SUCCESSOR LIABILITY…BUYER BEWARE

I bought his business and only bought the assets. Now I’m sued by a group of former employees for a huge wage and hour lawsuit. I thought I just purchased the assets of the business not their problems. What happened? Successor liability is what happened. This article will review this concept and some thoughts on your due diligence to avoid this real life scenario.

There are two basic ways to approach the acquisition of a business. 1. A merger or stock sale of a company; and 2. A purchase of just the assets. A buyer often thinks presumptively that the second form of acquiring a business protects them from the sellers underlying problems with products or employees. Indeed, the U.S. Supreme Court in Fogg v Blair (1890)affirmed this conclusion about an asset purchase. However, a phantom legal theory that has teeth emerged. This theory can surprise even the more sophisticated buyers. That legal theory is called “successor liability”.

What it means is that the seller’s hidden liabilities for employment claims including Wage and Hour, NLRB, ERISA, Title VII,ADA and FMLA etc. may follow the sale of the assets. While you may have a contract that says you do not assume liability for such claims, and that your seller will indemnify you, you will still have the hassle of the lawsuit. And, chasing your seller around for recovery. A bit messy and expensive. The same is true for products liability claims as well. The theory is designed to prevent fraud by a seller in trying to evade or avoid these liabilities through an asset sale.

The liberal “continuity of the enterprise” test used by courts to assess “successor liability” onto a buyer are relatively consistent from jurisdiction to jurisdiction and consist of the following elements:

  1. Did the buyer assume the seller’s name? Did it hold itself to the public as the same company? Maybe the trade name was wellrecognized in the industry or locale and was a part of the sale.
  2. Did the seller’s employees all move over to the buyer’s new business? The courts look at this as a continuity of employment.
  3. Did the management team remain the same or relatively the same? Again, was there a continuity of management and supervision of the same employees?
  4. Did the business carry on in the same location doing the same thing or things using the same equipment?
  5. Did the buyer know about the pending issues or claims?
  6. Did the seller remain in business or go out of business?
  7. Was there an assumption of any preexisting contracts of the seller?

This set of inquiries appears to be a more favored approach to analyzing whether the buyer should be held liable for the above claims. If the answer is “yes” to most if not all of these questions the courts tend to conclude that a “de facto” merger has occurred. This of course means all liabilities flow to the new entity.

Federal Courts in particular tend to adhere to this line of thinking. The Courts will seek to vindicate the enforcement of federal rights under federal laws. Some courts, a minority, will weigh the common law on this question which tends to favor what the parties agreed to do in their contract. The latter tend to be in the minority.

In Sullivan v. Dollar Tree Stores, 623 F3d 770 (9th Cir. 2010), the U.S. Court of Appeals for the Ninth Circuit held a Washington State employee plaintiff was not immediately entitled to FMLA benefits from her new employer because the buyer was not a successor in interest of her former employer.

In assessing whether the buyer, Dollar Tree, was a successor in interest of the seller under the FMLA, the Court considered that while Dollar Tree was operating a similar business out of the same location, Dollar Tree did not purchase any other assets besides the lease on the building. No inventory or equipment. Dollar Tree spent weeks renovating the store to meet its own design specifications. The court also noted seller’s employees were not all rehired by buyer, rather they were required to re-apply for jobs with Dollar Tree. The buyer only brought over 2 employees from the seller. Buyer trained its employees in its own methods; and employed a new store manager.

You can see from this case that when these questions were reviewed by the court there were sufficient facts to overcome a successor liability claim. When you enter into a decision to buy an ongoing business you will want to keep these elements in mind.

Having tight indemnity clauses and clear unequivocal seller warranties in the purchase and sale agreement is helpful. Clarity on what you are not buying is also critical. You may need to draw on these contract provisions for your contract claim against a seller. Such a claim however, does not stop the underlying employment litigation or products liability case. It means you will have two claims to pursue.

What about in Oregon? In Blachana, LLC v. Bureau of Labor and Industries, 354 Or 676 (2014), the Oregon Supreme Court imposed successor liability for reimbursement of unpaid wages by the old company on the new company. An employer was found to be a successor employer for purposes of wage claims if it "conducts essentially the same business as conducted by the predecessor”. Here the Oregon Supreme Court looked at many of the elements of the continuity of the enterprise test above.

I have witnessed many a transaction where the buyer minimizes their due diligence on the seller’s exposure to employment claims and products claims. This is an important aspect of any due diligence process. Your decision to use an asset purchase agreement alone will not insulate you from these claims. You should also be aware of the above issues and make changes in order to minimize this phantom exposure to risk.