by Matthew H. Parker
The Rhode Island federal court recently held that a buyer of an employer’s assets can be liable for the seller’s violations of federal and state wage laws, even if the buyer is a separate entity with distinct management and ownership from that of the seller. If the buyer continues the seller’s business operations, it should conduct careful due diligence and confirm that the seller will have sufficient assets after the sale to satisfy any lingering debts.
Deals Involving Wage Liability Get More Scrutiny
Under long-standing Rhode Island case law, a company that purchases the assets of another company generally isn’t liable for the debts of the seller. In a decision issued on January 3, 2017, however, Senior Judge Mary M. Lisi of the U.S. District Court for the District of Rhode Island held that isn’t an absolute defense to claims under the Fair Labor Standards Act (FLSA) or the Rhode Island Minimum Wage Act.
Specifically, Judge Lisi adopted a report and recommendation in which Magistrate Judge Patricia A. Sullivan concluded that when an asset purchaser continues the business operations of the seller, the purchaser can be held accountable for the seller’s wage violations if the purchaser had constructive notice of the violations or if the transaction left the seller incapable of satisfying its liability.
Guarcas v. Gourmet Heaven, LLC, involved GSP Corp.’s purchase of a single Providence food store known as Gourmet Heaven from two sellers, Gourmet Heaven, LLC, and Chung Cho. GSP also purchased the store’s lease, the rights to use its trade name and phone number, and all of its property, equipment, and merchandise. Significantly, however, GSP didn’t purchase the store’s holding company from Cho. It also didn’t purchase a second Gourmet Heaven in Providence, which Cho owned through a separate holding company.
There Were Some Red Flags
Before the sale closed—in fact, before the parties signed the underlying asset purchase agreement—Cho was named in two lawsuits and one criminal proceeding in which he was accused of multiple counts of wage theft associated with Gourmet Heaven stores in Connecticut and Rhode Island. One of the stores was the store that was ultimately purchased by GSP, and all three cases were matters of public record.
The Guarcas case was one of the two pending lawsuits. A group of employees who had worked at both Gourmet Heaven stores in Providence sued Cho and his holding companies under the FLSA and the Rhode Island Minimum Wage Act. Among other things, they alleged that Cho had never posted the required notices explaining their employment rights, had never given them statements detailing their earnings, including records of their hours worked and itemized deductions, and had paid the them under the table in cash, even when they worked more than 40 hours in a week.
Despite the fact that all of the allegations were a matter of public record, GSP moved forward with the transaction. In fact, it appears that GSP was incorporated solely for that purpose. While the employees’ original complaint was pending and publicly available, GSP filed its articles of incorporation with the Rhode Island Secretary of State’s Office. In that document, GSP identified its registered agent as an individual who was also the chief executive officer of BCS Corporation, a wholesale food supply company.
According to the employees, nearly half of the $500,000 that GSP paid for the store and its assets went directly to two of BCS’s subsidiaries to satisfy “existing debts.” The employees also alleged that GSP paid most of the other half directly to the state of Rhode Island and the city of Providence to satisfy back taxes. The seller, “Chung Cho/Gourmet Heaven, LLC,” allegedly netted only $1,620.78 from the entire transaction.
Same Store, ‘Under New Management’
The employees alleged that 2 days after the closing, GSP “took over operation” of the store and renamed it Serendipity Gourmet. They alleged that the new store continued to operate at the same address, with many of the same employees, and sold the same products. The new sign used the same font and colors that were used on Gourmet Heaven’s sign.
Two weeks later, Cho filed for personal bankruptcy. The employees amended their complaint and identified GSP as an additional defendant in the wage and hour claims they had originally asserted against Cho and his two holding companies. GSP asked the court to dismiss the claims, arguing that because it had purchased only assets, it couldn’t be a successor to the seller’s liability.
Court: Not So Fast
Because the employees had asserted claims under both federal and Rhode Island law, Magistrate Judge Sullivan concluded (and Judge Lisi agreed) that GSP couldn’t simply rely on its status as an asset purchaser to evade successor liability under established state law.
Instead, it was necessary to review the employees’ FLSA claims under federal common-law principles. In light of the FLSA’s stated purpose of protecting workers, federal courts have taken a more liberal approach to imposing successor liability under the FLSA than the more stringent approach typically taken by state courts in construing other claims.
Successor Liability Under the FLSA
Under federal common law, courts typically analyze three factors to decide if imposing successor liability in FLSA cases is appropriate:
- Whether the purchaser is a bona fide successor to the original employer;
- Whether the purchaser had notice of the potential liability; and
- The extent to which the seller can directly provide adequate relief.
Whether an employer qualifies as a bona fide successor typically hinges on the degree of business continuity between the buyer and the seller.
Unfortunately for GSP, Magistrate Judge Sullivan concluded that all three factors weighed in favor of holding it liable for the alleged violations at both Providence Gourmet Heaven stores before the relevant sale.
Strike 1. Turning to the first factor, Magistrate Judge Sullivan concluded that the employees had alleged sufficient facts to establish that GSP was a bona fide successor. Not only did GSP purchase the lease and all the property associated with one store, but it also bought the right to use the Gourmet Heaven trade name (which had been used by both Providence stores), it used the word “Gourmet” in its own trade name (Serendipity Gourmet), it used the same font and colors in its signage, and it employed many of the same employees to sell the same products.
According to the employees, they had worked at both stores before the sale, and they had performed work that benefited the entire enterprise at both locations. Furthermore, because Cho had been the sole owner of both holding companies and the transaction had apparently benefited both him and GSP by settling his debts to GSP’s affiliates, the sale appeared to be less than an arm’s-length transaction.
Strike 2. With respect to the second factor, Magistrate Judge Sullivan concluded that the three pending legal proceedings against Cho at the time of the transaction were more than enough to put GSP on constructive notice of the employees’ alleged claims. Not only had their complaint been filed before GSP signed the asset purchase agreement, but Cho had been criminally charged for his treatment of workers in Connecticut and was the subject of a scathing opinion by the Connecticut federal court over practices at his New Haven store.
Under federal case law, a pleading establishing that litigation is a matter of public record allows the court to infer that the parties had notice about it. There’s an expectation that normal due diligence, in the absence of collusion, would uncover such matters. At the time of the closing, Cho had given GSP an “indemnity agreement” in which he represented that there were “no actions at law, suits in equity or other legal proceedings pending in which the Seller is a party,” but Magistrate Judge Sullivan held that GSP shouldn’t have blindly accepted that representation.
And . . . strike 3. As for the final factor, Magistrate Judge Sullivan found that the terms of the deal left Cho and his holding company incapable of directly providing adequate relief to the employees. The $500,000 purchase price netted him and his holding company less than $2,000, Cho filed for bankruptcy 2 weeks later, and approximately 6 months later, the secretary of state revoked Gourmet Heaven, LLC’s entity status for failing to file an annual report. That left the employees with nowhere else to turn. If GSP couldn’t be held liable, the entire purpose of the FLSA—protecting workers—would be frustrated.
Successor Liability Under Rhode Island Law
Once Magistrate Judge Sullivan concluded that the employees’ FLSA claims could survive GSP’s motion to dismiss, she turned to their claims under the state’s minimum wage law. Successor liability is generally tougher to impose under state law, but that isn’t to say there are never exceptions. In particular, the Rhode Island Supreme Court has held that a purchaser corporation can be liable for the debts of its predecessor when (1) the purchaser is merely a continuation of the seller corporation or (2) the transaction was entered into fraudulently to escape liability.
To determine whether a corporation is merely a continuation of its predecessor, Rhode Island courts analyze five “persuasive criteria”:
- There was a transfer of corporate assets.
- There was less than adequate “consideration” (i.e., payment).
- The new company continues the business of the predecessor.
- Both companies have at least one common officer or director who was instrumental in the transfer.
- The transfer rendered the predecessor incapable of paying its creditors.
In finding successor liability based on fraud, Rhode Island courts will consider whether there were “suspect occurrences,” such as collusive actions by the involved individuals, with an emphasis on whether the factors are sufficient to establish a “scenario to defraud.”
Court: Deal Was Still Sketchy
GSP argued that one of the five continuation criteria was absent because it had no common officer or director with Gourmet Heaven LLC. But Magistrate Judge Sullivan concluded that wasn’t enough to let GSP off the hook. After reviewing other cases in which this issue was considered, she found that all five criteria are not required. Furthermore, she found it relevant that there were multiple allegations suggesting that the sale might have been intentionally structured by Cho and GSP, acting in collusion, to defraud the employees who had asserted wage claims against Gourmet Heaven.
There was an “array” of plausible allegations permitting the inference that the sale was “an arrangement between close business associates resulting in nearly half of the purchase price being disbursed to corporations owned and operated by an official representative of the purchaser and leaving no assets available to satisfy claims against the seller.” As a result, Magistrate Judge Sullivan recommended the denial of GSP’s motion to dismiss entirely, and Judge Lisi adopted that recommendation in her January 3 decision.
Lessons for Potential Buyers
Although most decisions imposing successor wage liability on a buyer that purchased assets rather than an entire business are based on the specific facts relevant to the transaction, there are some important takeaways from the Guarcas decision for potential buyers of businesses in Rhode Island:
- First and foremost, a pure asset transaction is not a complete defense to potential claims if the buyer intends—in whole or in part—to carry on the seller’s former business.
- Second, there’s absolutely no excuse for not conducting thorough due diligence before any potential transaction. In the Guarcas case, GSP probably knew or should have known that it was buying a store that was staffed by a group of employees who had a lawsuit pending against the seller.
- Third, if there is potential liability, make sure sufficient assets to satisfy it remain with the seller following the transaction. By engaging in a one-sided deal with the seller, leaving him with next to nothing to satisfy the employees’ claims, GSP put a target on itself. A more prudent buyer in its position would have required the seller to set aside in escrow enough money from the purchase price to satisfy the employees’ claims.
At the end of the day, never forget that the purpose of the FLSA and its state-law analogues is to protect workers, not businesses. Anyone considering entering into an asset transaction that could involve lingering wage liability should be sure to secure qualified counsel beforehand to help navigate the potential risks.
Matthew H. Parker is a partner at Whelan, Corrente, Flanders, Kinder & Siket LLP in Providence, specializing in employment law and business litigation. Parker is also an editor of Rhode Island Employment Law Letter. He can be reached at 401-270-4500 or email@example.com.