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Successor liability for labor and employment violations depends on continuity and notice

October 2nd, 2017  |  Lorene Park

By Lorene D. Park, J.D.

No matter how cleverly a purchase agreement is drafted to avoid the assumption of liabilities, successor companies that have purchased another company may find themselves liable for the predecessor’s labor and employment law violations. Generally, courts consider three things in deciding whether to hold a successor company liable:

  1. Continuity in operations and work force of successor and predecessor employers. Were there changes in staff, office space, equipment, or working conditions? What was the pre-purchase relationship of the parties?
  2. Notice to the successor-employer of the predecessor’s legal obligation.
  3. The ability of the predecessor to provide adequate relief. Is the predecessor defunct?

Importantly, notice may include “constructive notice,” and successors can’t avoid liability by purposefully burying their heads in the sand. As the examples below suggest, courts generally see through this and other clever machinations designed to avoid liability. Before getting to that, however, it bears mentioning that there is some variation by jurisdiction in how the analysis plays out, including the development of a federal common law test that sets a lower bar for liability than the traditional common law test.

Traditional common law vs federal common law

A federal court in New York recently explained the development of the federal test. Under the traditional common law, a corporation that purchases another’s assets is generally not liable for the seller’s liabilities. Some states recognize exceptions for: (1) a buyer who formally assumes a seller’s debts; (2) transactions made to defraud creditors; (3) a buyer who de facto merged with a seller; and (4) a buyer that is a “mere continuation of a seller.” Courts have held that the latter two are “so similar that they may be considered a single exception” (Wang v. Abumi Sushi Inc. dba Abumi Sushi).

As for federal law, most employment statutes do not discuss whether liability may be passed to innocent successor employers, explained the Wang court. However, beginning with NLRA cases, federal courts developed a “substantial continuity” test, which sets “a lower bar to relief than most state jurisprudence” (it doesn’t require continuity of ownership), and was designed to impose liability on successors when necessary to protect important employment-related policies.

So how does this play out? Consider two cases with different outcomes, both focusing largely on whether the purchaser had notice, or “constructive notice” of potential liability.

Playing ostrich won’t preclude notice

In the first case, a debt collection law firm purchased a failing debt collection firm for $15,000. The successor admitted discussing some of the failing firm’s litigation but denied knowing of an employee’s sexual harassment claim until it was named as a defendant in her Title VII suit. Denying the successor’s motion for summary judgment, a federal court in New Hampshire explained that the principal reason for imposing a notice requirement is to ensure fairness by giving a successor “the opportunity to protect against potential liability through the negotiation process.” That purpose is not served if prospective liabilities could be shed simply by “playing ostrich,” the court averred, and here, the purchasers appeared to be engaging in an unspoken but mutually understood game of “don’t ask, don’t tell.”

Noting that precedent is unsettled on whether constructive notice is enough to establish successor liability, the court nonetheless applied the standard here. It explained that the purchasers were sophisticated attorneys. Also, the successor firm had, months before the purchase, hired an individual who was involved in the mediation of the employee’s sexual harassment claim before the EEOC. He testified that he did not discuss her claim with the successor, but the court was unconvinced, particularly since only a cursory review of the predecessor’s records would disclose the suit. The court also found substantial “business continuity.” The successor was using the predecessor’s office, hired most of its former employees, and now performs services for many of the same clients. Indeed, the modest purchase price of $15,000 was more suggestive of a de facto merger than a purchase, in the court’s view (Kratz v. Boudreau & Associates, LLC).

No notice, no liability

In the Wang case, the successor owner of a Japanese restaurant in New York was granted summary judgment against alleged FLSA violations that occurred before it was the plaintiff’s employer. The purchase agreement stated that the new owner bought the stock in trade, good will, and other assets “free and clear” of any debts or encumbrances, and there was no assumption of liabilities. Also, a rider represented that “the business sold herein is being operated in accordance with all laws, ordinances and rules affecting said business.” Nonetheless, a delivery worker employed by both the predecessor and successor claimed both should be liable for wage and hour violations that happened before the restaurant changed hands (subsequent alleged violations were not addressed by the motion).

Disagreeing, the court explained that the employee presented no evidence that the new owner had notice of the lawsuit or of the alleged violations giving rise to the suit. The court rejected the employee’s expansive view of constructive notice, which would impute notice of a predecessor’s violations on an innocent purchaser whenever the violations could have been discovered through diligence. That would “effectively create a duty of due diligence, which in the Court’s view should be imposed by Congress, or at least the Second Circuit, in the first instance.”

In discussing whether the federal “substantial continuity” test applied to FLSA cases, the Wang court noted that the Second Circuit has not yet weighed in. However, other Circuits have applied it in FLSA cases, including the Third, Seventh, Ninth, and Eleventh. Here, the Wang court found that the claim failed under both the traditional common law and the federal test. The lack of notice and the ability of the predecessor to provide relief were critical factors in this case, particular considering the goal of striking a proper balance between (1) preventing wrongdoers from escaping liability, and (2) facilitating the transfer of corporate assets to their most valuable users. To hold a purchaser of assets liable as a successor without notice of the potential liability, or where the predecessor is capable of providing relief to the wronged party—simply because it retained substantially the same work force to conduct a substantially similar business—would directly hamper the transfer of corporate assets to their most valuable users, said the court.

Cases where continuity is key

Purchase as a going concern. While the first two examples focused on whether the successor had notice of a claim so as to impose successor liability for a predecessor’s violations of labor and employment laws, the continuity of operations (office, equipment, business model, customers, etc.) is key in other cases.

For example, a company that purchased a troubled business as a going concern could not avoid WARN Act liability through clever drafting of the purchase agreement. Though the asset purchase agreement was written so the purchaser, Celadon Trucking, would avoid WARN Act requirements (stating that non-hired drivers “shall not be deemed . . . employees” of Celadon, that it would not be responsible for the predecessor’s “liabilities or obligations,” including under the Act), the Eighth Circuit affirmed a district court’s ruling that, because the company was purchased as a “going concern,” the laid-off individuals were Celadon’s “employees,” and it was liable for failing to give 60 days’ notice of a mass layoff. The appeals court also found that Celadon could not reduce any damages through the good faith defense (Day v. Celadon Trucking Services, Inc.).

Cherry-picking workforce. Continuity of operations is also key in cases where a purchaser allegedly tries to avoid legal obligations under employment laws by cherry-picking which of the predecessor’s employees to hire or retain after a purchase. In such cases, a court might find the purchaser was a “successor employer” and the refusal to hire was done for an unlawful purpose.

For example, purchasers have been held to be successor employers under ADA, liable for discriminatorily refusing to hire the predecessor’s disabled workers. In one case, a federal court in Florida upheld punitive damages against a successor based on a jury’s finding that it acted with malice or reckless indifference in refusing to a predecessor’s employee who had just taken FMLA leave due to cerebral meningitis. Though the employer claimed she failed to fill out application materials, she testified that she was informed by an employee of the successor, on the very day it assumed operations, that she was rejected due to excessive medical leave. This and other evidence raised a reasonable inference that the successor “used the transition . . . as a ruse to rid itself of certain employees under the guise of declining to offer employment,” said the court (Noel v. Terrace of St. Cloud, LLC).

Bringing work in-house, going non-union. In another case, the District of Columbia Circuit agreed with the NLRB that CNN was a successor employer to outside contractors that it had for years used to provide technicians to operate the electronic equipment at its New York City and Washington, D.C., bureaus. CNN did not contend that it made a significant change in the essential nature of the contractor’s operations; basically, it continued the same operations with employees who performed the same work, at the same locations, using the same equipment. The only question was whether the majority of CNN’s employees were previously employed by the contractor. Here, the overwhelming evidence of anti-union animus on CNN’s part led the Board to presume that a majority of incumbent employees would have been hired but for CNN’s discriminatory hiring practices. In the appellate court’s view, it was reasonable for the Board to infer that CNN planned to hire a sufficient number of former contractor employees to lend an air of impartiality, while avoiding the number that would impose a bargaining obligation. By replacing a unionized contract with a nonunion, in-house workforce, CNN violated the NLRA (NLRB v. CNN America, Inc.).

Successor bar doctrine – let dust settle before challenging union’s majority status. Cherry-picking a workforce is not the only way successor companies have tried to avoid collective bargaining. In an April 2017 opinion authored by retired Supreme Court Justice Souter, the First Circuit found that the NLRB properly applied its successor bar doctrine, under which an incumbent union is entitled to represent a successor employer’s employees for a reasonable period of time (not less than six months) before its majority status may be questioned. In the case at issue, Lily Transportation took over part of a bankrupt employer’s business that distributed parts for Toyota, and the incumbent union soon demanded to be recognized as the drivers’ bargaining rep. Refusing, Lily produced signed statements it claimed were from a majority of drivers saying that they no longer wished to be represented by the union. A law judge found that the company was a “successor employer” because it made a “conscious decision to maintain generally the same business and to hire a majority of its employees from the predecessor.” Applying the successor bar, the Board found that Lily unlawfully refused to bargain with the union (NLRB v. Lily Transportation Corp.).

You might as well be diligent

The take-away from these cases is fairly clear—courts will not let a purchaser avoid compliance with, or liability under, labor and employment laws through clever contractual language, purposeful ignorance of pending claims, or cherry-picking a workforce. As a consequence, purchasers are well advised to do their due diligence, uncover all the skeletons in the closet, and either factor potential liabilities into the purchase price or walk away.

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