On March 26, 2013, in the case of Teed v. Thomas & Betts Power Solutions, L.L.C.,1 the Seventh Circuit, in an opinion written by Judge Posner, joined at least one other circuit court and a multitude of district courts across the country in extending the federal common law standard for evaluating successor liability to suits brought under the Federal Labor Standards Act (“FLSA”).2 This federal standard, which was originally promulgated by the Supreme Court in the contexts of the Labor Management Relations Act (“LMRA”) and the National Labor Relations Act (“NLRA”), has already been applied to a myriad of other employee protection statutes, including the Employee Retirement Income Security Act (“ERISA”), Family and Medical Leave Act (“FMLA”), Age Discrimination in Employment Act (“ADEA”) and Title VII, and is generally a more plaintiff friendly standard than its state law counterparts. Although this case was decided in the context of a distressed asset acquisition made via auction during a Wisconsin state court receivership, this decision has potential implications for companies undergoing either out-of-court restructurings or formal reorganizations in the Bankruptcy Court.

This case originally arose when a group of employees filed suit against JT Packard & Associates (Packard) and S.R. Bray Corporation (Bray) under FLSA to recover their overtime pay. Several months after the lawsuit was filed, but prior to its resolution, Bray defaulted on its bank loan. All of Bray’s assets, including its stock in Packard, were placed in a receivership and auctioned off. Thomas & Betts acquired Packard’s assets for approximately $22 million, and continued to operate Packard, keeping the same facility, offering employment to many of the same employees, and retaining the company’s original name. Thomas & Betts and the bank specifically included in their definitive agreement of sale that the transfer of assets would be “free and clear of all liabilities” and that Thomas & Betts would not assume any liabilities of Packard relating to the FLSA litigation. Over the objection of Thomas & Betts, the federal district court in Wisconsin allowed Packard’s employees to substitute Thomas & Betts for the original defendants (Packard and Bray) under a theory of successor liability. Thomas & Betts and the plaintiffs entered into a settlement agreement, conditioned on the outcome of the appeal, which resulted in a final judgment against Thomas & Betts for $500,000, along with costs and attorney fees.

The Seventh Circuit affirmed Thomas & Betts’ successor liability, albeit under slightly different reasoning. In order to determine whether Thomas & Betts was liable to the employees under a theory of successor liability, the Court first analyzed whether Wisconsin state law or a federal standard applied to this case. Most states, including Wisconsin, limit successor liability to situations in which the buyer assumes the seller’s liabilities (with minor exceptions that were inapplicable to this case). As Thomas & Betts disclaimed all successor liability with respect to the FLSA lawsuit, had the Court found that Wisconsin state law applied, there would have been no successor liability for Thomas & Betts.

However, the Seventh Circuit instead found that the “federal common law standard,” which is “more favorable to plaintiffs” applied. In reaching this conclusion, the Court reasoned that the logic for having a distinct federal standard for federal labor and employment statutes such as the NLRA and Title VII is equally applicable to the FLSA. Otherwise, if the federal standard is not utilized, the efficacy of FLSA in protecting workers’ standards of living would be obviated by the fact that violators could either escape or at least impede a finding of liability by selling its assets and then dissolving.

Once the Court determined that the federal standard applied, the Court considered the factors typically evaluated when ascertaining successor liability in the federal context, including: (1) Whether the successor had notice of the pending lawsuit; (2) Whether the predecessor would have been able to provide the relief sought in the lawsuit prior to the sale of the company; (3) Whether the predecessor would have been able to provide the relief sought in the lawsuit after the sale of the company; (4) Whether the successor would be able to provide the relief sought in the lawsuit after to the sale of the company; (5) Whether there is continuation between the operations and work force of the predecessor and the successor.

The Court went on to state that “successor liability is appropriate in suits to enforce federal labor or employment law—even when the successor disclaimed liability when it acquired the assets in question—unless there are good reasons to withhold such liability.” The Court ruled that absent a showing of a “good reason” to the contrary, successor liability was the default result for buyers where FLSA claims were made against the seller. As the Court ruled that there was “no good reason to reject successor liability” proffered in this case, it upheld Thomas & Betts’ liability for $500,000 under FLSA.

The Court, sua sponte and in dicta, provided examples of what some “good reasons” there might be to withhold successor liability and discussed its view of the merits of those “good reasons.”

The first of the “good reasons” for withholding successor liability articulated by the Court would be an instance in which imposition of successor liability on Thomas & Betts would give a “windfall” to the claimants given Bray’s precarious financial condition. The Court rejected this argument because it reasoned that to allow Thomas & Betts to acquire assets and avoid legitimate liabilities would create an equal “windfall” to them.

The second “good reason” raised by the Court for withholding successor liability was that by allowing successor liability, the unsecured claims of the plaintiffs might be deemed to have priority over the senior secured claim of the bank. If a buyer knew it had to first pay FLSA claims in order to buy the assets at auction, it would bid less for the assets and the bank would get less, effectively subordinating its senior secured claim to the unsecured claim of the FSLA claimants. The Court rejected this argument, stating that while this might be a good reason not to find successor liability after an insolvent debtor’s default, it was inapplicable here because Thomas & Betts had conceded that it did not discount its bid for the assets because of the FLSA claims.

A third “good reason” to withhold successor liability discussed by the Court was in instances where successor liability would complicate the reorganization of an insolvent debtor by creating incentives for employees to file FLSA claims hoping that they would succeed in getting a substitute solvent buyer to be liable for those claims. The Court found that this potential “good reason” to avoid successor liability did not exist here, because there was no evidence offered that the plaintiffs used such a tactic.

The fourth and final “good reason” to withhold successor liability raised by the Court was that the possibility of a finding of successor liability could cause companies to sell their assets piecemeal rather than as a larger going concern. The Court subsequently rejected this idea by saying that this reason was only theoretical because only rarely will the company’s assets fetch more broken up than as a sale for all the assets as a going concern.

Bankruptcy Ramifications

As noted, this decision arose in the context of a receivership action under Wisconsin law and not in the context of a sale of assets under section 363 or a reorganization plan under the Bankruptcy Code. It remains to be seen whether its holding will be extended to bankruptcy cases in the Seventh Circuit or elsewhere. The classic conflict between the policies of federal labor laws and federal bankruptcy laws may again be tested in the context of successor liability for FLSA or other federal labor law claims.3

Nevertheless, this case serves as a reminder and warning to buyers who are pursuing distressed acquisition strategies for a company or its assets, that through the doctrine of successor liability, they may still be held responsible for the federal labor law claims against the seller, even if they affirmatively disclaim all liabilities in the documentation of sale.