As businesses grow, business owners may start to think about further expansion and even consider acquiring another company’s operations. Typically, these acquisitions can be structured in a way that limits the potential liabilities for the purchaser company based on obligations on the seller company and the assets being acquired. However, even if a business owner thinks they are being business-savvy when considering the acquisition and related matters, failure to complete adequate due diligence can result in significant unexpected issues for the purchasing company, including unexpected labor and employment claims. Court cases in recent history have broadened potentially liability for successor companies in some jurisdictions and business owners should be aware of these possibilities to ensure they protect against them.
Successor Liability in Asset Sales
Generally, a buyer corporation, or acquiror, in an asset sale (as opposed to a stock sale) does not assume the liabilities of the seller’s corporation solely by purchasing the asset. Typically in asset sales, the buyer acquires the company’s assets, but not necessarily its liabilities. However, there are exceptions to that rule. Under the federal common law, “a successor corporation takes on the liabilities of its predecessor if (1) the successor expressly or impliedly agrees to assume the liabilities of the predecessor; (2) the transaction may be considered a de facto merger; (3) the successor may be considered a “mere continuation” of the predecessor; or (4) the transaction is fraudulent. Under the “mere continuation” exception, successor liability may apply if, “after the transfer of assets, only one corporation remains, and there is an identity of stock, stockholders, and directors between the two corporations.”
Recent court cases have also shown that some courts are further expanding exceptions to the general rule, with a more “lax” substantial continuity exception. Federal appellate courts in some circuits have found an exception to the general rule, holding that “when liability is based on a violation of a federal statute relating to labor relations or employment, a federal common law standard of successor liability is applied that is more favorable to plaintiffs than most state-law standards to which the court might otherwise look.” These circuits have applied this exception in matters arising under labor and employment statutes such as the Fair Labor Standards Act (“FLSA”), the Employee Retirement Income Security Act (“ERISA”), and the Family and Medical Leave Act (“FMLA”). When this standard applies, successor liability can result from an asset sale if: (1) the successor had notice of the claim; (2) the predecessor is unable “to provide the relief sought in the lawsuit” before or after the sale; and (3) “there is continuity between the operations and workforce of the predecessor and the successor.” In these circumstances, the above criteria are factors a court will consider, rather than elements that must be established.
The Fourth Circuit, which governs Maryland and Virginia, has not adopted the broad expansion of successor liability some circuits have, but applies the four exceptions provided under the federal common law.
Court Treatment of Successor Liability Claims
In 1990, the Seventh Circuit expanded successor liabilities in asset sales in Upholsterers’ International Union Pension Fund v. Artistic Furniture of Pontiac. There, the court held that a successor company, that purchased the predecessor company’s assets, could be liable under ERISA for pension contributions owned by the seller company to a multiemployer pension plan. The court found liability because there was sufficient evidence of continuity of operations and the successor company knew of the seller company’s liability. Later in 2011, the Third Circuit joined the Seventh Circuit in this expansion of successor liability when it held that a purchaser of assets from a seller company was liable for the seller’s delinquent contributions to a multiemployer plan, because there was continuity of operations and the purchaser company knew of the seller’s delinquency.
Then, in 2015, the Seventh Circuit yet again expanded potential successor liability when it held that an asset purchaser could be liable for a seller’s withdrawal liability, which was triggered by the asset sale, if the purchaser knew the seller’s multiemployer pension withdrawal would be triggered by the sale. In 2021, the Seventh Circuit again upheld this expansive view of successor liability.
In 2017, the Fourth Circuit considered successor liability under the False Claims Act (“FCA”) in U.S. ex rel. Bunk v. Gov’t Logistics N.V. However, the Fourth Circuit declined to expand the substantial continuity theory to claims under the FCA and held that common law controlled the issue. The court determined the Supreme Court had previously held that statutes could expand common law corporate ownership principles only if they did so explicitly. Since there was no explicit liability expansion in the FCA, the Fourth Circuit determined the FCA does not allow broader successor liability than what the common law allows.
What Does This Mean For Business Owners?
The key takeaway for business owners is that any potential acquisition should include significant asset due diligence to determine if there are liabilities that the purchaser may be liable for under this expanded theory of successor liability. This due diligence is even more crucial if the purchaser intends on substantial continuity of operations after the sale or if the sale could fall under the jurisdiction of a court that adheres to the expanded liability theory. Any due diligence should include a review of potential employment violations that may lead to successor liability issues for the purchaser. Businesses will also want to carefully consider the best way to structure asset acquisitions to best avoid triggering successor liability. Failure to consider the potential for successor liability after an asset sale can have significant financial consequences. In addition to the need for adequate due diligence, business owners contemplating asset purchases should consult with experienced counsel to ensure any transaction is structured properly and potential liability issues are considered and accounted for.
While, as of now, the Fourth Circuit hasn’t adopted this broader successor liability standard, future cases may require the court to consider this issue under different statutes, which may result in a different outcome as more jurisdictions adopt the standard. However, while this split amongst the circuits exist, with other jurisdictions applying different variations of the standard or disagreeing on application of factors to consider, it’s important to understand the specific laws of the jurisdiction you’re in or that might govern a potential business transaction.
Attorneys at General Counsel, PC are experienced in employment and corporate law matters and will be able to help business owners understand how the laws may affect them and how best to proceed if they’re considering an acquisition.
If you need more guidance or information, contact the corporate and employment law experts at General Counsel, PC today at 703-782-3266. Attorneys at General Counsel, PC are specialized in labor and employment law and corporate matters and have experience working with business owners and individuals across Virginia, specifically in Fairfax County, Arlington, Loudoun County, and Prince William.