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Asset Purchase Agreements No Longer Protect Purchasers from Wage & Hour Claims Against Sellers


By Patricia Porter Kryder

A Company that was the highest bidder of the assets of another company, was found to be bound by a federal common law principle of successor liability for claims arising under the Fair Labor Standards Act (FLSA) and other federal labor and employment laws, although the written agreement between the buyer and seller stated the transfer would be “free and clear of all liabilities.”  Additionally, it was understood the purchaser Company would not assume any liabilities relating to the pending FLSA litigation.  However, the U.S. Court of Appeals of the Seventh Circuit agreed with the  lower federal district court that the federal common law of successor liability controlled because the  pending claims were based on a violation of a federal statute relating to labor relations or employment.

Disgruntled Employees being Purchased
The purchased company was forced into auction due to a defaulted loan.  The new Company’s purchased employees had previously filed a collective action to recover overtime pay under the FLSA for the purchased company.  When the new Company purchased the assets of the previous company, it knew of the pending FLSA lawsuit.  Therefore, one condition specified in the transfer of assets was that the transfer would be “free and clear of all liabilities” and that the Company would not assume any liabilities the old company might incur in the pending FLSA litigation.  However, and over the Company’s objections, the purchased employee’s pulled a fast one on the Company and were allowed to substitute the previous company for the new Company in its pending lawsuit, resulting in a $500,000 judgment against the Company.  The Company appealed.   

Contract cannot limit successor liability
The  Seventh Circuit found it  was appropriate to enforce successor liability on the new Company in a suit involving federal labor or employment laws, even in cases in which the successor Company explicitly disclaimed liability in writing when it acquired the selling company’s assets.  The Seventh Circuit reasoned a violator of the FLSA (i.e. the previous company) could otherwise escape liability by selling its assets at a higher price without having the purchasing Company assume those liabilities.  In reaching this decision, the Seventh Circuit followed  prior U.S. Supreme Court  precedent which held it  was necessary to liberalize general common law successor principles in cases brought under the Labor Management Relations Act and the National Labor Relations Act (NLRA) in order to achieve the objectives of those laws.

The   Seventh Circuit reasoned the principles set forth by the U.S. Supreme Court should be extended to the FLSA too, because there is an interest in legal predictability that is served by applying the same standard of successor liability to all federal statutes that protect employees.  The  Seventh Circuit discussed FLSA, NLRA and Title VII as part of its policy discussion.

Factors to be considered when purchasing assets of business
The Seventh Circuit considered five factors in making its determination.  The most important factor seemed to be the fact that the purchasing Company had notice of the pending FLSA lawsuit. The  Seventh Circuit considered whether the  employees were getting a “windfall” benefit due to the insolvency of the selling company and the defaulting bank loan.  The  Seventh Circuit reasoned that the predecessor company’s inability to provide relief favored successor liability, because without it, the  employees’ claims would be worthless.  Thus, the purchased employees were not obtaining a windfall through successor liability.  In addition, the  Seventh Circuit determined that the acquiring Company could afford to pay the successor liability, and it was benefiting from the continuity of the operations and work force of  its predecessor.

Take Away
Contrary to common belief of asset sales, a buyer cannot escape all company liabilities even with stellar attorney drafting of contracts.  This case will serve as a new angle of thought when assessing the pros and cons of acquiring companies and/or their assets in the future.

Read the case here.

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