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Closing the Deal: Buyers Beware of FLSA Successor Liability

Last week we discussed pitfalls in ignoring and strategies for addressing labor and employment issues in due diligence from both the buyer and seller side, but with special attention to buyers.  I wanted to finish the series with a larger point from the mergers and acquisitions part of my practice and my days doing M&A in the tech world: labor and employment issues are too often overlooked in purchase agreements. Too often, amid all the talk about asset valuations, tax implications, and structuring the financing, buyers can lose sight of the serious wage and hour issues they are buying in the deal.  For buyers in particular, the single best way to avoid costly lawsuits or DOL enforcement actions is to conduct detailed FLSA and state wage and hour due diligence like we discussed last week.  This holds true for any purchase that involves employees, regardless of whether the buyer plans to take them on post-acquisition.

This is true even if the deal is set up correctly from a corporate standpoint with a clean break between seller and buyer.  Last year, the Third Circuit held in Thompson v. Real Estate Mortgage Network that plaintiffs only need to meet a very lower bar to establish successor liability post-acquisition.  The plaintiffs were mortgage underwriters for a New Jersey-based mortgage company.  In 2010, the plaintiffs completed new job applications for Real Estate Mortgage Network (REMN).  The former employer eventually went out of business, but plaintiffs continued to work for REMN: same work, same desks, same location, only with a different employer issuing the paychecks.

The plaintiffs sued both the former employer and REMN, alleging that they had violated the FLSA and New Jersey law by misclassifying them as exempt employees who were not entitled to overtime.  The district court disagreed, dismissing the case.  However, adopting the rationales from the Seventh and Ninth Circuits, the Third Circuit concluded on appeal that REMN could be held liable as a successor under the federal common law test used with Title VII and other employment statutes.  The three part test required plaintiffs to allege: “(1) continuity in operations and work force of the successor and predecessor employers; (2) notice to the successor-employer of its predecessor’s legal obligation; and (3) ability of the predecessor to provide adequate relief directly.”  Applying those factors, the Third Circuit found that the plaintiffs had done enough.  In particular, the court noted that a small group of managers from the former company had assumed corporate leadership roles with REMN and had continued the same wage and hour violations.  Without allowing a claim against REMN, the plaintiffs would have had no relief, since the predecessor company had gone out of business and could not satisfy any judgment.

In other cases, importantly for buyers, courts have refused to enforce asset purchase agreement provisions that purport to disclaimed liability for FLSA claims, finding that they did not preclude successor liability.  As the Thompson court explained, allowing this result would let violators of the FLSA to “escape liability or at least make relief much more difficult to obtain.”

Upshot for Employers

The Third Circuit’s decision last year serves to highlight the importance of last week’s due diligence tips and strategies.  Buyers cannot assume that courts will allow them to contract away or otherwise disclaim their successor liability.  Plan accordingly and don’t leave labor and employment due diligence to a last minute afterthought.  Following through on due diligence can minimize buyers’ ultimate liability, or at least allow a reassessment of the true value of an acquisition in light of the wage and hour risks uncovered.

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