toll free, 1-888-688-8500.