Recently, the U.S. Court of Appeals for the Seventh Circuit, in a decision authored by Judge Richard Posner, Teed v. Thomas & Betts Power Solutions, L.L.C., held that federal common law and not state law applied to the determination of successor liability for a Federal Labor Standards Act judgment. The case involved a claim for unpaid overtime under FLSA brought by former employees of JT Packard & Associates. When the assets of JT Packard were sold to Thomas & Betts, the plaintiffs substituted Thomas & Betts into the lawsuit (against Thomas & Betts’ objection), and the district court, applying the doctrine of successor liability, enforced a $500,000 settlement that JT Packard had reached with the plaintiffs prior to the asset sale.
On appeal, Judge Posner’s opinion noted that the question to be decided was whether Thomas & Betts was liable for the settlement amount by virtue of the doctrine of successor liability. By way of background, subject to certain exceptions, many states limit liabilities in asset sales unless expressly or implicitly assumed by the buyer. (In a stock sale only the owners of the entity change and thus liabilities of the entity continue in existence; the new owners cannot disclaim such liabilities.) However, the doctrine of successor liability places liability in an asset sale on the buyer in certain circumstances, even if, as in this case, the buyer in the asset purchase and sale agreement expressly disclaimed such liabilities.
Significantly, the court held that the doctrine of successor liability was to be determined by federal common law and not the state law of Wisconsin, which was the governing law otherwise. Wisconsin law would not have found Thomas & Betts to be liable, because in the asset agreement it had specifically disclaimed responsibility for the FLSA settlement. However, the court held that federal common law applied because it was appropriate in suits to enforce federal labor or employment laws and to achieve federal statutory goals of promoting labor peace and protecting workers rights.
Having concluded that federal common law applied to the determination of successor liability, the court then analyzed a five- factor test to find that, on balance, successor liability was appropriate in this case. The five factors consisted of the following:
- Whether the successor entity had notice of the lawsuit. Since Thomas & Betts had notice, this factor favored successor liability;
- Whether the predecessor entity would have been able to provide the relief sought in the lawsuit prior to the sale. Since JT Packard was insolvent, the answer was no, a factor against successor liability;
- Whether the predecessor entity could have provided the relief sought after the sale. Since JT Packard was insolvent, the answer was no, a factor against successor liability;
- Whether the successor entity could provide the relief sought, without which successor liability is a phantom. The answer was yes, a factor that favored successor liability; and
- Whether there is continuity between the operations and work force of the predecessor and successor entities. The answer was yes, a factor that favored successor liability.
The case should serve as a wake-up call to buyers in an asset sale to consider not only state law in assessing whether they may become liable for the obligations of the seller relating to the business that is purchased. There may be circumstances where a buyer should consider trying to negotiate a reduction in the purchase price to account for such liabilities.