Everlast Roofing, Inc. vs. David Schlabach t/a Dave’s Metal Roofing and Dave’s Metal Roofing LLC No. 2010-02317

Civil Action-Law-Confession of Judgment-Motion for Leave to Amend-Additional Defendant-Newly Formed Corporation-Obligations of Predecessor-Successor Liability.

Plaintiff, which instituted an action in Confession of Judgment against Defendants Schlabach t/a Dave’s Metal Roofing, a sole proprietorship, to recover a debt for metal roofing supplies, filed a Motion for Leave to file an Amended Complaint to add Dave’s Metal Roofing, LLC, a limited liability corporation, as a defendant. After a bench trial, the Court granted the Motion for Leave to Amend and entered judgment against Defendants. Defendants filed a Motion for Post Trial Relief asserting that the Court erred in granting the Motion for Leave to Amend and adding Dave’s Metal Roofing, LLC, as a Defendant in the case.

1. A newly formed corporation does not necessarily assume the obligations of its predecessor. However, this general rule is not applicable when: (1) the new company is a de factor merger; (2) the new company merely is a continuation of the previous company; (3) the transaction fraudulently is entered into in order to escape liability; or (4) the transfer was made without adequate consideration and provisions being made for creditors of the transferor.

2. Since the evidence adduced at trial indicated that there was a de factor merger of the entities, the new limited liability corporation was a continuation of the sole proprietorship, the new entity had been established to escape liability and no provisions had been made for the creditors of the sole proprietorship, the new entity properly could be held jointly and severally liable with its predecessor under the theory of successor liability.

3. The theory of successor liability is applicable to situations involving different types of business entities, including when a sole proprietorship merges into a limited liability corporation.

L.C.C.C.P. No. 2010-02317, Opinion by John C. Tylwalk, President Judge, November 10, 2015

IN THE COURT OF COMMON PLEAS OF LEBANON COUNTY

PENNSYLVANIA

CIVIL ACTION – LAW NO. 2010-02317

EVERLAST ROOFING, INC., Plaintiff

v.

DAVID SCHLABACH t/a DAVE’S METAL ROOFING and DAVE’S METAL ROOFING, LLC, Defendants

ORDER OF COURT

AND NOW, this 10^th day of November, 2015, upon consideration of Defendants’ Motion for Post-Trial Relief Pursuant to Pa.R.C.P. No. 227.1, and the Briefs submitted by the parties, it is hereby Ordered that said Motion is DENIED.

APPEARANCES:

KEVIN M. FRENCH, ESQUIRE FOR EVERLAST ROOFING, INC.

BRANDON S. HARTER, ESQUIRE

HARTMAN UNDERHILL & BRUBAKER, LLC

TONI M. CHERRY, ESQUIRE FOR DAVID SCHLABACH t/a

GLEASON, CHERRY AND CHERRY, LLP DAVE’S METAL ROOFING and

DAVE’S METAL ROOFING, LLC

OPINION, TYLWALK, P.J., NOVEMBER 10, 2015.

Plaintiff Everlast Roofing, Inc. instituted this litigation to collect a debt for metal roofing supplies which it had sold on credit to Defendant David Schlabach t/a Dave’s Metal Roofing, a sole proprietorship. After filing a Second Amended Complaint, Everlast Roofing filed a Motion for Leave to File a Third Amended Complaint (“Motion to Amend”) to add Dave’s Metal Roofing, LLC as a defendant. We reserved decision on that Motion pending trial. A bench trial was conducted on February 27, 2014 and July 15, 2014. On July 10, 2015, we issued a Verdict in which we granted the Motion to Amend and entered judgment against Defendants in the principal amount of $153,516.99, interest at the rate of one and one-half per cent until the principle is paid in full, $199.50 in costs, and attorney’s fees in the amount of $30,861.55. Defendants have filed a Motion for Post-Trial Relief in which they assign error to our granting Plaintiff’s Motion to Amend and in our failure to make a finding that Defendants were not credited with a number of payments.

In its Motion to Amend, Plaintiff averred that after discovery which was conducted subsequent to the filing of the Second Amended Complaint, it learned that David Schlabach had formed a new entity, Dave’s Metal Roofing, LLC. Plaintiff claimed that the limited liability corporation was a continuation of the business which Schlabach had previously operated as Dave’s Metal Roofing and that the new entity was jointly liable for the debts of its predecessor.

In reaching our verdict, we recognized that a newly-formed corporation does not necessarily assume the obligations of its predecessor. Carlos R. Leffler, Inc. v. Hutter, 696 A.2d 157 (Pa. Super. 1997). We further noted that this general rule is not applicable when (1) the new company is a de facto merger, (2) the new company is merely a continuation of the previous company, (3) the transaction is fraudulently entered into to escape liability, or (4) the transfer was without adequate consideration and provisions being made for creditors of the transferor. Bostick v. Schalll’s Brakes and Repairs, Inc., 725 A.2d 1232, 1237-38 (Pa. Super. 1999). After a consideration of the evidence adduced at the bench trial, we determined that there was a de facto merger of the two entities, that the new limited liability corporation was a continuation of the sole proprietorship, that the evidence indicated that the new entity had been set up in order to escape liability, and that no provisions had been made for the creditors of the sole proprietorship. Thus, we concluded that the new entity could be held jointly and severally liable with its predecessor under the theory of successor liability and granted Plaintiff’s Motion to Amend.

In their Post-Trial Motion, Defendants argue that there could have been no de facto merger because a sole proprietorship cannot merge into a limited liability corporation. We disagree. Although the application of the theory of successor liability is most often applied in situations involving two corporations, we do not believe that the principles behind successor liability are inapplicable to situations involving different types of business entities.

For example, Plaintiffs point to Heritage Realty Management, Inc. v. Symbiot Snow Management Network, LLC, 207 WL 2903941 (W.D. Pa. 2007) where the defendant argued that successor liability did not apply to a transfer from an individual or partnership because, unlike the situation where a corporation transfers its assets and then dissolves, an individual does not disappear and remains liable on the obligation. 2007 WL 2903941 at 4. In that case, the federal district court, applying Pennsylvania law, noted that “the de facto merger test does not require as an element the lack of a remedy against he predecessor,” and that the defendant’s argument “has not been adopted by any Pennsylvania court or federal court applying Pennsylvania law.” Id. at 5. Plaintiff also points out that other state and federal courts have rejected the argument that “as a matter of law, a corporation cannot be a mere continuation of a predecessor sole proprietorship,” citing Cambridge Townhouses, LLC v. Pacific Star Roofing, Inc., 166 Wash. 2d 475, 483 (2009) and GMAC, LLC v. Hillquist, 652 F. Supp. 2d 908 (N.D. Ill. 2009).

The law of successor liability has been applied in situations involving different types of business entities by courts in Pennsylvania. For example, in Krosnar v. Schmidt Krosnar McNaughton Garrett Co., 423 A.2d 370 (Pa. Super. 1980), it was found that a successor corporation had assumed an obligation of one of the accountants who had practiced in a partnership before joining the firm:

…The first question concerns whether a liability assumed by Garrett in his practice before the merger of practices with the corporation was assumed by the corporation and remained as a corporate obligation after his withdrawal. Garrett had purchased the interest of his former partner, James Todd, payment of which was to be made in installments. In her findings of fact, the chancellor found that this obligation was indeed assumed by the corporation when Garrett became a shareholder and brought his practice into SKMG but that the obligation ceased to be a corporate one when Garrett withdrew his assets. We agree that the corporation is not liable on this debt and it should not enter into the calculation of the final distribution of the corporate assets.

The evidence fully supports a finding that the Todd-Garrett obligation became the responsibility of SKMG. Although the mere fact that a corporation takes over the assets and business of a partnership does not make it liable for the latter’s debts, In re W. J. Marshall Co., 3 F.2d 192 (S.D.Ga.1924); 18 Am.Jur.2d Corporations s 18, when it appears that the property of a partnership is simply transferred to the corporation, often without consideration other than corporate stock being paid, and the business continues essentially unchanged as a result of incorporation, then the corporation may be found liable for the partnership debts. Irby v. Davis, 311 F.Supp. 577 (E.D.Ark.1970). See Forest Laboratories, Inc. v. Pillsbury Co., 452 F.2d 621 (7th Cir. 1971); 149 A.L.R. 787, 797 (1944). The instant facts demonstrate that the continuity of the business was maintained. …

423 A.2d at 376. (When the accountant subsequently left the professional corporation, the debt ceased to be a corporate obligation.)

In Satler v. Rice, 135 A.2d 775 (Pa. Super. 1957), the court also found that a corporation had assumed the obligation of an individual. That case involved a writ of attachment execution pursuant to a judgment which had been entered against the defendant. The defendant had previously operated as in individual trading as a floor covering business and was registered under the Fictitious Names Act. He cancelled the fictitious name registration and formed a corporation along with three others. However, the defendant was the only one who received a salary or any other financial benefit from the corporation. The court noted:

The chronology attending the forming of the corporation is very significant. The rule to open the judgment was discharged by the court on June 11, 1955. Immediately thereafter the registration of Joseph P. Rice trading as Girard Floor Covering was canceled and a corporation bearing the name of Girard Floor Covering Company, Inc., was formed. If the alleged $1,000.00 was advanced by each of the three relatives it was contributed solely for the benefit of Joseph P. Rice. The three nominal incorporators and stockholders apparently expected and actually received no remuneration whatsoever.

It is true that the individual incorporators are persons other than the individual debtor but they are close relatives and all the surrounding circumstances make it clear that the sole purpose of forming the corporation was to allow the defendant, Joseph P. Rice, to continue in business without responsibility to his individual creditors. As was said in Gagnon v. Speback, 1957, 389 Pa. 17, 21, 131 A.2d 619, 621, “… this fiction will be disregarded and the individuals and corporation considered as identical whenever justice or public policy demand it and when the rights of innocent parties are not prejudiced thereby * * * “. We find that no rights of innocent parties will be prejudiced in this case because we are convinced that the relatives of Joseph P. Rice joined with him in forming the corporation for the purpose which we have stated.

Joseph P. Rice continued to have full control of the corporation and continued to operate it as his business without interruption or any essential change in the manner in which his business had been conducted. Under the circumstances we are of the opinion that the corporate veil must be pierced so that justice may be done. The fiction of the corporate entity may not be used to bring about unjust results – Norris Tool and Machine Co. v. Rosenlund, 1947, 355 Pa. 560, 50 A.2d 273; Edirose Silk Manufacturing Company v. First National Bank and Trust Company, 1940, 338 Pa. 139, 12 A.2d 40, and Tucker v. Binenstock, 1933, 310 Pa. 254, 165 A. 247.

Where a newly formed corporation takes over all the assets of an existing business it is responsible for debts and obligations of that business-Miller v. South Hills Lumber and Supply Company, 1939, 334 Pa. 293, 6 A.2d 92; Kulka v. Nemirovsky, 1936, 321 Pa. 234, 182 A. 692. In the instant case there were no tangible assets, but there is an intangible asset that passed from the individual to the newly formed corporation. Joseph P. Rice’s principal customer was S. Yellin & Son, Inc. Retaining almost the identical name the corporation continued to do business with S. Yellin & Son, Inc. In fact Frank W. Butterworth, vice president of S. Yellin & Son, Inc., testified that he continued to do business with Joseph P. Rice under the impression that Joseph P. Rice was still operating as an individual trading as Girard Floor Covering, and he did not know that Joseph P. Rice had formed a corporation.

135 A.2d at 776.

The situations in these cases are similar to those present in the instant action. While he was still operating as a sole proprietor, Defendant David Schlabach entered contracts for the purchase of metal fabricating equipment between March and May of 2010 and was purchasing material to be used in making metal roofing components. He received the fabricating machines in June of 2010. These items were subsequently used in the operation of the limited liability corporation. In addition, other equipment which was used during the operation of the sole proprietorship continued to be used in the operation of the limited liability corporation. Although David Schlabach eventually hired other employees to work in the manufacturing aspect of the new business, Christy C. Hostettler, an employee of the sole proprietorship since 2007, remained an employee of the new corporation. The limited liability corporation continued to conduct banking activities with the bank used by the sole proprietorship.

Plaintiff instituted a confession of judgment action against Defendant Dave Schlabach d/b/a Dave’s Metal Roofing on June 11, 2010 and the complaint in that action was served on June 17, 2010. Five days later, on June 22, 2010, the Certificate of Organization for Dave’s Metal Roofing, LLC was filed along with a fictitious name registration for the new corporation. This is the same name used for the operation of the sole proprietorship. Although the new corporation manufactured the roofing panels it sold, the business of the sole proprietorship continued otherwise unchanged. The new entity marketed the same products from the same physical location to the same customers in the same geographical area as the sole proprietorship.

At the time of its formation, Dave Schlabach was the sole member of the new limited liability corporation. Prior to the termination of the sole proprietorship, Schlabach made no arrangements regarding the debt owed to Plaintiff. Although Schlabach remained liable for the obligation, there remained no significant assets upon which any judgment could be executed. Defendants indicate that the real property upon which both businesses were conducted was held by Dave Schlabach in joint tenancy with his wife. All of the income-generating assets had become part of the new corporation. As the sole member of the limited liability corporation, Schlabach had the power to control the financial benefits and profits afforded by the new corporation; however, those profits remained beyond the reach of the creditors of the sole proprietorship due to the manner in which they were titled or because they were tied up in the corporation. We believe these circumstances justified our findings with regard to successor liability and that Dave’s Metal Roofing, LLC was properly added as a Defendant to this action. Thus, we find no error in our grant of Plaintiff’s Motion to Amend.

Defendants also argue that we erred in failing to find that they had not been credited with over $199,000.00 in payments in 2008. As noted by Plaintiff, Defendants appear to have abandoned that argument as they failed to address this issue in their Brief. However, we will briefly address this contention.

At the bench trial, Defendants’ expert, Derek Wolfganger, testified that Defendants’ payments from March, April, May, August and September of 2008 totaling $199,732.45 did not appear on any billing statements. Wolfganger reasoned that because the payments were not reflected on any of the statements, they were not credited to Defendants’ account balance.

This testimony highlighted one of the problems created by Plaintiff’s computerized billing system and the manner in which Defendants’ payments were handled on billing statements. As we noted in the discussion section of the Verdict, at the first portion of the bench trial on February 27, 2014, Plaintiff’s representatives stated that all payments would have been indicated on the billing statements, yet they acknowledged that the figures contained on the billing statements did not add up to the amount claimed to be the unpaid balance of the account. After it became apparent that some payments were not reflected on any of the billing statements, Plaintiff’s Chief Financial Officer, Carl Smith, conducted a review of all of the invoices issued to Defendants applied against all of the payments received and arrived at the figure of $153,516.99. He found no overpayment.

Smith explained that Wolfganger’s analysis was incorrect because payments were usually applied to the oldest outstanding invoice and would not necessarily appear on a billing statement, depending on what invoice they were applied against. This system led Wolfganger to believe that various payments had not actually been applied against the amount owed, when they had actually been applied to an invoice which did not appear on a particular billing statement. Smith pointed out other flaws with Wolfganger’s analysis such as giving double credit when Defendants’ checks were returned for insufficient funds and a second check would be issued by Defendants. We believe that this testimony, along with the documentation submitted by Plaintiff, supports our determination that $153,516.99 was the correct amount of the amount owed by Defendant on this account.

For these reasons, we will deny Defendants’ Post-Trial Motions and enter an appropriate Order.

1) Christy Hostettler became a 25 percent member of the limited liability corporation in 2013. However, as previously noted, he was an employee prior to that time.