A common method for business expansion is for one company to acquire another company’s operations and then merge the operations into the acquiring company. However, even when care is taken to structure such acquisitions to limit or avoid the potential liabilities of the company being acquired, the transaction can result in the purchasing company being faced with unexpected employment claims, including claims made for unpaid minimum wage and overtime under the Fair Labor Standards Act (FLSA). A purchaser of the assets of an existing company can be held liable for the acquired company’s violations of the FLSA as a successor in interest under federal common law. In a recent case out of the Eastern District of Pennsylvania, a company that purchased the assets of a Philadelphia exotic dance nightclub discovered this fact the hard way. Herzfeld v. 1416 Chancellor, Inc., 2017 U.S. Dist. LEXIS 88732 (E.D. Pa. Jun. 9, 2017).
The plaintiff in Herzfeld worked as an exotic dancer at The Gold Club, a Philadelphia exotic dance nightclub that was previously owned and operated by 1416 Chancellor, Inc., (Chancellor). In 2014, Ms. Herzfeld sued Chancellor under the FLSA on behalf of herself and other dancers alleging that they were improperly classified as independent contractors and denied minimum wage and overtime as required by law. After the lawsuit was filed, APM Club, Inc., (APM), purchased Chancellor’s assets and continued to operate “The Gold Club” under new ownership with very little change in operations. In the asset purchase agreement, APM specifically disclaimed any liability for the Herzfeld lawsuit. Following the sale, Ms. Herzfeld added APM as a defendant to the lawsuit claiming that it too was responsible for Chancellor’s FLSA violations. The court ultimately agreed and allowed Ms. Herzfeld to pursue her pre-acquisition FLSA claims against APM under a federal common law theory of successor liability.
The United States Courts of Appeal for the Third, Seventh and Ninth Circuits have each adopted the federal common law standard on FLSA successor liability. Under that standard, which “presents a lower bar to relief than most state jurisprudence,” successor liability applies if there is “(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) [the] ability of the predecessor to provide adequate relief directly.”* Various federal district courts outside of the aforementioned circuit courts have also applied this standard, or a variation of it, to determine whether successor liability exists for FLSA claims. This standard has not been applied uniformly, however, as courts have disagreed about the application of the factors such as whether actual notice of liability is required or whether constructive notice is sufficient. In addition, other circuit courts of appeal have not addressed this issue directly and it is possible that they may adopt a different standard for determining FLSA successor liability. Accordingly, it is prudent to analyze the law in the applicable jurisdiction to determine the standard followed by the courts and what steps an asset purchaser may need to take to protect its end of the bargain.
The most important takeaway is that existing (and potential) employment liability issues should always be considered as part of any asset purchase. A due diligence review should include a review of any employment violations that could lead to successor liability so that necessary measures can be discussed and implemented prior to closing the deal. Companies with questions about how to address acquisition related issues should consult with experienced employment counsel to make sure that they understand how the laws may impact them.
Jeffrey B. Cadle is an attorney in Obermayer’s Pittsburgh Office, practicing in the areas of commercial litigation and employment law. He can be reached at 412-288-2473 or Jeffrey.Cadle@obermayer.com.
* Thompson v. Real Estate Mortgage Network, 748 F.3d 142, 150-51 (3d Cir. 2014); see also Teed v. Thomas & Betts Power Solutions, L.L.C., 711 F.3d 763, 765-67 (7th Cir. 2013); Steinbach v. Hubbard, 51 F.3d 843, 845 (9th Cir. 1995).