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Although buyers of businesses in asset transactions traditionally acquire the assets

free and clear of any liabilities of the seller expressly left behind when they pay

reasonably equivalent value for the assets and do not influence the seller’s

satisfaction of unsecured creditors, certain courts have recently applied the de facto merger

doctrine to hold buyers responsible for the liabilities of sellers of assets of distressed

businesses. This article will discuss these concepts, highlight a recent decision of the

Pennsylvania Supreme Court that may result in the de facto merger doctrine being applied

in such a manner and provide some helpful tips for practitioners.

In its recent decision in Fizzano Bros. Concrete Products, Inc. v. XLN, Inc. v. XLNT

Software Solutions, Inc., 42 A.3d 951 (Pa. 2012), the Pennsylvania Supreme Court

addressed for the first time the question of whether, in the context of an asset purchase, it is

necessary for shareholders of the selling corporation to have any ownership in the buyer in

order for the de facto merger doctrine to apply. Although the Court held that in a dispute

based on a contract that does not implicate any public policy concerns the de facto merger

A Stradley Ronon Publication | www.StRAdley.com SEPTEMBER 2012

The Real Deal:

Buyer Beware: A Cautionary Tale of the De Facto Merger Doctrine

By David E. Beavers and Caroline C. Gorman

Information contained in this publication

should not be construed as legal advice or

opinion or as a substitute for the advice of

counsel. The enclosed materials may have

been abridged from other sources. They are

provided for educational and informational

purposes for the use of clients and others

who may be interested in the subject matter.

Copyright © 2012

Stradley Ronon Stevens & Young, LLP

All rights reserved.

Stradley Ronon Stevens & Young, LLP

2005 Market Street, Suite 2600

Philadelphia, PA 19103-7018

215.564.8000 Telephone

215.564.8120 Facsimile

www.stradley.com

With other offices in:

Malvern, Pa.

Harrisburg, Pa.

Wilmington, Del.

Cherry Hill, N.J.

Washington, D.C.

New York, N.Y.

www.meritas.org

Our firm is a member of Meritas – a worldwide business alliance of more than 170 law offices in 60 countries,offering high-quality legal servicesthrough a closely integrated group ofindependent, full-service law firms.

Stradley M&A Insider

Transaction Tips: Letters of Intent

By Deborah Hong and John J. McGrath III

Before undertaking to negotiate

or draft a letter of intent, a party

to a contemplated transaction

should first determine whether entering

into a letter of intent is appropriate in

light of the contemplated transaction

and the surrounding circumstances.

Letters of intent may assist the parties to

agree in principle on basic material deal

terms, such as deal structure, purchase

price, closing conditions and basic

indemnification concepts, prior to

commencing the often time-consuming

and expensive process of negotiating the

definitive transaction agreements.

Parties often refer to letters of intent

while negotiating the definitive

agreements to bolster their negotiating

position or to refute the other party’s

position. Carefully drafted letters of

intent may also provide parties with

certain protections during the

negotiation process, such as through

confidentiality and exclusivity

provisions.

Letters of intent may also result in

certain drawbacks. An executed letter

(continued on page 2)


IN THIS ISSUE

Buyer Beware: A Cautionary Tale of the De Facto

Merger Doctrine...........................1

Transaction Tips: Letters of Intent.............................1

Pennsylvania Supreme Court Holds Shareholders Have LimitedPost-Merger Recourse..................5

Stradley Ronon’s M&A PracticeContinues Growth .......................6

doctrine requires “some sort of” proof of continuity of

ownership or stockholder interest, it expressly rejected any

mechanical interpretation of this requirement. Rather, the

Court required that the transactional realities and their

consequences be considered. The decision will make

acquisition planning and structuring more difficult for the

M&A practitioner, as there is now less certainty associated

with asset purchase transactions particularly when the

seller is financially distressed.

Asset Purchases and the De Facto Merger

Doctrine Generally

Traditionally, the standard approach when buying a distressed

business is to structure the transaction as an asset purchase,

which allows the buyer to choose which assets it will acquire

and which liabilities, if any, it will assume, leaving the

remaining assets and liabilities behind in the selling entity.

Under the traditional analysis, as long as the buyer pays

reasonably equivalent value for the assets and does not

interject itself in any way into the seller’s decision on how to

satisfy the seller’s unsecured creditors, the buyer takes the

assets free and clear of any liabilities expressly left behind.

Unfortunately, courts in Pennsylvania and New Jersey

recently have applied the de facto merger doctrine to hold

the buyer responsible for debts of the seller in connection

with the purchase of assets of a distressed business. In

determining whether a de facto merger exists, courts

consider the following factors in the context of each case:

(1) continuity of ownership between the buyer and seller;

(2) cessation of ordinary business operations and the

dissolution of the selling corporation as soon as possible

after the transaction; (3) the buyer’s assumption of

liabilities necessary for the uninterrupted continuation of

the seller’s business; and (4) continuity of management,

personnel, physical location, assets and the general

business operation. In the past, courts have emphasized the

importance of the continuity of ownership element, and

buyers have avoided successor liability by eliminating any

common shareholders between the buyer and seller. As a

result of the decision in Fizzano, this may no longer hold

true in Pennsylvania, and creditors’ counsel may point to

Fizzano as persuasive authority in other jurisdictions. Also,

there are a number of New Jersey Superior Court decisions

which have held in favor of creditors on de facto merger

claims while finding no continuity of ownership.

The Pennsylvania Supreme Court's Decision

Whether the seller or its shareholders must have a

continuing equity ownership in the buyer for a claim under

the de facto merger doctrine was the principal question in

Fizzano. The Supreme Court, in a nearly unanimous

decision, expressly held that:

“[I]n cases rooted in breach of contract and express

warranty, the de facto merger exception requires ‘some sort

of’ proof of continuity of ownership or stockholder interest.

... However, such proof is not restricted to mere evidence

of an exchange of assets from one corporation for shares in

a successor corporation. Evidence of other forms of

stockholder interest in the successor corporation may

suffice ...” (emphasis added).

The Court justified its imprecise standard due to the

equitable nature of the de facto merger doctrine and the

express provisions of the Pennsylvania Business

Corporation Law (BCL), which allows for the payment of

cash or other obligations to the shareholders of the selling

corporation in a statutory merger. The Court’s discussion of

the statutory merger provisions of the BCL, while correct

in its technical analysis, seems irrelevant. The Court’s

analysis, taken to its logical conclusion, completely

eliminates from the de facto merger doctrine the

requirement for any continuity of shareholder interest in

the buyer.

Further confusion results due to the lack of any guidance

on what the Court believes would constitute “some sort of

... continuity of ownership or stockholder interest.” Does

a promissory note to the seller or its shareholders satisfy

this test; what about employment by the buyer of one or

more shareholders of the seller? Some of these elements

would seem to relate more to the continuity-of-

management test and not to continuity of ownership, but

the Court drew no such distinction. In Fizzano, the

interests that carried over to the buyer were promissory

notes given by the seller to the shareholders of the entity

from which the seller had previously acquired the

business. Neither the seller nor any of its shareholders

had any continuing interest in the buyer.

Instead of giving legal substance to a recognized form of

transaction, presumably chosen by the parties because of its

predictable legal consequences, the Court required a review

of the “transactional realities and their consequences”

without stating any public policy to support its ruling. In

fact, the Court expressly stated that the underlying cause of

action in Fizzano is rooted in contract and corporate law

and does not implicate any public policy concerns.

Practical Takeaways

There are several points to consider when purchasing assets

from an insolvent or distressed seller that is located or

actively conducts business in Pennsylvania, New Jersey or

other jurisdictions that have an expansive interpretation of

the de facto merger doctrine:

2 | The Real Deal: Stradley M&A Insider, September 2012 © 2012 Stradley Ronon Stevens & Young, LLP

De Facto Merger Doctrine (continued from page 1)


• Evaluate whether a prepackaged bankruptcy may be the

best approach. The extra time and cost may be inexpensive

protection in the long run.

• Be sure to pay reasonably equivalent or fair value for the

assets being acquired.

• Be cautious with payment of employment or consulting

compensation or of restrictive covenants to the principals

of the seller.

• Do not discuss with the seller payments to specific

unsecured creditors, but consider requiring that the seller

establish an escrow of a portion of the purchase price to be

available for creditors.

• Consider carefully whether it is necessary to make the

former shareholders officers of the buyer.

• If you purchase the seller’s business name, consider

whether you should simply shelve it so that it cannot be

used by others, and commence trading under your business

name to rebrand as soon as possible,

• and do not advertise as a “successor” to the seller.

• Avoid using the seller’s business location other than for a

brief transition period. n

WWW.STRADLEY.COM The Real Deal: Stradley M&A Insider, September 2012 | 3

If you would like more information about the de facto

merger doctrine, please contact:

David E. Beavers215.564.8036 or

[email protected]

Caroline C. Gorman 215.564.8633 or

[email protected]

De Facto Merger Doctrine (continued from page 2)

Theodore D. Segal, chair ........202.419.8437 [email protected]

Deborah Hong, vice chair........610.640.5818 [email protected]

Frank A. Bacelli ........................202.419.8436 [email protected]

David E. Beavers .....................215.564.8036 [email protected]

Jonathan F. Bloom...................215.564.8065 [email protected]

Michael P. Bonner....................856.321.2405 [email protected]

Kevin R. Boyle .........................215.564.8708 [email protected]

Erin Troy Clinton ......................202.292.4526 [email protected]

Christopher S. Connell ............215.564.8138 [email protected]

Linda A. Galante ......................215.564.8075 [email protected]

Alan R. Gedrich .......................215.564.8050 [email protected]

Lori Buchanan Goldman..........215.564.8707 [email protected]

Caroline C. Gorman.................215.564.8633 [email protected]

Douglas A. Grimm....................215.564.8539 [email protected]

Thomas L. Hanley....................202.292.4525 [email protected]

Thomas G. Harris ....................484.323.1341 [email protected]

Amber A. Hough ......................215.564.8537 [email protected]

Thomas O. Ix ...........................215.564.8030 [email protected]

Jason R. Jones ........................215.564.8194 [email protected]

David H. Joseph ......................215.564.8090 [email protected]

Kevin P. Kundra .......................215.564.8183 [email protected]

William T. Mandia.....................215.564.8083 [email protected]

Christine M. McDevitt...............215.564.8136 [email protected]

John J. McGrath III ..................484.323.1343 [email protected]

Ryan A. McKenzie ...................215.564.8040 [email protected]

Kaitlin M. Piccolo......................215.564.8553 [email protected]

William S. Pilling III ..................215.564.8079 [email protected]

James F. Podheiser..................215.564.8111 [email protected]

Christopher W. Rosenbleeth ...215.564.8051 [email protected]

Christopher C. Scarpa.............215.564.8106 [email protected]

Gary P. Scharmett....................215.564.8046 [email protected]

Eric D. Schoenborn..................856.321.2413 [email protected]

Dean M. Schwartz ...................215.564.8078 [email protected]

Steven A. Scolari .....................610.640.8005 [email protected]

Anastasia C. Sheffler-Wood ......610.640.8012 [email protected]

Joshua N. Silverstein...............856.321.2416 [email protected]

Todd C. Vanett .........................215.564.8070 [email protected]

Alycia M. Vivona ......................202.419.8424 [email protected]

Ranan Z. Well ..........................202.419.8404 [email protected]

Steven J. White........................215.564.8161 [email protected]

Mergers & Acquisitions Practice Group

of intent may trigger certain reporting obligations for

publicly traded companies. In addition, if a letter of

intent is not drafted carefully and in line with the

parties’ intentions, the parties may inadvertently create

binding obligations, including an obligation to close

the proposed transaction.

Assuming the parties decide to enter into a letter of

intent, below are certain tips they should keep in mind

while drafting the letter of intent:

• Binding or Nonbinding Provisions. The

parties should clearly specify which provisions of a

letter of intent, if any, are binding and/or will

survive the termination or expiration of the letter of

intent. For example, a potential purchaser will want

to insist that an exclusivity provision be binding for

a specific period of time, or the parties will want to

create binding obligations of confidentiality that

survive termination. Outside those provisions that

the parties desire to be binding, the parties should

include an express provision that the remainder of

the letter of intent be nonbinding and that the

parties have no obligations until the definitive

agreements are executed or other conditions are

met. In making a determination as to the binding or

nonbinding nature of the provisions of a letter of

intent, courts will often examine: (i) whether the

parties manifested an intention to be bound; (ii)

whether the terms are sufficiently definite to be

enforced; and (iii) whether the letter of intent as a

whole is (or the specific provisions in question are)

supported by valid consideration.

When analyzing the parties’ intent to be bound,

courts will often consider the language of the letter

of intent, the negotiations and prior dealings of the

parties, industry practice, partial performance under

a letter of intent, and the nature and complexity of

the transaction.

• Duty to Negotiate in Good Faith. Parties to a

potential transaction, especially potential

purchasers, should pay particular attention to any

language in a draft letter of intent requiring the

parties to negotiate the transaction to closing in

good faith. While the duty to negotiate in good faith

does not require the parties to consummate the

contemplated transaction, it may affect the ability of

a party to terminate negotiations for any or no

reason or to condition closing on the acceptance of

deal terms contrary to those set forth in an executed

letter of intent. Whether a party has satisfied an

obligation to negotiate in good faith is a question of

fact, and courts have imposed serious penalties

when holding that a duty to negotiate in good faith

has been violated. While all courts do not agree,

certain courts have held that parties to a letter of

intent may be bound to negotiate in good faith,

even where such a duty is not expressly set forth

in the letter of intent. Therefore, it is important to

understand whether such an implied duty exists and,

if so, or if there is an express, binding duty in the

letter of intent to negotiate in good faith, that the

parties so conduct themselves in good faith.

• Include All Major Deal Points. The parties

should include in a letter of intent references to all

major deal points or face possible resistance from

the other side to any “new” deal conditions. Certain

deal points that may result in such resistance if not

stated in a letter of intent include, for example,

concepts relating to purchase price assumptions and

adjustments, deferred purchase price payments and

escrows, important closing conditions including

material closing deliverables, and post-closing

covenants, especially noncompetition and

nonsolicitation covenants.

In sum, parties to a potential M&A transaction

should consider many factors when deciding whether

to enter into a letter of intent and when drafting the

provisions of a letter of intent. When the time

arises, the parties should consider contacting counsel

for guidance. n

Letters of Intent (continued from page 1)If you would like more information about letters of

intent, please contact:

Deborah Hong610.640.5818 or

[email protected]

John J. McGrath III484.323.1343 or

[email protected]


In a significant decision for Pennsylvania corporations and

their shareholders, the Pennsylvania Supreme Court

recently held in Mitchell Partners, L.P. v. Irex

Corporation that the post-merger remedies of minority

shareholders whose shares are exchanged for cash in a freeze-

out merger are limited to a judicial appraisal in the absence of

fraud or fundamental unfairness.

Mitchell Partners arose out of a merger transaction involving

Irex Corporation, a privately owned Pennsylvania

corporation. Pursuant to the terms of the merger, minority

shareholders, such as Mitchell Partners, L.P., were to be

“cashed out” in exchange for their shares in Irex. Mitchell

Partners objected to the merger, claiming that it was a

“squeeze out” of minority shareholders at an unfair price.

Notwithstanding Mitchell Partners’ objection, Irex completed

the merger and commenced a post-merger valuation

proceeding in Pennsylvania state court to address the dispute

with Mitchell Partners over share price. While the valuation

proceeding was pending, Mitchell Partners filed a separate

lawsuit in federal District Court against Irex, its board of

directors and certain of its officers, asserting claims for

breach of fiduciary duty, aiding and abetting breach of

fiduciary duty, and unjust enrichment.

The defendants moved to dismiss Mitchell Partners’ federal

suit on the ground that Section 1105 of the Pennsylvania

Business Corporation Law (BCL) limited the post-merger

remedies of shareholders to a judicial valuation proceeding.

The District Court granted the motion and Mitchell Partners

appealed. On appeal, the Third Circuit reversed the District

Court’s decision, concluding that Section 1105 of the BCL

does not preclude post-merger common law claims brought

by minority shareholders. Because the Third Circuit did not

find the issue before it to have been decided by the

Pennsylvania courts, it also looked to Delaware law, which it

described as the “vanguard of corporate law,” for guidance.

The Court found the conclusion reached by Delaware courts

that appraisal is not an exclusive remedy to be persuasive.

The defendants sought a rehearing before the Third Circuit.

At the request of the Governor of Pennsylvania, who had

filed an amicus brief in support of defendants’ request for a

rehearing, the Third Circuit certified the following question to

the Pennsylvania Supreme Court:

“Does [Section 1105 of the BCL], providing for

appraisal of the value of the shares of minority

shareholders who are ‘squeezed out’ in a cash-out

merger, preclude all other post-merger remedies

including claims of fraud, breach of fiduciary duty,

and other common law claims?”

In a unanimous decision (with one justice abstaining), the

Supreme Court held that the express language of Section 1105

limited the post-merger rights of a minority shareholder to an

appraisal in the absence of “fraud or fundamental unfairness.”

The Supreme Court rejected the Third Circuit’s conclusion and

its reliance on Delaware law, which the court found to be

inapplicable because unlike Section 1105, the Delaware

appraisal statute does not expressly make valuation an exclusive

remedy. The Supreme Court did not address what specific

circumstances would constitute “fraud or fundamental

unfairness,” but it stated that “the fraud and fundamental

unfairness exception may not be invoked lightly,” and noted that

that the exception would not apply merely because a merger

was a “cash-out transaction” or the price was inadequate. The

Supreme Court further stated that “appraisal is intended as the

usual remedy in the absence of exceptional circumstances.”

The Irex decision is important for Pennsylvania corporations,

directors, officers and shareholders, as it confirms that the

BCL provides an extra layer of protection from post-

transaction claims for breach of fiduciary duty or other

common law claims. Of course, corporate decision-makers

must continue to avoid conduct that could be construed as

“fraud or fundamental unfairness” as the Supreme Court also

made clear that it would allow post-merger remedies if such

conduct were present, although it noted this would only occur

in exceptional circumstances. Corporate decision-makers

must also be mindful that Pennsylvania courts have permitted

minority shareholders to bring civil suits to enjoin corporate

transactions or seek money damages as long as such suits are

filed before the corporate transaction is completed. n

If you would like more information,

please contact William T. Mandia at

215.564.8083 or [email protected]

Pennsylvania Supreme Court Holds Shareholders Have Limited Post-Merger Recourse

By William T. Mandia

WWW.STRADLEY.COM The Real Deal: Stradley M&A Insider, September 2012 | 5


Ted Segal, formerhead of DLA Piper’sWashington office,joined us in January2011 to head our M&Apractice group. Ted

focuses his practice on corporate andsecurities law, representing public andprivate companies in business andfinancial transactions, includingmergers and acquisitions, equityfinancings, venture capitaltransactions, domestic andinternational joint ventures, andcorporate restructurings andreorganizations. The Legal Timesselected Mr. Segal as one of the Top10 “Dealmakers” in Washington, D.C.

Alycia Vivona, alsofrom DLA Piper, wasthe second significantrecent addition to ourM&A practice group.With more than 17

years of experience practicingtransactional law, Alycia’s deepexperience in domestic and cross-border transactions greatly enhancesour ability to help our clients obtainthe greatest value in their most criticalbusiness representations.

Third to join Stradleywas Ranan Well, anattorney formerly withBingham McCutchen.With more than 13 yearsof practice, Ranan has

counseled companies in regulatedindustries including financial services,energy and telecommunications,media and technology on mergers and acquisitions, private equity and venture capital investments, debt financings, joint venturearrangements, and general corporate matters.

Douglas Grimm, whopreviously served as thechair of the healthcarefraud & abuse practicegroup at PillsburyWinthrop, joined us in

December 2011. Douglas chairs ourHealth Care Practice and is active as aFellow of the American College ofHealthcare Executives (FACHE).Douglas has extensive experience inrepresenting health care clients invarious transactional matters, includingmergers and acquisitions, joint venturesand managed care contracting.

Thomas L. Hanley,former co-chair of SNRDenton’s securities andpublic companiespractice group, was ourfifth significant attorney

acquisition. During his career, Tomhas served as the seller’s or acquirer’scounsel in M&A transactions totalingmore than $11 billion and as issuer’scounsel in capital-raising transactionstotaling more than $7 billion. Inaddition, he serves as a primaryliaison between public companyclients and SEC, NYSE andNASDAQ staffs concerningdisclosure, governance, listingqualifications and interpretive issues.

Erin Troy Clinton, asenior attorneyexperienced incorporate, nonprofit andtransactional matterswas number six to

recently join us. Erin represents clientsin a range of corporate andtransactional matters includingcorporate formations, corporategovernance, venture financings,mergers and acquisitions, and jointventures. She also provides advice fornonprofit and tax-exempt organizations

including formation, registrations ofexemption, governance and financing.

Frank A. Bacellimarked the seventhsignificant attorneyacquisition for our M&Apractice group sinceJanuary 2011. Frank

joined the firm as of counsel in ourWashington office and will headStradley Ronon’s private equity practice.He was previously with GoodwinProcter and Hogan & Hartson (nowHogan Lovells), where he representedprivate equity, growth equity andventure capital funds in middle-marketinvestment transactions. Frank hasextensive experience advising portfoliocompanies of private equity funds inmergers and acquisitions and generalcorporate matters, and he also regularlyprovides legal and strategic advice tostart-ups and emerging businesses inconnection with financing and early-stage company matters.

Last, but not least, wefurther strengthened ourhealth care and M&Apractices with theaddition of Kaitlin M.Piccolo as an

associate in our Philadelphia,Pennsylvania office. Kaitlinrepresents clients in the health careindustry on a variety of complianceand regulatory issues. She hascounseled numerous health careindustry clients, including for profitand nonprofit hospitals, multi-hospitalsystems, integrated delivery systems,academic/teaching medical centers,medical schools, post-acute and long-term care facilities, downstream andancillary health care providers (suchas providers of home health care,durable medical equipment, infusiontherapy, hospice and dialysis). n

Since January 2011, we have added eight attorneys to our M&A practice group, which reflects our deliberate strategic

initiative to attract practitioners with sophisticated transactional and related experience who can advise our growing

public and private company client base.

Stradley Ronon’s M&A Practice Continues Growth

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