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A Seller’s Labor Law Violations Can Transfer to the Buyer of Business Assets

Businesses often acquire other businesses through an asset purchase, rather than a stock purchase, so that the buyer does not inherit the liabilities of the seller. Not all business owners realize that state contract law (which governs the purchase transaction) does not apply to federal labor law violations, and that buyers may be liable for seller’s violations no matter what their purchase agreement says.

Federal courts have been extending successor liability to the Fair Labor Standards Act (“FLSA”) since 2013. This would apply to overtime violations and misclassification of workers, either as contractors instead of employees or as exempt instead of non-exempt. Penalties for violations include back pay and liquidated damages equal to the amount of back pay owed. Willful violations are subject to fines and imprisonment.

The Seventh Circuit (with jurisdiction in Illinois, Indiana and Wisconsin) ruled in Teed v. Thomas & Betts Power Solutions, LLC, that a buyer of a company’s assets can’t rely on state law to keep a seller’s violations of the FLSA from transferring to the buyer of assets. Federal labor law claims are governed by federal common law, not state law.

The Court’s rationale was that it is not fair for deals in some states — but not others – to extinguish federal labor law violations upon sale of a company. In addition, employees with claims do not have power to stop the employer from selling the company to get out of paying for the employment law violations. When certain criteria are met, the buyer (successor) is stuck with the seller’s liability, no matter what their contract says.

The concept is not new. The federal common law standard for successor liability has been applied to the Labor Management Relations Act, National Labor Relations Act, Title VII of the Civil Rights Act, Age Discrimination in Employment Act, Family and Medical Leave Act. This ruling extends this doctrine to violations of the FLSA. This ruling is not the law in the Fourth Circuit, which covers North Carolina, but it would be influential if the Fourth Circuit were asked to rule on this issue.

To determine whether successor liability applies, the Seventh Circuit considered the following multi-part balancing test:

1. Whether the successor (buyer) had notice of the pending lawsuit;

2. Whether the predecessor (seller) would have been able to provide the relief sought in the lawsuit before the sale;

3. Whether the predecessor (seller) could have provided relief after the sale;

4. Whether the successor (buyer) can provide the relief sought in the suit (if not successor liability is a phantom); and

5. Whether there is continuity between the operations and workforce of the predecessor (seller) and the successor (buyer) – which favors successor liability because nothing really has changed.

It is now more important than ever to conduct thorough due diligence before purchasing another company, and to adjust the price or to reserve funds to account for labor violations.

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