In many asset sales, buyers expressly state that they are not assuming any liability for pre-closing benefit plan operations. Parties to these transactions have assumed that courts will respect these disclaimers, but the reality is that there is some troubling authority on successor liability under ERISA where a seller fails to provide benefits or make contributions.

There are a few specific instances, for example under COBRA where a buyer may automatically have successor liability for continuing benefits if the seller of the business terminates all coverage. A recent decision by the Court of Appeals for the Third Circuit has created even more cause for buyer concern.

Recent Case Law

The Court of Appeals for the Third Circuit found that a purchaser of assets could be liable for an insolvent seller’s unpaid contributions to multi-employer plans by expanding upon precedent under federal labor law and Title VII. The court ruled that as a matter of statutory policy of protecting plan participants, successor liability can be found under ERISA if the buyer has notice and there is a continuation of the seller’s business without interruption or substantial change.

The court was influenced by the fact that the employees had lost their medical coverage after contributions stopped. We don’t know all of the terms of the purchase agreement from this decision, but the court mentions that unpaid contributions were not listed among the assumed liabilities in the agreement. Underpinning the court’s rationale was that the buyer with notice of a liability was in a position to insulate itself by a purchase price reduction or through an indemnity clause.

The law on successor liability under ERISA is far from settled and other courts may defer to the contractual agreement of the parties. For example, the U.S. Court of Appeals for the Seventh Circuit recently held that the purchaser of all of the assets of a bankrupt business did not have successor liability for “top hat” plan benefits under more traditional common law principles of successorship liability, which are stricter than the statutory policy requirements applied by the Third Circuit. (It should be noted, however, that other federal courts, including the Court of Appeals for the Seventh Circuit, have found that there is successor liability for benefits obligations in other circumstances.)

Practical Tips for Employers

Here are some practical tips for buyers desiring to protect themselves from successor liability:

  • Do thorough due diligence to identify potential liabilities and problems. By requiring notice, the court may have seemed to say that ignorance of problems is bliss, but you can’t adjust the sale terms to properly account for specific liabilities unless you know about them.
  • Require good representations from the seller that all required plan contributions have been made in a timely manner, and that there are no material outstanding benefit liabilities.
  • Draft covenants requiring the seller to continue to provide benefits accrued prior to the closing, and consider asking that certain benefits be paid out or that escrow accounts be established to back up the seller’s obligations.
  • Expressly disclaim any liability for benefits and contributions accrued prior to the closing.
  • Negotiate a current purchase price adjustment for disclosed problems and delinquencies.
  • Consider obtaining indemnification commitments from individual shareholders as well as from the selling entity. This is particularly important if the seller will not have remaining active businesses.
  • Try to work out practical arrangements to avoid the risk of successor liability. For example, require that the seller continue to offer medical benefits to COBRA beneficiaries for the statutory continuation period.

In some cases where the risk of a seller’s failure to fulfill its obligations seems high, the buyer might decide not to go ahead with the purchase.