Free and Clear? Not Quite: Court Hangs FLSA Liabilities on Purchaser

Contributed by Beverly Alfon

The term successor liability tends to make business owners uneasy – and rightly so, considering that it treads on our general notions of free enterprise.  Last week, the Seventh Circuit federal appellate court issued a decision that will undoubtedly increase those apprehensions (Teed v. Thomas & Betts Power Solutions, LLC, 7th Cir., No. 12-2440, 3/26/13).

JT Packard & Associates defaulted on a $60 million bank loan.  The company’s assets were sold at auction to Thomas & Betts Power Solutions, LLC.   Thomas & Betts entered into an asset transfer agreement with Packard that included standard language indicating that the transfer of assets was “free and clear of all liabilities” of Packard, and specifically included any liabilities arising from a pending Fair Labor Standards Act (federal wage and hour law) lawsuit that Packard employees filed before the company auctioned its assets. 

Eventually, the employees who brought the FLSA lawsuit against Packard settled their claims for $500,000.  However, in order to collect on that settlement, the former Packard employees successfully convinced a district court that Thomas & Betts should be substituted as the defendant in that case.  Thomas & Betts appealed the decision to the Seventh Circuit federal appellate court (which covers Illinois, Indiana and Wisconsin). 

The Seventh Circuit agreed with the lower court.  While most state laws tend to limit an acquiring company’s exposure to a predecessor’s legal obligations, the Seventh Circuit held that a broader federal standard for successor liability applies to liability under any federal labor statutes, including the FLSA.  The court explained that in labor and employment cases, “the imposition of successor liability will often be necessary to achieve the statutory goals because the workers will often be unable to head off a corporate sale by their employer aimed at extinguishing the employer’s liability to them.”  Simply put, an employer’s disclaimer to successor liability is no defense to these claims.

The court looked to several factors in determining that Thomas & Betts was a successor:

  • whether it had notice of the pending lawsuit prior to the auction;
  • whether Packard would have been able to provide the relief sought by the FLSA plaintiffs either before or after the sale;
  •  whether Thomas & Betts could provide the relief sought; and,
  • whether Packard operations and workforce continued through Thomas & Betts. 

Interestingly, the court acknowledged that there may have been good reasons to withhold successor liability.  However, Thomas & Betts either failed to raise them or there was no evidence to support the reasons.  For example, Thomas & Betts did not argue that the FLSA plaintiffs had another viable option of filing wage claims in Packard’s bankruptcy proceedings if the court imposed successor liability after Packard defaulted on the bank loan.  Their wage claims would have been treated as priority claims superseding the claims of the bank.  The court also indicated that a good reason for denying successor liability would be if the FLSA plaintiffs set out to file lawsuits for the mere hope of substituting a solvent successor as the defendant.  However, the court determined that in this case, the plaintiffs were not maneuvering for this result when they initially filed their lawsuit. 

Bottom line:  Regardless of “free and clear” language in asset transfers, an acquiring business may be left holding the bag on federal labor and employment liabilities incurred by the predecessor company.  Avoiding successorship factors, such as continuance of workforce and operations, must be contemplated if due diligence reveals a potential liability under federal labor and employment laws.