In a decision that might raise more questions than it answers, a federal appellate court has addressed the imposition of successor liability under the Fair Labor Standards Act (the FLSA).1

In Teed v. Thomas Power Solutions,2 the US Court of Appeals for the Seventh Circuit upheld the imposition of successor liability for FLSA claims on a company that had acquired the assets of an insolvent predecessor at an auction conducted by a state law receiver. In doing so, the court ruled that federal common law (and not state law) governs the issue of successor liability for FLSA claims, but rejected the multifactor test usually applied to such successor liability questions under state law in favor of an apparent rule that presumes such liability absent the showing of sufficient good reasons to the contrary: “We suggest that successor liability is appropriate in suits to enforce federal labor or employment laws … unless there are good reasons to withhold such liability.”3

The court did not find any such sufficient “good reasons” present in Teed. However, it did identify one “good reason” that might be present in almost every distressed situation, including a sale of a bankruptcy debtor’s assets under Section 363 of the Bankruptcy Code: that the imposition of such successor liability after an insolvent debtor’s default would upend established legal priorities by elevating the unsecured FLSA claims of employees or former employees over the secured claims of any creditor with liens on the sold assets of their former employer. Thus, Teed, even in the Seventh Circuit, may well have continued to leave the issue of the imposition of successor liability for FLSA claims open not only in the context of Section 363 sales, but also in the context of state court receiver sales and secured creditor foreclosures, where it can be shown that the imposition of such liability “in such a case might upend the priorities of competing creditors.”4

Background

Employees of JT Packard & Associates (Packard) filed a suit against Packard and Packard’s parent, S.R. Bray Corp. (Bray) under the FLSA for overtime pay. After the FLSA suit was filed, Bray defaulted on a $60 million secured loan that was guaranteed by Packard. Bray assigned its assets, including its stock in Packard, to an affiliate of the lender bank, which placed the assets in receivership. The assets were then auctioned off to Thomas & Betts Corporation for approximately $22 million and placed in a wholly owned subsidiary, Thomas & Betts Power Solutions, LLC (Thomas & Betts). One condition of the transfer of assets to Thomas & Betts was that it was “free and clear of all Liabilities” and, specifically, that Thomas & Betts would not assume any of Packard’s liabilities in the FLSA litigation. Thomas & Betts continued to operate the Packard business much as Bray had done.

The district court in the FLSA litigation allowed the plaintiffs to substitute Thomas & Betts for the original defendants, Packard and Bray. Thomas & Betts objected to being substituted, and an appeal to the Seventh Circuit followed.

The Seventh Circuit’s Opinion

The Seventh Circuit addressed two questions in the appeal: (i) does the federal standard of successor liability apply in this situation and if so (ii) does it authorize the imposition of successor liability on Thomas & Betts.

As to the first question, the Seventh Circuit held that the federal standard of successor liability applied. The relevant state standard, in this case Wisconsin’s, limits successor liability to asset sales in which a buyer expressly or implicitly assumes the seller’s liabilities. The court noted that if the state standard applied, Thomas & Betts would not be liable because of its condition on the transfer of assets that it would not assume any of Packard’s liabilities in the FLSA litigation. The Seventh Circuit held that the state standard does not apply, however, because “when liability is based on a violation of a federal statute relating to labor relations or employment, a federal common law standard of successor liability applies that is more favorable to plaintiffs.”5 The court stated that the idea behind a federal standard applicable to federal labor and employment statutes is that these statutes are intended to foster labor peace and/or protect workers’ rights, and that these goals would be thwarted if the employer could extinguish liability via a corporate sale. The Seventh Circuit concluded that this reasoning extends to suits to enforce the FLSA.

Having determined that the federal standard applied, the court turned to whether that standard imposed liability on Thomas & Betts. The Seventh Circuit noted that “[a]s usually articulated, the federal standard of successor liability requires consideration of several listed factors.”6 However, the court suggested a slightly different standard. Pursuant to the Seventh Circuit’s standard, “successor liability is appropriate in suits to enforce federal labor or employment laws—even when the successor disclaimed liability when it acquired the assets in question—unless there are good reasons to withhold such liability.”7

The Seventh Circuit examined several potential “good reasons” for withholding successor liability. One of these arguments is that imposing successor liability on Thomas & Betts would provide a “windfall” to the plaintiffs given Packard’s financial situation before its assets were sold to Thomas & Betts. Packard was worth less than what its parent, Bray, owed to the lender bank, and Packard guaranteed that debt. Therefore, if Packard’s assets had not been sold, or if they had been sold piecemeal without successor liability, the plaintiffs would not have been able to obtain any relief on their FLSA claims. The Seventh Circuit rejected this argument because “to allow Thomas & Betts to acquire assets without their associated liabilities, thus stifling workers who have valid claims under the [FLSA], is equally a ‘windfall.’”8

Another potential reason for withholding successor liability is that allowing relief might allow the plaintiffs, whose claims are unsecured, to obtain a preference over the senior secured creditor, i.e. the lender bank. If potential bidders such as Thomas & Betts knew they would have to pay the workers’ FLSA claims, they would have bid less at the auction for Packard’s assets and, as a result, the bank would have obtained less money from the auction. Thus, “the bank’s secured claim would in effect become junior to the workers’ unsecured claim by the amount by which that claim depressed the price that the successor would pay for Packard.”9 The Seventh Circuit concluded while this may be a good reason not to apply successor liability after an insolvent debtor’s default, it does not apply in this case because Thomas & Betts admitted it did not discount its bid for Packard because of the FLSA litigation.

The Seventh Circuit also considered whether successor liability might complicate the reorganization of an insolvent company by incentivizing its workers to file a flurry of lawsuits in the hope that they will be able to substitute a solvent buyer for their current employer. Such lawsuits could scare off prospective buyers of the insolvent company’s assets. While the court acknowledged this may be a valid reason to withhold successor liability, it noted that there is no evidence the plaintiffs used such a tactic in this case.

Finally, the Seventh Circuit considered whether the possibility of successor liability will cause insolvent companies to sell their assets piecemeal rather than as going concerns. But the court dismissed this reason as “a theoretical rather than a practical objection” since it will only arise in the small fraction of cases where a company’s assets are worth more dispersed than as a going concern.10 For all of these reasons, the Seventh Circuit held that “there is no good reason to reject successor liability in this case— the default rule in suits to enforce federal labor or employment laws.”11

The reasons identified by the Seventh Circuit itself as “good reasons” for not imposing successor liability might be present in almost every other case involving a distressed employer, whether inside or outside of bankruptcy. Perhaps because the court did not find any of these reasons present in Teed, it provided no guidance as to whether (and when) the presence of one or more of these “good reasons” will warrant the rejection of Teed’s default rule of successor liability in future cases.

Moreover, where it arises in the context of a sale of assets under Section 363 of the Bankruptcy Code, the issue is likely to be further complicated because of the competing policy concerns of another federal statute—the Bankruptcy Code’s goals of maximizing the value of a debtor’s bankruptcy estate and preserving the going concern value of a debtor’s business. The imposition of successor liability for FLSA claims in the context of a Section 363 sale is already a source of disagreement among other circuits.12 Again, as Teed did not arise in the context of such a bankruptcy sale, the court did not expressly address these competing federal statutory schemes or this existing circuit split.

Thus, while Teed resolves in the Seventh Circuit the question of whether federal common law or state law applies to successor liability issues under the FLSA, an argument can be made that Teed appears to leave unsettled, even in the Seventh Circuit, the question of the likelihood of the imposition of successor liability for FLSA claims in a typical distressed situation, particularly one occurring in a federal bankruptcy case.