A recent Supreme Judicial Court case considered whether a firm was liable for debts incurred by its predecessor.

Imagine that you sue a business for unpaid debts. After months of litigation, you secure a money judgment against the business. While you celebrate this victory, the business discontinues operations and files for bankruptcy, and the business owner immediately starts a new business under a similar name, using the same assets to provide the same services to the same customers. 

Would you have any recourse against the new business? The Massachusetts Supreme Judicial Court considered this question last month in Smith v. Kelley. 

Robert Smith was a hard-luck case. A Marine Corps veteran, Smith suffered from debilitating mental illness. He was functionally illiterate and living in his car in 2005, when Dwight Jenkins recruited him as an unwitting participant in a mortgage fraud scheme. Jenkins would enter into contracts to buy property, then assign his rights as buyer to straw purchasers for fraudulent higher prices. The straws then closed loans based on the fraudulent higher prices, but only paid the lower prices for the properties, with Jenkins collecting the difference as a “release fee.” The straws received small payments for participating. 

The sole proprietorship used the same email address, office space, IOLTA account and health insurance as RKelley-Law, PC. Under these circumstances, the SJC had little difficulty finding Kelley’s new law office liable under successor liability theory.

Jenkins created false financial profiles for Smith, who then closed mortgage loans with Louis Bertucci, an associate attorney at RKelley-Law, PC. Bertucci (who unsurprisingly has been suspended from practicing law) directed the unknowing Smith to sign fraudulent documents to obtain the loans. Smith received $19,000 for his trouble. 

Smith defaulted on the loans, resulting in foreclosures, a ruined credit history and further deterioration to his mental health. He sued Bertucci and RKelley-Law, PC, together with Robert E. Kelley, the sole officer, director and stockholder of RKelley-Law, PC. A federal court found RKelley-Law, PC vicariously liable for Bertucci’s misconduct, and entered a judgment for over $200,000 against it.  However, the court determined that Kelley himself was not liable, because he was unaware of the mortgage fraud scheme. 

Kelley terminated RKelley-Law, PC’s employees, wound down its affairs and put it into bankruptcy. He continued his law practice as a sole proprietorship, at the same office with the same email address, using similar letterhead. Smith’s efforts to collect the $200,000 against RKelley Law, PC were fruitless, so Smith sued Kelley personally in Superior Court under successor liability theory.   

SJC Overrules Superior Court Decision 

Massachusetts courts generally are unwilling to entertain suits against successor businesses under this theory, unless one of four conditions are met; namely the successor assumes its predecessor’s liabilities, the transaction is a merger or consolidation, the successor is a mere continuation of the predecessor or the transaction is a fraudulent effort to avoid the predecessor’s liabilities.   

The Superior Court ruled against Smith without following this analysis. Instead, it held that Smith could not invoke the doctrine of successor liability against Kelley, because the doctrine does not apply when the predecessor is a corporation and the successor is a sole proprietorship. Smith appealed. 

The Supreme Judicial Court reversed the Superior Court. The SJC rejected Kelley’s attempt to shed business debts by simply changing his law practice from a professional corporation to a sole proprietorship. The SJC then focused on whether Kelley’s sole proprietorship was a “mere continuation” of RKelley-Law, PC. 

Christopher R. Vaccaro

The SJC noted several significant facts. Before Kelley dissolved RKelley-Law, PC, the professional corporation was effectively controlled by Kelley alone, as was the successor sole proprietorship. Kelley’s sole proprietorship continued to receive legal fees from clients of RKelley-Law, PC. Kelley’s sole proprietorship took equipment, inventory and supplies from the predecessor corporation, without paying for them. The sole proprietorship used the same email address, office space, IOLTA account, and health insurance as RKelley-Law, PC. Under these circumstances, the SJC had little difficulty finding Kelley’s new law office liable under successor liability theory. 

Kelley’s use of a sole proprietorship to avoid the judgment against RKelley-Law, PC appeared to backfire. However, the SJC was not totally insensitive to Kelley’s plight. The SJC held that revenues from Kelley’s proprietorship should be available to pay Smith, but that Kelley’s other assets should not.  The SJC reversed the Superior Court’s decision and instructed that court to fashion an equitable remedy so that only Kelley’s law practice revenues would pay the debt to Smith. 

This decision raises interesting issues for small businesses generally, not just lawyers. Contractors, architects, physicians and other professionals should be aware that they cannot escape their debts simply by closing one business, then opening another at the same location and with the same clientele. 

Christopher R. Vaccaro, Esq. is a partner at Dalton & Finegold, L.L.P. in Andover.  His email address is cvaccaro@dfllp.com.