Pringle v. Hunsicker

California Court of Appeal
154 Cal. App. 2d 789 (1957)

ELI5:

Rule of Law:

A corporation formed to take over the business of a sole proprietor is not liable for the proprietor's undisclosed prior debts when the new entity has a different ownership structure, new investors contribute substantial capital, and the proprietor does not retain control.

Facts:

Homer L. Hunsicker operated a business as a sole proprietorship called Amber Duck Products Company.
Hunsicker owed his employee, Henry Pringle, $3,456 in unpaid wages earned long before the corporation was formed.
Hunsicker also owed $48,800 to numerous creditors, documented by promissory notes.
To resolve his financial difficulties, Hunsicker organized a new corporation, Amber Duck Products Corporation, to take over the business.
Hunsicker transferred his business assets to the new corporation in exchange for 1,132 shares of stock.
The corporation issued 4,880 shares to Hunsicker's note-holding creditors in exchange for their notes, making them the majority owners.
An additional 1,400 shares were sold to new investors for $14,000 in cash, providing working capital.
Pringle's wage claim was not disclosed on the balance sheet Hunsicker provided to the corporation, the note holders, or the new investors.

Procedural Posture:

Henry Pringle's administratrix sued Homer L. Hunsicker and Amber Duck Products Corporation in a state trial court to recover unpaid wages.
The trial court found in favor of Pringle's estate and entered a judgment against both Hunsicker and the corporation.
Amber Duck Products Corporation, as appellant, appealed the judgment to the California Court of Appeal, an intermediate appellate court.

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Issue:

Is a newly formed corporation that acquires the assets of a sole proprietorship liable for the proprietor's preexisting, undisclosed wage debt when the proprietor becomes a minority shareholder and new investors and creditors acquire a controlling interest?

Opinions:

Majority - Ashburn, J.

No. A newly formed corporation is not liable for the predecessor's debts under these circumstances because it is not a mere continuation of the old business. The court reasoned that the doctrine of successor liability, which applies when a corporation reorganizes with the same stockholders and directors, is inapplicable here. The court highlighted several key factors distinguishing this case: 1) Hunsicker became a minority shareholder, holding only 1,132 of 7,412 total shares, so he lost control. 2) His former creditors and new cash investors became the controlling majority. 3) The infusion of $14,000 in new capital from outside investors fundamentally changed the business. 4) The new board of directors, which included new members, formally disclaimed liability for Hunsicker's prior, undisclosed personal debts. Therefore, the corporation cannot be considered a mere continuation or alter ego of Hunsicker's sole proprietorship.

Analysis:

This decision clarifies the limits of the 'mere continuation' theory of successor liability, particularly in the context of incorporating a sole proprietorship. It establishes that a substantial change in ownership, the loss of control by the original owner, and the infusion of new capital from unaffiliated investors are sufficient to break the chain of liability. The ruling protects new investors and creditors who rely on financial disclosures when joining a new corporate enterprise, reinforcing the principle of corporate separateness. It distinguishes cases where a business owner simply changes the legal form of the entity while retaining control and ownership, which would trigger successor liability.

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