Buyers Beware: Seventh Circuit Holds Asset Purchaser Liable for Target Company’s Fair Labor Standards Act Violations under Successor-in-Interest Liability

December 1, 2014

In the world of mergers and acquisition law, corporations and their attorneys have long used asset purchases to avoid a target company’s unsavory liabilities. The strategy is relatively straight-forward: by purchasing the target’s assets only, the buyer typically avoids the target’s liabilities, which the buyer would otherwise have to assume in a merger or stock purchase. The exception to this general rule is when a buyer either explicitly or implicitly assumes successor-in-interest liability. In the recent case of Teed v. Thomas & Betts Power Solutions, LLC, the Seventh Circuit held that an asset purchaser is still liable for the target company’s Fair Labor Standards Act (FLSA) violations under successor liability even if the purchaser explicitly disclaims liability for the FLSA claims.

In Teed, the target company’s parent organization defaulted on a secured loan and, in order to pay off the loan, assigned its stock in the target company to a receiver. At auction, another company bought all of the target’s assets and placed them in a wholly-owned subsidiary named Thomas & Betts Power Solutions, LLC, the defendant in Teed. Thomas & Betts ran itself in nearly identical fashion as the target company had done before its assets were sold, including keeping a majority of the target’s employees.

Before Thomas & Betts acquired the target’s assets, the Teed plaintiffs filed their FLSA suit against the target. Realizing this suit was pending, Thomas & Betts’ acquisition of the target included two conditions. First, Thomas & Betts took the target’s assets “free and clear of all Liabilities” which Thomas & Betts had not explicitly assumed. Second, Thomas & Betts would not assume any liabilities with respect to the pending FLSA litigation.

Under Wisconsin law and most state laws, such a disclaimer of liability would have been sufficient for Thomas & Betts to avoid successor liability.  However, because the Teed claims were based upon violation of federal statute, specifically, relating to labor relations or employment, the Seventh Circuit found that a federal common law standard of successor liability is applied that is more favorable to plaintiffs than most state law standards… In particular, a disclaimer of successor liability is not a defense.” Rather, in such federal labor or employment suits, a court will look to the federal standard for successor liability, which utilizes the following five factors to determine whether such liability exists. If answered in the affirmative, each of the following factors favor successor liability:

(1) Whether the successor had notice of the pending lawsuit.

(2) Whether the predecessor could have provided the relief sought in the lawsuit before the sale.

(3) Whether the predecessor could have provided relief after the sale.

(4) Whether the successor can provide the relief sought in the suit.

(5) Whether there is continuity between the operations and work force of the predecessor and the successor.

Applying these five factors to the facts in Teed, the Seventh Circuit determined that a majority of them favored imposing successor liability and held Thomas & Betts liable for the plaintiffs’ FLSA claims.

The Seventh Circuit offered the following explanation for applying such a standard in cases like Teed:

[T]he imposition of successor liability will often be necessary to achieve the [federal labor and employment statutes’] goals because the workers will often be unable to head off a corporate sale by their employer aimed at extinguishing the employer’s liability to them… In the absence of successor liability, a violator of the Act could escape liability, or at least make relief much more difficult to obtain, by selling its assets without an assumption of liabilities by the buyer (for such an assumption would reduce the purchase price by imposing a cost on the buyer) and then dissolving.

In light of the Teed holding, potential purchasers should fully investigate a target company’s pending or unresolved federal labor and employment litigation before executing the acquisition. Additionally, purchasers should be aware that either generally or specifically disclaiming liability for potential federal labor and employment violations is insufficient. A federal court will not consider such disclaimers; rather, it will look to the five factors outlined above.