UNWANTED BAGGAGE: ASSET ACQUISITION AND SUCCESSOR LIABILITY
If you buy the assets of a company, have you also acquired the liabilities for infringement associated with those assets? That is the issue addressed in a recent decision by the federal district court for the Southern District of New York in Energy Intelligence Group, Inc. et al. vs. Cowen and Company, LLC, No. 14 Civ. 3789. The court ruled on cross-motions for summary judgment that defendant Cowen did not expressly assume liability for the acts of copyright infringement alleged by the EIG plaintiffs, and that Cowen was not liable as a successor under the de facto merger doctrine.
EIG had sued Cowen, a boutique investment bank and broker-dealer, for infringement, alleging liability for unauthorized internal email forwarding of EIG’s copyrighted trade publications in the global energy field. EIG sought to hold Cowen liable not only for its own infringement, but also for alleged infringement by employees of a company named Dahlman Rose & Company. The alleged infringement at Dahlman had occurred prior to a corporate transaction in which Dahlman was acquired by Cowen’s parent company, Cowen Group. Specifically, EIG alleged that a series of emails from the summer and fall of 2012 revealed that certain Dahlman employees had been forwarding EIG’s “Oil Daily” publication to colleagues in violation of the terms of their subscriptions, which were licensed for the individual subscriber’s sole use. Although EIG was aware of this practice in 2012 – and even cautioned Dahlman that it was prohibited – EIG took no legal action at that time.
At around the same time, Dahlman was experiencing financial difficulties and its parent corporation was looking to sell the company. In late 2012, Cowen Group made an initial offer to acquire Dahlman and, shortly thereafter, began conducting a due diligence review of Dahlman. In the course of its due diligence review, Cowen Group requested information regarding “significant suits, actions [or] litigations . . . pending or threatened, affecting [Dahlman].” Notably, Cowen Group was not provided with any information regarding the 2012 emails that EIG later contended constituted evidence of infringement.
The Cowen-Dahlman transaction proceeded in two steps. First, Cowen Group formed a subsidiary that acquired all of Dahlman’s stock in exchange for Cowen Group stock, a potential cash dividend, and the assumption of certain liabilities. Second, Dahlman assigned most of its assets to Cowen in exchange for Cowen assuming Dahlman’s “known liabilities, contingencies, and obligations” pursuant to an Assignment and Assumption Agreement (AAA). The AAA was executed on March 11, 2013, and closed on May 31, 2013.
Nearly a year later, on March 3, 2014, EIG sent a demand letter to Cowen setting forth its copyright infringement claims and filed the complaint against Cowen in the Southern District of New York on May 28, 2014. In the fall of 2015, both parties filed cross-motions for summary judgment solely on the issue of Cowen’s purported successor liability for Dahlman’s alleged copyright infringement.
The Court conducted a two-part analysis to determine whether Cowen was liable for Dahlman’s alleged infringement. First, the Court examined whether Cowen expressly assumed liability for EIG’s infringement claims. The Court concluded that the AAA (by which Cowen assumed the assets of Dahlman) did “not mention EIG or any liability, contingency, or obligation to EIG.” Moreover, because EIG sent its first demand letter in March 2014, and had not previously asserted a copyright infringement claim against Dahlman or Cowen, the Court found no evidence either of those parties knew of a copyright-related liability to EIG prior to the closing of the AAA on May 31, 2013.
Second, the Court addressed the issue of whether the Dahlman/Cowen transaction constituted a de facto merger, rendering Cowen a successor to Dahlman’s liabilities. As the Court explained, a “de facto merger occurs when a transaction, although not in form a merger, is in substance a consolidation or merger of seller and purchaser.” The purpose of the doctrine is to “avoid the patent injustice which might befall a party simply because a merger has been called something else.”
After conducting a choice of law analysis, the Court determined that Delaware law applied to the de facto merger question because Cowen is a Delaware corporation (the Court also noted that Delaware courts are less likely than New York courts to apply the de facto merger doctrine – i.e., Delaware corporations may have less risk of successor liability under this doctrine). Under Delaware law, a de facto merger requires “a transfer of all of the transferor’s assets and an assumption of all its liabilities, in exchange for a payment made in the stock of the transferee directly to the shareholders of the transferor.” The Court held that because the AAA between Cowen and Dahlman did not involve a transfer of Cowen’s stock to Dahlman or its shareholders, or a transfer of all Dahlman’s assets or liabilities to Cowen, the elements of a de facto merger were not met.
The Court further concluded that the de facto merger doctrine did not apply because “there is no allegation of fraud or inadequate consideration.” In other words, because there was no evidence that the Cowen/Dahlman transaction was unfair or intended to defraud EIG, the de facto merger doctrine did not render Cowen liable for Dahlman’s alleged infringement. Finally, the Court noted that no equitable considerations underlying the de facto merger were present in this case. Specifically, there was no evidence anyone at Cowen knew of the alleged infringement at Dahlman or structured the transaction to avoid such liability.
What are the takeaways from the EIG decision? First, it appears that vague warnings that a practice is prohibited or constitutes copyright infringement are insufficient to put a party (or its corporate successor) on notice of liability. Thus, if an infringing entity is a potential acquisition target, it may make sense to send a demand letter immediately so that any potential acquirer is aware of (and thus is more likely to expressly assume) the liability of the infringer. Second, in the absence of any evidence of fraud or unfairness, an asset acquisition like the Cowen/Dahlman transaction is unlikely to result in successor liability for the acquirer, at least under Delaware law. By contrast, where an asset acquisition involves a transfer of all of the transferor’s assets and an assumption of all its liabilities, in exchange for a payment made in the stock of the transferee directly to the shareholders of the transferor, courts may apply the de facto merger doctrine and impose successor liability on the acquirer.