How Successor Liability May Disrupt The Best Laid Plans Of Cyber Ninjas

PHOENIX, AZ – MAY 01: Contractors working for Cyber Ninjas, who was hired by the Arizona State … [+] Senate, examine and recount ballots from the 2020 general election at Veterans Memorial Coliseum on May 1, 2021 in Phoenix, Arizona. (Photo by Courtney Pedroza/Getty Images)

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A recent news article mentions that Cyber Ninjas, the firm employed by the Arizona Senate to conduct its ill-fated review of the 2020 election, will be formerly shutting down but will then be re-created as a new firm with the same workers doing essentially the same thing. The reason for this is that Cyber Ninjas is currently facing a $50,000 daily fine imposed by an Arizona judge for its contemptuous failure to turn over certain election review records. But will that work for Cyber Ninjas II, or whatever the new firm will be called, to avoid this liability? Probably not.

American law has long recognized the concept of \successor liability\, which means that a successor entity can be liable for the claims and judgments against its predecessor. The idea behind this concept is to prevent a company like Cyber Ninjas from doing exactly what it intends, i.e., to shut down the predecessor company so as to cut off its liabilities and then start up a new liability-free company doing basically the same thing.

Consider a local pizza place called ABC Pizza LLC down on the corner which is very successful in making pizzas. However, the pizza place gets into a dispute with one of its suppliers, and goes to court and suffers a large judgment. Instead of paying the supplier\’s judgment, the owners of ABC Pizza LLC reorganize it as DEF Pizza LLC and it continues business down on the same corner, with the same employees and making the same pizzas. In that event, the court would apply successor liability to make DEF Pizza LLC liable for the judgment against ABC Pizza LLC.

Successor liability is a concept which is an adjunct of alter ego liability, which is about as an amorphous a concept as is found in our law. There are a good number of factors that a court can properly look at, and the determination of whether successor liability exists is ultimately one of the particular facts and circumstances of a given case. However, there is a bit of certainty in that to establish successor liability, a creditor would need to prove at least two thing: First, that the same person or persons own or control both the predecessor entity and the successor entity, and, second, that an inequitable result would obtain were the entity separateness of the predecessor and the successor be respected.

As to the first element, it appears from news reports that the founder of Cyber Ninjas, being Doug Logan, will be forming the new company, and thus common ownership or control will be relatively easy to establish. The second element, being that it would be inequitable to recognize Cyber Ninjas as distinct from the new company, is more problematic for the reason that what constitutes an inequitable result is often difficult to figure out.

Among the circumstances that the court should look at would include whether the employees are common to both companies. That Logan has stated that he intends to re-hire the former Cyber Ninjas employees for his new company would be evidence in favor of successor liability. That the new company will apparently be in the same business as Cyber Ninjas will likely be more evidence that the new company will simply be a successor entity. But most important will be Logan\’s own public statements that he will essentially just be re-creating Cyber Ninjas with a different name ⸺ that is as close to a confession of successor liability as one will find.

A court might also take into account the nature of the liability against Cyber Ninjas, which is the $50,000 per day fine for contempt of court for refusing to turn over certain documents. Few things are taken so seriously by the courts as contempt of their orders, and this will likely way very heavily in the court\’s analysis of whether to impose this liability on a new entity.

Some might wonder whether bankruptcy of the predecessor company can cut off liability such that the liability doesn\’t follow to the new company. Normally, bankruptcy can wash out the claim against the predecessor company, thus allowing the business owner to start a new company without the liabilities of the old. The downside is that the filing of bankruptcy creates a bankruptcy estate, and if the predecessor is being liquidated in a Chapter 7 proceeding (as opposed to reorganized in a Chapter 11 proceeding), then a bankruptcy trustee will be appointed who will liquidate all the assets of the predecessor company and thus make it much more difficult for the successor company to get started.

In a way, that doesn\’t get Cyber Ninjas anywhere in its current apparent desire not to turn over documents as ordered by the court. If Cyber Ninjas goes bankruptcy, then a bankruptcy trustee will be appointed to take over Cyber Ninjas. The bankruptcy trustee could both come up with the document to satisfy the court\’s order, considering that bankruptcy will not block a contempt order, and also on behalf of Cyber Ninjas waive any attorney-client privilege that it might have regarding the documents, or even just communications with its own attorneys involving the recount. So, bankruptcy really doesn\’t get Cyber Ninjas anywhere, and it would frankly be a surprise if they filed for bankruptcy.

But let\’s say that Cyber Ninjas doesn\’t go bankrupt, but instead simply dissolves. This actually makes things worse for Mr. Logan, because the dissolution of an entity will also dissolve the entity\’s liability shield for its owners and make them directly liability for the entity\’s liabilities. That would mean that any owners of Cyber Ninjas could become liable for the $50,000 per day contempt order. So that\’s not much of an option either.

The more practical course for Cyber Ninjas to take would be to go back into court and attempt the so-called Impossibility Defense, which basically means that a person or entity held in contempt cannot be punished for that contempt if they lack the means to comply with the order, i.e., such compliance is impossible. The problem here for Cyber Ninjas is in making that showing, since they would literally have to show that they can\’t come up with any of the documents that they have been ordered to produce, and in this day and age of electronic records that is almost never the case.

All that leaves Cyber Ninjas with trying to do what they are doing now, which is simply ceasing to do business in the name of Cyber Ninjas but then setting up essentially the same company doing the same thing with the same owners, more or less, the some folks in control, and the same employees, and thus ignoring the contempt order. But that will likely result in the contempt liability flowing to the new company as well.

There is also the chance that the judge will apply the contempt order directly to Mr. Logan and any persons others in charge of Cyber Ninjas, which is frankly the most logical next step for the court. But we\’ll have to wait and see if that materializes. The bottom line is that if Cyber Ninjas just thinks it can change its name and continue doing business, that is probably a mistaken assumption.