The recent decision of the U.S. Court of Appeals for the Seventh Circuit in Teed v. Thomas & Betts Power Solutions, LLC, holding that a successor company may be held liable for its predecessor’s violations of the Fair Labor Standards Act, serves as a cautionary tale to businesses when evaluating potential acquisitions. Traditionally, when evaluating and analyzing risk, buyers will rely on state-law successorship principles and avoid liability by including a disclaimer in the asset purchase agreement. But the decision of the Seventh Circuit, which hears appeals from federal courts in the states of Illinois, Indiana, and Wisconsin, held that buyers cannot disclaim liability under the federal labor and employment statutes.

What happened

S.R. Bray Corporation acquired the stock of JT Packard & Associates in 2006, and Packard retained its name and standalone operations. Two years later, employees fi led a lawsuit alleging violations of the FLSA. About the same time, Bray defaulted on a $60 million dollar loan and was put into receivership in Wisconsin. Thomas & Betts Power Solutions, LLC, acquired the company at auction for $22 million dollars on the condition that its acquisition was “free and clear of all Liabilities,” including any arising from the FLSA lawsuit.

Meanwhile, the FLSA plaintiffs and the predecessor agreed to settle for $500,000, and in seeking court approval of the settlement, the plaintiffs substituted Thomas & Betts as the defendant. Thomas & Betts objected, but a federal court in the Western District of Wisconsin rejected the objection, meaning that Thomas & Betts would have to pay the $500,000 FLSA settlement if the court approved the settlement.  

Federal common law standard of successor liability

In Wisconsin, as in most other states, disclaimers such as the one used when Thomas & Betts acquired Packard would normally have been suffi cient to protect Thomas & Betts from assuming the seller’s liabilities. However, the Seventh Circuit held that the disclaimers may be void when the violation of a federal labor or employment statute is at issue. In the case of violation of a federal law, a broader, more plaintifffriendly, federal common law standard of successor liability applies. To determine liability, the court considered the following:

  1. Whether the successor had notice of the pending lawsuit. Thomas & Betts had notice, which favored liability.
  2. Whether the predecessor would have been able to provide the relief sought in the lawsuit before the sale. The predecessor’s insolvency made the acquisition appear to be a “windfall” for the plaintiffs, according to the court, and thus counted against successor liability.  
  3. Whether the predecessor could have provided relief after the sale. The answer was no because the predecessor had already been sold, “with the proceeds of the sale going to the bank.” The predecessor’s inability to pay was a factor favoring successor liability.  
  4. Whether the successor can provide the relief sought. Thomas & Betts was able to provide the relief sought, another factor favoring successor liability.  
  5. Whether there is continuity between the operation and work force of the predecessor and the successor. After acquisition, the business and its workforce operated in the same capacity, thus favoring successor liability.

The Seventh Circuit cited as its rationale the need to foster labor peace and protect workers’ rights. “In the absence of successor liability, a violator of the Act could escape liability, or at least make relief much more diffi cult 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.” The court concluded that allowing Thomas & Betts to acquire the predecessor without its liabilities would “stiff” the workers’ recovery of their valid FLSA claims.

The court’s decision serves as a reminder for businesses and lawyers when analyzing the risks and structure of mergers and acquisitions. As was seen here, traditional conditional “free and clear” language will not necessarily allow the successor to avoid obligations based on a predecessor’s violation of federal labor and employment regulations. When considering asset purchases, successors should carefully consider whether federal employment liabilities exist, and if so, take that into account when structuring such purchases.