Last week, the U.S. Court of Appeals for the Seventh Circuit addressed whether a buyer of assets outside of bankruptcy (in this case, from a receivership), takes on successor liability for federal Fair Labor Standards Act ("FLSA") claims made by the employees of the company whose assets it purchases. Although the case arose in a receivership, the Seventh Circuit’s opinion provides important insights into how these issues play out in bankruptcy sales of substantially all assets of a debtor.

Successor Liability Imposed. In Teed v. Thomas & Betts Power Solutions, L.L.C., the Seventh Circuit held that the buyer took on successor liability for the FLSA claims, even though the sale was made "free and clear" of all liabilities generally and of the FLSA claims in particular. The Seventh Circuit ruled that although those provisions would have protected the buyer, Thomas & Betts, under applicable Wisconsin state law, the FLSA is a federal statute and under federal common law, the buyer had successor liability for the FLSA claims. You can read a copy of the Seventh Circuit’s opinion, issued March 26, 2013, by clicking on the link in this sentence.

Contrast With Section 363 Bankruptcy Sales. As discussed in a recent post, when a debtor is facing major potential liabilities, the ability of a bankruptcy court to order the sale to the buyer "free and clear" of liabilities, including successor liability, can lead to a much higher price in a Section 363 sale. Cases discussing successor liability in bankruptcy therefore get the attention of those involved in distressed asset sales.

  • At first glance, the Seventh Circuit’s opinion seems to be troubling news for buyers of assets from distressed companies because the buyer in the Teed case was held to have successor liability for the FLSA claims at issue.
  • However, there appears to be more to the Seventh Circuit’s thinking. In its opinion, written by Judge Richard A. Posner, the Seventh Circuit concluded that "successor liability is appropriate in suits to enforce federal labor or employment laws–even where the successor disclaimed liability when it accepted the assets in question–unless there are good reasons to withhold such liability."  It was in examining possible "good reasons" not to impose successor liability that the Seventh Circuit specifically highlighted bankruptcy sales.

Seventh Circuit’s Analysis. Given that most bankrupt companies are insolvent, the Seventh Circuit noted that imposing successor liability on a buyer might allow unsecured FLSA claims against the seller (debtor) to become, effectively, senior to a secured creditor’s claim against the debtor if the buyer lowered its purchase price to account for such claims:

That is a good reason not to apply successor liability after an insolvent debtor’s default, whether its assets were sold in bankruptcy or outside (by a receiver, for example, as in this case): to apply the doctrine in such a case might upend the priorities of competing creditors. See In re Trans World Airlines, 322 F.3d 283, 290, 292-93 (3d Cir. 2003); Douglas G. Baird, The Elements of Bankruptcy 227-28 (5th ed. 2010). It’s an example of a good reason not mentioned in conventional formulations of the federal standard for not imposing successor liability. But it doesn’t figure in this appeal. Thomas & Betts has not urged it. It says that it didn’t discount its bid for Packard because of the workers’ claims; this both suggests that it didn’t anticipate successor liability and may explain why the bank has not complained about the imposition of that liability.

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Thomas & Betts argues finally, with support in Musikiwamba v. ESSI, Inc., supra, 760 F.2d at 751, that allowing the workers to enforce their FLSA claims against the successor, in a case such as this in which the predecessor cannot pay them, complicates the reorganization of a bankrupt. Seeing the handwriting on the wall and wanting to minimize the impact of the reorganization on them (in loss of employment or benefits), the workers might decide to file a flurry of lawsuits, whether or not well grounded, hoping to substitute a solvent acquirer for their employer as a defendant in the suits. The prospect thus created of increased liability might scare off prospective buyers of the assets. But there is no suggestion of such a tactic by workers in this case; if there were, it would be another good reason for denying successor liability. Still another concern is that an insolvent company, seeking to maximize its value, might decide not to sell itself as a going concern but instead to sell off its assets piecemeal, even if the company would be worth more as a going concern than as a pile of dismembered assets. In the latter case there would be as we said no successor liability, and successor liability depresses the going concern value of the predecessor, so the insolvent company might be better off even though it was destroying value by not selling itself as a going concern. Once a firm is in Chapter 7 bankruptcy (or in a Chapter 11 bankruptcy in which a trustee is appointed), or receivership, it is “owned” by the trustee (or receiver), whose sole concern is with maximizing the net value of the debtor’s estate to creditors (and maybe to other claimants—including shareholders, if the estate is flush enough to enable all the creditors’ claims to be satisfied in full). In re Taxman Clothing Co., 49 F.3d 310, 315 (7th Cir. 1995); In re Central Ice Cream Co., 836 F.2d 1068, 1072 (7th Cir. 1987). With immaterial exceptions, the trustee in a Chapter 7 bankruptcy (or, we assume, a receiver) must sell the debtor’s assets for the highest price he can get. 11 U.S.C. § 704(a)(1); In re Moore, 608 F.3d 253, 263 (5th Cir. 2010); In re Atlanta Packaging Products, Inc., 99 B.R. 124 (Bankr. N.D. Ga. 1988). He may not cut the price so that some junior creditor can enforce a claim not against the debtor’s assets but against a third party, the successor, in this case Thomas & Betts. The trustee would be required to sell the assets piecemeal if that would yield more money for the creditors as a whole (to be allocated among them according to their priorities) than sale as a going concern would, even if some creditors would be harmed because successor liability would have been extinguished, and even if economic value would have been destroyed.

But this is a theoretical rather than a practical objection. Since most firms’ assets are worth much more as a going concern than dispersed, successor liability will affect the choice between the two forms of sale in only a small fraction of cases. Lynn M. LoPucki & Joseph W. Doherty, “Bankruptcy Fire Sales,” 106 Mich. L. Rev. 1, 5 (2007).

Conclusion. Although the Court of Appeals did not find any of the potential "good reasons" applicable in the Teed case, its discussion of the problems with imposing successor liability in a bankruptcy sale is helpful.  Despite the holding, the decision’s analysis provides support for buyers seeking protection from successor liability in bankruptcy sales, even from liability under federal labor and employment statutes that might otherwise trump state law, and likewise for bankruptcy courts issuing orders granting buyers that protection. For that reason, it is an interesting and important opinion for buyers and sellers of distressed assets and the professionals that work with them.