Because M&A Due Diligence Was Not Already Complicated Enough…

21 April 2014 Labor & Employment Law Perspectives Blog

A recent federal appeals court decision suggests that businesses looking at potential acquisitions or mergers have yet another, relatively new concern to their due diligence list when examining the target business: an increased potential for claims alleging federal wage-and-hour law violations under a successor employer theory. In the case, the United State Court of Appeals for the Third Circuit concluded that the federal common law standard for successor liability – a much easier standard for plaintiffs to meet than state law successorship standards – applies to federal Fair Labor Standards Act wage-and-hour claims. This evolving successor liability standard means merger and acquisition considerations just received another layer of potential complexity.

Historically, the question of whether successor entities are liable for a predecessor entity’s violation of the FLSA has been governed by state law standards, which often require a formal assumption of liabilities or proof that the successor is a mere “continuation” of the predecessor company. Among other things, the FLSA provides employees with the ability to bring claims against their employers to recover damages where they have not been paid proper overtime compensation for over 40 hours in a workweek. In the recent decision, the former employee had worked for one entity for approximately 8 months, and then was asked to submit an application to a new entity, and thereafter, she received her paychecks from the new entity. However, after the change in formal employers, she continued to do the same work, at the same desk, for the same rate of pay, and under the direct supervision of the same individuals.

In her unpaid overtime lawsuit, the employee named both the original employing entity and the later entity as defendants, with the claim against the later entity also alleging successor liability for the overtime violations allegedly committed by the prior employer. The subsequent company claimed that New Jersey’s standard for successor liability barred the employee’s claim, but the appellate court disagreed, asserting that lower bar of the federal common law standard applied. Under that standard, successor liability is based only on the consideration of: “(1) continuity of operations and work force of the successor and predecessor employers; (2) notice to the successor employer of its predecessor’s legal obligation; and (3) ability of the predecessor to provide adequate relief directly.” Against that standard, appellate the court found that the employee’s allegations were sufficient to allow her to proceed with her successor liability claim.

With the recent decision, the Third Circuit now joins several other circuits of the Court of Appeals in determining that federal common law, and not state standards, govern successor liability under the FLSA. As a consequence of what appears to be an emerging trend, businesses interested in acquiring or merging with an existing company should carefully investigate a target’s wage and hour practices as part of their due diligence. We thus recommended that parties looking to acquire or merge with an existing business should engage counsel who, among other things, are knowledgeable about the requirements of the FLSA and successor liability standards under the federal common law and the laws of the jurisdictions in which the successor company will operate.

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