Caveat Emptor… Especially When Purchasing a Company at Auction

In late March, a federal court of appeals ruled that an electrical contractor who purchased the assets of another company in a foreclosure sale was responsible for a $500,000 Fair Labor Standards Act settlement of the acquired business.

It’s an important reminder to employers about the potential for successor liability, writes Ted Boehm of law firm Fisher & Phillips:

“In Teed v. Thomas & Betts Power Solutions LLC, a company that acquired another business’s assets at a receiver’s auction was held to be responsible for paying a $500,000 settlement reached in an FLSA lawsuit between the predecessor business and its employees. The acquiring company knew about the FLSA lawsuit prior to the asset acquisition and specifically disclaimed liability for the lawsuit as a condition of the asset-transfer agreement.”

The court ruled that buyer and seller cannot make liabilities go away merely by writing them into the contract. Boehm continues:

“[I]n what is perhaps one of the most-instructive aspects of the decision for other employers, the court ruled that an explicit contractual disclaimer of the FLSA liability was not a good enough reason standing alone to avoid the default rule. The court concluded among other things that, if an acquiring employer could contractually disclaim liability in this fashion, the ‘statutory goals’ of the FLSA would be frustrated, and ‘a violator of the Act could escape liability or at least make relief much more difficult to obtain.’”

Three takeaways from the Seventh Circuit ruling:

1. More uncertainty for buyers:

“The Court’s decision is premised on the concept that if an asset purchaser has notice of FLSA claims, it can adjust its offer accordingly. However, it is unclear what constitutes ‘notice’ of the claims. If the asset purchaser learns in due diligence that the predecessor has received a demand letter from an attorney representing a single plaintiff, and that plaintiff subsequently files a collective action on behalf of thousands of employees, dis the asset purchaser have ‘notice’ of the potential liability? The decision also creates uncertainty as to what constitutes continued operations in determining successor liability.” (Baker Donelson)

2. Both state and federal successor liability rules must be considered:

“In structuring mergers and acquisitions transactions, businesses and lawyers typically analyze the risk of an ‘excluded’ liability being imposed on the purchaser in opposition to the contractual intent of the parties within the framework of these state laws. The Seventh Circuit’s decision in Teed stands as a reminder that a further level of analysis is in order when the liability to be left behind by the purchaser arises under a federal statute relating to labor relations or employment, including (as a highlighted in this decision) the FLSA. The federal common law standards for successor liability in such circumstances bear similarities to certain state theories, but acquirors and their advisors should take care to consider all of the factors under both state and federal theories of successorship when assessing potential asset purchases where employment liabilities are present.” (Morgan Lewis)

3. Ignoring liabilities is never the right approach:

“While the decision might at first appear to discourage due-diligence on this score – the court referred to the acquirer’s knowledge of the pending FLSA lawsuit as favoring successor liability – this would not be the wisest approach… The more prudent course would instead seem to be to determine early on whether potential FLSA liability exists, and then to consider the prospects for successor liability under the specific facts presented, what might be done to decrease the chances that successor liability would be found, and whether the acquisition might be structured in such a way as to provide a financial cushion if successor liability is imposed. The employer can then give these matters informed consideration in evaluating the overall risks and benefits of proceeding with the transaction.” (Fisher & Phillips)

The updates:

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