The federal successor-liability doctrine makes a buyer company responsible for the seller's Fair Labor Standards Act liability even if state law would hold otherwise, the seventh circuit rules.

The seventh circuit has ruled that the federal common-law doctrine of successor liability is applicable to cases filed under the Fair Labor Standards Act, even in states that limit liability to cases in which the buyer expressly or implicitly assumed the seller's liabilities.

In Teed, et al., v. Thomas & Betts Power Solutions LLC, 12-2440 and 12-3029, consolidated (7th Cir., 2013), a unanimous seventh circuit panel affirmed a Wisconsin District Court's finding of successor liability for FLSA claims, even though the defendant corporation purchased the plaintiffs' employer pursuant to an agreement that expressly stated the transfer of assets would be "free and clear of all Liabilities."

Gary R. Gehlbach, a partner with Ehrmann, Gehlbach, Badger, Lee & Considine LLC, said the seventh circuit's decision, drafted by Judge Richard Posner, created a tough result for the defendant corporation, which did not seek to reduce the purchase price when it bought the assets of the bankrupt predecessor corporation that employed the plaintiffs at the time of the alleged FLSA violations.

"It's a little disingenuous when property is sold by a bank and the agreement said the liability would not attach and the court says it does, but now we know," Gehlbach said. "When we represent companies buying other businesses, our due diligence now extends to whether there could be potential Fair Labor Standards Act liability."

The five federal-law factors

The case involved plaintiffs who were employed by a company commonly known as "Packard," which allegedly violated the FLSA when Packard was owned by a parent corporation, S.R. Bray Corp.

Several months after the plaintiffs filed their FLSA suits, Bray defaulted on a $60 million secured loan it had obtained from a Canadian bank. To repay the debt, Bray assigned its assets, including its ownership of Packard, to an affiliate of the bank. The assets were placed in receivership under Wisconsin law and were auctioned off, with the proceeds going to the bank.

Thomas & Betts, the successor company and substituted defendant in this case, purchased Bray's assets and continued operating Packard in essentially the same manner and with almost all the same employees. According to the court, the purchase agreement expressly stated that Thomas & Betts would not be liable for any and all damages that might be incurred in these FLSA cases.

"If Wisconsin state law governed the issue of successor liability, Thomas & Betts would be off the hook because of the conditions" of the asset-transfer agreement, Posner wrote for the appellate panel. "But as we said, [state laws] do not control, or even figure, when the federal standard applies."

The appeals court identified and applied the five elements of the federal common-law doctrine of successor liability as follows:

The first issue was whether the successor company had notice of the pending lawsuit, "which Thomas & Betts unquestionably had when it bought Packard at the receiver's auction; this is a factor favoring successor liability."

The second factor was whether the predecessors (Packard and Bray) would have been able to provide the relief sought in the lawsuit before the sale. "The answer is no, because of Packard's and Bray's insolvency caused by Bray's defaulting on the bank loan. This answer counts against successor liability by making such liability seem a windfall to plaintiffs."

The third element was whether the predecessor could have provided relief after the sale. "[A]gain, no-Packard had been sold, with the proceeds of the sale going to the bank…. The predecessor's inability to provide relief favors successor liability."

The fourth issue was whether the successor (Thomas & Betts) could provide the relief sought in the suit. "Thomas & Betts can - without which successor liability is a phantom."

The final factor was whether there was continuity between the operations and work force of the predecessor and the successor, "as there is in this case, which favors successor liability on the theory that nothing really has changed."

No 'windfall' for buying company, Posner writes

The defendant had argued that allowing plaintiffs to obtain relief would give them a "windfall" because they had no right to expect Packard would be sold. If Packard would have remained under Bray's control, or if Packard had been dissolved rather than purchased, there would have been no way for the plaintiffs to obtain the relief sought. The trial and appellate courts, however, disagreed.

"[T]o allow Thomas & Betts to acquire assets without their associated liabilities, thus stiffing workers who have valid claims under the Fair Labor Standards Act, is equally a 'windfall'," the court held. "We suggest that 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."

Gehlbach said this decision is a substantial change from the history of how liabilities were, or were not, transferred to successor corporations.

"Historically, transferee liability for companies acquiring other businesses was limited to things like unpaid sales tax or state employment tax," Gehlbach said. "But Judge Posner, in his own unique style of writing, said that federal common law applies instead of state law. So, again, at least now we know and we can advise our business clients accordingly."