Buyers of assets through the bankruptcy court process seek comfort and solace in the entry of a sale order providing for the transfer of assets “free and clear” of all liabilities. Except for those liabilities expressly assumed by the buyer and new owner, the bankruptcy court order typically includes exacting and precise language transferring those assets, under the imprimatur of the United States Bankruptcy Court, free and clear of all liabilities. A recent appellate court decision has found that the buyer did not take free and clear of certain claims of the insolvent former company in receivership, even though the sale order made that express finding. Although the asset sale concerned a receivership and not a bankruptcy, courts could impose liability on purchasers of assets in bankruptcy sales under the rationale articulated by the Seventh Circuit in certain circumstances.

On March 26, 2013, in Teed v. Thomas & Betts Power Solutions, L.L.C., 711 F.3d 763 (7th Cir. 2013), the U.S. Court of Appeals for the Seventh Circuit concluded that the imposition of successor liability on the buyer for the insolvent seller’s former employees’ claims for overtime pay under the Fair Labor Standards Act (FLSA) was appropriate, even in the wake of a sale that sought to transfer those assets free and clear of all liabilities of the former employees’ FLSA claims. The holding in Teed highlights the need for asset purchasers to strongly consider potential successor liability issues when conducting due diligence related to an asset purchase, including the purchase of assets from insolvent companies in receivership and, by analogy, those assets sold free and clear pursuant to bankruptcy court orders.

While Teed did not involve an asset sale by a debtor in bankruptcy, an understanding and overview of the bankruptcy sale process provides a good overview and backdrop to Teed. Section 363 of the Bankruptcy Code governs all asset sales, except for sales proposed as part of a chapter 11 plan of reorganization or liquidation. A Section 363 sale is made by motion on relatively short, 21-day notice to creditors. By contrast, a sale pursuant to a plan of reorganization involves a prolonged notice period and a two-step approval process: First, the approval of a disclosure statement (similar to an investor prospectus) and then the plan itself. Confirmation (approval) of a plan is further subject to creditor voting rights. Because a Section 363 sale is quicker, it is often the preferred vehicle of debtors-in-possession, committees and prospective purchasers.

Section 363(f) of the Bankruptcy Code provides that a sale of assets may be approved free and clear of liens and other interests if one of five statutory conditions are met:

  • Applicable nonbankruptcy law permits a sale free and clear of interests;
  • The interest holder consents to the sale;
  • The interest is a lien and the sale price exceeds the total value of all liens on the property;
  • The interest is in bona fide dispute; or
  • The holder could be compelled in a legal or equitable proceeding to accept money satisfaction of its interest in the property.

Section 363(f) strikes a balance between the property rights of interest holders and the policy of the Bankruptcy Code to maximize value for the estate. Outside bankruptcy, a buyer cannot acquire clear title until all liens and any clouds on title to the assets are resolved and a lienholder cannot be compelled to accept less than the full amount of its claim. By contrast, the bankruptcy court may approve a sale even if there are disputed liens on the assets or the sale proceeds will not be sufficient to satisfy the claims of all lienholders.

Although Teed is not a bankruptcy case, its holding regarding the imposition of successor liability, as well as its discussion related to the imposition of successor liability in the bankruptcy context, is insightful and should be considered by those looking to acquire assets free and clear of liability through the bankruptcy court process. In Teed, an employer which had defaulted under its secured obligation to a bank assigned its most significant and valuable asset to an affiliate of the bank. The bank subsequently placed the new assignee and new owner of the assets into receivership under Wisconsin law. The assets were then auctioned off to the defendant-appellant, Thomas & Betts Powers Solutions, LLC (Thomas & Betts). The Wisconsin court order provided that the transfer of assets was to be “Free and clear of all Liabilities” that were not assumed and expressly any liability under FLSA.

Following the purchase, the former employee and plaintiffs in the pending litigation, in search of a solvent defendant from which to recover on their claims from, substituted Thomas & Betts as a defendant. After the trial court overruled the objection of Thomas & Betts to their substitution as a party defendant, Thomas & Betts appealed to the Court of Appeals for the Seventh Circuit.

On appeal, the Seventh Circuit concluded that, absent good reason to withhold successor liability, such liability is appropriate in suits to enforce federal labor or employment laws because a federal common law standard of successor liability (which is more likely to find liability than most state laws of successor liability) is the proper standard to apply. The court concluded that the enforcement of successor liability was appropriate even where the purchaser sought to disclaim such liability.

In objecting to their joinder and substitution, Thomas & Betts argued that the imposition of successor liability would provide the plaintiffs with a windfall because, prior to the asset purchase when the seller was insolvent, the plaintiffs had no expectation that the company would be sold as a going concern and not piecemeal. To the extent the company assets were sold piecemeal, successor liability would have been precluded because of the lack of continuity between the predecessor and successor company. The Seventh Circuit, however, concluded that Thomas & Betts would equally be the recipient of a windfall absent the transfer of liability under the FLSA along with the assets.

Thomas & Betts also argued that allowing the workers to enforce their FLSA claims against them as successor would upset the creditor priority scheme by depressing the value of the assets sold and thus the potential recovery for the secured lender, while maximizing the value for workers who might file a lawsuit hoping to substitute a solvent purchaser for the employer. While the Seventh Circuit concluded that such a tactic might be a good reason to deny successor liability, the court rejected the argument because the purchaser admitted that it did not discount the purchase price despite knowing of the workers’ claims.

The Seventh Circuit also recognized that its ruling may result in an insolvent company or trustee for such company attempting to maximize the company’s value by selling the company piecemeal and not as a going concern. The court did not view such concerns as dispositive however, because most companies’ assets are worth much more as a going concern than piecemeal.

The Seventh Circuit’s decision in Teed provides a helpful reminder that additional consideration of potential successor liability issues, especially those arising under federal statutes, is necessary when purchasing assets. The court’s analysis provides a helpful framework for proactive asset purchasers and sellers to work from in order to help shield purchasers from successor liability in bankruptcy sales. In addition, a purchaser with a bankruptcy court order may be able to raise additional arguments in defense of such successor liability related to the effect successor liability would have on the bankruptcy priority system. Such arguments were not addressed by the decision in Teed and remain available to defend against claims for successor liability.