Corporate lawyers negotiating asset purchase agreements believe strongly in the concept of freedom of contract.  Asset purchase agreements invariably have carefully crafted provisions dictating which assets and liabilities transfer to the buyer and which assets and liabilities remain with the seller.

Unfortunately, when it comes to employee and employee benefit liabilities, courts don’t always respect these carefully written contracts.  Courts are loathe to rule against employees or retirees who have lost certain rights or benefits as a result of a transaction, and an unsuspecting buyer can easily find itself responsible for employee-related liabilities that the buyer thought it had avoided.

In a recent example of this “buyer beware” phenomenon, the 7th Circuit held in Teed v. Thomas & Betts Power Solutions that an asset buyer was on the hook for a $500,000 settlement award for violations of the Fair Labor Standards Act (“FLSA”), even though the buyer expressly disclaimed the liability in the asset purchase agreement.

Thomas & Betts Corp. had purchased certain assets from JT Packard & Associates at an auction after Packard’s parent company defaulted on a bank loan.  Prior to the sale, a group of employees had sued Packard for unpaid overtime under the FLSA and reached a $500,000 settlement.  Thomas & Betts bought Packard’s assets and continued its operations, offering employment to most of its workers.  The employees sought to enforce the settlement against Thomas & Betts, even though the asset purchase agreement said the transfer was “free and clear of all liabilities,” including, specifically, any liabilities relating to the FLSA litigation.

The 7th Circuit noted that state law typically limits liability in an asset sale to those liabilities expressly or implicitly assumed by the buyer, respecting the concept of freedom of contract.  However, when the liability is based on a violation of a federal statute relating to labor relations (such as the National Labor Relations Act) or employment (such as Title VII), a federal common law standard of successor liability applies, which is more favorable to employees.  The 7th Circuit held that the federal standard extends to liability for FLSA claims.

This decision follows in a long line of cases that have imposed an employee-friendly standard of successor liability on asset buyers when certain employee benefits are at stake, such as:

• A buyer in an asset purchase has been found to be responsible for continuing disability benefits of the seller even though the purchase agreement provides otherwise.
• Buyers in an asset purchase could be liable for retiree health obligations where there is continuity of operations (even if there isn’t continuity in ownership) and notice of the liability.
• Successor liability can also apply to a top hat plan in an asset sale.

The Thomas & Betts case serves as a reminder that thorough due diligence in asset acquisitions and careful drafting of asset purchase agreements aren’t enough.  The parties need to be aware of the possibility of successor liability.  Buyers should carefully discuss these issues with their lawyers to understand the risks and consider ways to structure the transaction to minimize these risks, particularly if they are purchasing substantially all of the seller’s assets.  Sellers should be on notice that they may need to structure the deal to provide assurances to buyer that these employment-related liabilities will not be passed on to the buyer; otherwise, buyers may demand a discount in the purchase price.