Fizzano Bros. Concrete Prods., Inc. v. XLN, Inc.

• Decision Date: 26 March 2012
• Citation: 42 A.3d 951
• Parties: 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 Fizzano Brothers Concrete Products, Inc.
• Court: Pennsylvania Supreme Court

42 A.3d 951

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 Fizzano Brothers Concrete Products, Inc.

Supreme Court of Pennsylvania.

Argued Nov. 30, 2010.

Decided March 26, 2012.

Robert Daniel Ardizzi, Paul A. Bucco, Davis Bucco & Ardizzi, Conshohocken, for Fizzano Brothers Concrete Products, Inc.

John Hartman May, May, Metzger, and Zimmerman, L.L.P., Lancaster, for XLNT Software Solutions, Inc.

BEFORE: CASTILLE, C.J., SAYLOR, EAKIN, BAER, TODD, McCAFFERY, ORIE MELVIN, JJ.

OPINION

Justice McCAFFERY.

At issue in this appeal is a question of corporate successor liability under the de facto merger doctrine or exception. The trial court concluded that XLNT Software Solutions, Inc. (“XLNT”) was liable for a judgment owed by XLN, Inc. (“XLN”), pursuant to this exception. XLNT and XLN lacked common shareholders and higher management; however, the corporations each employed the same two key employees in positions of authority and who, at all relevant times, were principal owners of the essential asset around which the business of the two corporations operated.

The Superior Court determined that the trial court misapplied the de facto merger exception and, hence, reversed. We granted allowance of appeal to determine the following issues:

1. Does the de facto merger doctrine always require proof of continuity of ownership?

2. Did the Superior Court improperly substitute its own fact-finding for that of the trial court?

Fizzano Bros. Concrete Products, Inc. v. XLN, Inc., 606 Pa. 48, 994 A.2d 1081 (2010) ( per curiam ).

I. BACKGROUND

Appellant, Fizzano Brothers Concrete Products, Inc., purchased a license for accounting and manufacturing software, known as the XLN Enterprise Management Software (“the Software”), from System Development Group, Inc. (“SDG”) sometime prior to 2000. Appellant paid $66,818.25 for the license, Software implementation,training, and sales tax, based on assurances or expectations that the Software would update and streamline Appellant's ability to track sales, maintain accounts receivable, and improve record keeping. However, Appellant was never able to implement the Software.

On April 19, 2000, XLN acquired all of the stock and assets of SDG, in addition to all of its liabilities, pursuant to a stock purchase agreement. Appellant filed a cause of action against XLN on October 25, 2001, alleging breach of contract and breach of express warranty arising from the failure of the Software's implementation. XLN denied Appellant's essential allegations.

On or about September 4, 2004, after securing leave of court, Appellant filed an amended complaint, joining XLNT and its president, Gregg Alan Montgomery (“Montgomery”), as additional defendants. Appellant joined these defendants after learning that on or about August 29, 2003, XLNT had entered into an asset purchase agreement with XLN, pursuant to which XLNT purchased virtually all of XLN's assets. Included in the agreement was the transfer of control over the Software, which was owned by the former shareholders of SDG, subject to payment of two promissory notes. Appellant alleged that the additional defendants had engaged in a fraudulent transfer of assets, and further alleged that XLNT was liable under the original breach of contract and warranty actions as the successor corporation of XLN. Following the trial court's denial of their preliminary objections, XLNT and Montgomery filed an answer denying the critical allegations in the amended complaint.

Although there was no dispute that XLN had assumed all of the liabilities of SDG under the stock purchase agreement, including those liabilities arising from the licensing of the Software to Appellant, XLNT contended that, as mere purchaser of the assets of XLN, it had no responsibility arising from Appellant's lawsuit, as XLNT had not expressly assumed XLN's potential liability concerning Appellant. This contention is supported by a general principle of corporation law that a purchaser of a corporation's assets does not, for such reason alone, assume the debts of the selling corporation, unlike a purchaser of the corporation's stock. See Continental Ins. Co. v. Schneider, Inc., 582 Pa. 591, 873 A.2d 1286, 1291 (2005) (“Schneider II”). However, exceptions to this principle include circumstances where (1) the asset sale amounted to a consolidation or a de facto merger; ¹ or (2) the purchasing corporation was merely a continuation of the selling corporation. Id.² Appellant argued that XLNT was liable under these two exceptions. Because Appellant's contentions are factually based, a more thorough review of the essential transactional background must be undertaken.

At the time of the sale of SDG to XLN, ownership of the Software was transferred from SDG to SDG's shareholders, Daniel T. Fritsch, Jr., Michael R. Hamlin, Phillip C. Theis, and Paul J. Stehlik (“the Shareholders”). XLN purchased SDG's stock for $5,420,000, with the majority of the purchase price being paid to the Shareholders in the form of two promissory notes totaling $5,100,000. The stock purchase agreement provided that the source code for the Software would be placed in escrow, and that the ownership of the Software would remain with the Shareholders until the promissory notes were paid in full. Under both promissory notes, Shareholders Fritsch and Hamlin were each to receive 42.223% of the value of the note.³

The right to license the Software was the primary asset of value acquired by XLN. Two of the developers, who were also the primary owners of the Software, Shareholders Fritsch and Hamlin, were given employment contracts by XLN and worked at the company on a daily basis. However, neither Fritsch nor Hamlin was a shareholder of XLN, nor were the other two Shareholders.⁴ XLN operated out of the same Lancaster, Pennsylvania location where SDG had conducted its business. On January 17, 2003, XLN terminated Fritsch and Hamlin from their employment as part of an effort to stop cash outlays while XLN attempted to sell the company. Notes of Testimony (“N.T.”), 10/24/06, at 82.

On August 5, 2003, XLNT was incorporated in New York. The sole shareholders of XLNT are Montgomery and Richard Alexander. Montgomery, who owns 75% of XLNT's stock, is also that corporation's president. In the month of its incorporation, XLNT entered into the asset purchase agreement with XLN, pursuant to which XLNT purchased virtually all of XLN's assets, including intellectual property, accounts receivable, customer lists, good will, licenses, trademarks, trade names, and copyrights; XLN retained only two workstations and servers and an undeveloped derivative of the Software. XLN also assigned its lease of the premises in Lancaster to XLNT, which thus further obtained all leasehold improvements from XLN. The two aforesaid workstations and servers retained by XLN were to remain at this business location. Under the agreement, XLN also retained two customers, but was required to change its corporate and business name.⁵

As with XLN's stock purchase from SDG, the “key asset” acquired by XLNT was the right to license the Software. Trial Court Opinion, dated 4/11/07, Finding of Fact No. 27. The trial court credited testimony that (1) the right to license the Software was the only asset of XLN of significant value; (2) a software company “lives and dies” by its software; (3) XLNT's purchase of XLN's assets without the inclusion of the right to license the Software would have been meaningless; and (4) without the right to license the Software, XLN would have had difficulty remaining in business. Id., Findings of Fact Nos. 29–31. Indeed, the asset purchase agreement was expressly contingent upon XLNT coming to a contemporaneous agreement with the Shareholders whereby the Shareholders would ultimately transfer their ownership of the Software to XLNT, again contingent upon the satisfaction of promissory notes held by the Shareholders.⁶

The asset purchase agreement was also contingent upon the execution and delivery, simultaneous with the closing, of employment contracts between XLNT and Fritsch and Hamlin. These individuals had independently negotiated with XLNT, with XLN's consent, the value of the source codes for the Software, and the terms of conditions of their employment with XLNT. They were to perform the same duties for XLNT as they had for XLN. XLNT also hired from XLN its sole remaining employee.

A schedule to the asset purchase agreement listed five existing claims against XLN, both those in litigation, including Appellant's cause of action, and those not yet in litigation. XLNT agreed to assume liability only for one claim not in litigation. Further, the agreement required XLN to refrain from competing with XLNT by engaging in any activity involving the Software or any similar product. Following the sale, XLNT's website, which Hamlin helped to create, identified XLNT as the successor company to XLN. Id., Finding of Fact No. 43.

II. TRIAL COURT PROCEEDINGS

Appellant filed a motion for summary judgment against XLN, which did not file a response. Indeed, on September 23, 2005, XLN's counsel was granted leave to withdraw from the case. Because of the non-response, the trial court granted Appellant's summary judgment motion against XLN in the amount of $114,105.

The case against XLNT and Montgomery then proceeded to a three-day bench trial. Following the trial's conclusion, the court entered a verdict for Appellant and against XLNT for $114,000, consistent with the court's extensive findings of fact and conclusions of law. More specifically, the trial court concluded that XLNT was liable to Appellant under the “ de facto merger” and “mere continuation” exceptions to the general rule of corporate non-liability following a purchase of assets, pursuant to the following rationale.

With respect to the...