Due Diligence in Mergers & Acquisitions: Wage-and-Hour Liability Can Pass to Successor Businesses

Liability for wage-and-hour violations under federal employment laws may flow through to a successor business entity, even if a transaction is structured as an asset sale, rather than a stock sale.

When acquiring a business, a lot of time, energy, and money go into the due-diligence process, which includes a comprehensive review of the financial and operational strength of a business and its probability for success under new management. But it’s also important to look at a prospect’s employment practices. Beware of a company that uses a lot of “independent contractors” or that has possibly hired undocumented workers. Those red flags may indicate deeper problems— namely, wage-and-hour violations under the Fair Labor Standards Act. Even if other liabilities disappear in a business acquisition or asset sale, federal employment law claims may still flow through to the acquiring entity.

Businesses in violation of federal overtime and minimum-wage provisions will owe their employees two times the amount of the back wages with a two-year “claw back” period. 29 USC §§216(b), 255(a). Notably, undocumented workers are protected by the FLSA, despite the fact that they’re not legally allowed to work in the United States. See Wage and Hour Division, Fact Sheet #48 (Rev. July 2008). As you can imagine, wage-and-hour liability can be staggering, especially because the Department of Labor can pursue these claims collectively on behalf of all affected employees.

But it’s not just employers that have to worry about FLSA liability. The recent trend in the federal courts has been to impose federal employment-practices liability on acquiring entities (even when the transaction is structured as an asset sale, rather than a stock sale).[1] In fact, one court said that successor liability was “the default rule in suits to enforce federal labor or employment laws” and there must be a “good reason” to depart from that standard. Teed, 711 F.3d at 769. When performing due diligence on a prospect, it is, therefore, important to determine the potential for FLSA liability and to negotiate the acquisition accordingly.

Bankruptcy may be one “good reason” why successor liability should not attach, despite the worker-friendly federal-court trend. For example, in one Chapter 11 bankruptcy case, a successor entity acquired business assets yet was able to ditch discrimination liability because the transaction was, as a part of the bankruptcy, “free and clear” from any interest that “[arose] from the property being sold.” In re Trans World Airlines, Inc., 322 F.3d 283, 290 (3d Cir. 2003).

Although there are some exceptions, like the bankruptcy case above, courts seem to be trending in favor of workers on this issue. If you’re in the market to acquire a business, develop a checklist of red flags and cross reference your list with a prospect’s employment practices. Not every red flag will result in liability, but it’s a starting point for “employment practices” due diligence, which could save you big bucks in the long run.

[1] See Thompson v. Real Estate Mortgage Network, 748 F.3d 142, 150-51 (3d Cir. 2014); 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).

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