Franchise Asset Buyer Didn’t Inherit Seller’s Unemployment Tax Experience Rating

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M&A Stories

November 2, 2020

Introduction

A company’s unemployment insurance liability depends upon its experience rating; the employee turnover history of the business. A buyer of the assets of a business usually starts with a lower unemployment liability than the seller. However, there is a risk that the state may seek to impose a seller’s higher experience rating upon the buyer.

The deal

The deal involved the purchase of the assets of several Krispy Kreme stores in the Dallas area. The seller was a limited partnership and the general partner was the franchisor. The buyer entered into a franchise agreement with the franchisor as part of the deal.

Texas law states that the buyer of a business inherits the seller’s experience rating if the seller had substantial management or control over the three stores purchased by the buyer after they were sold.  After the closing Texas claimed that the franchisor as general partner of the seller had substantial management or control of buyer’s operations as a result of the franchise agreement. It transferred the unemployment compensation experience rating of the seller to the buyer.

The lawsuit 

The transfer resulted in additional unemployment taxes for the buyer. The buyer paid the taxes and made a refund claim in the approximate amount of $300K.

The Texas state trial court denied the refund claim and the buyer appealed to an intermediate appellate court.  That court held that the franchisor’s rights and obligations under the franchise agreement did not amount to the required substantial management or control of buyer’s store operations:

The court:The evidence submitted by … (the buyer) … established that after it purchased the three stores from … (the seller) …, it had no further relationship or dealings with … (the seller) … that would show “substantially common management or control” by … (the seller) … to justify transferring its unemployment compensation experience rating to … (the buyer) …. Even though … (the franchisor) … was listed as a “Seller” on the Assert Purchase Agreement, the summary judgment evidence showed that … (the franchisor) … was merely a franchisor and did not have “substantially common management or control” over … (the buyer’s) … day-to-day operations of the seller stores beyond those set forth in the franchise agreements.”

This case is referred to as Dulce Restaurants, LLC v. Texas Workforce Commission, No. 07-19-00213-CV, Court of Appeals of Texas, Seventh District, Amarillo, (September 25, 2020) 

Comment

This result is not surprising. The deal was no different than any deal involving the acquisition of the assets of a franchised business, other than the fact that the general partner of the limited partnership seller in this case happened to be the franchisor.

Laws giving a state the right to transfer the seller’s unemployment tax experience rating to the buyer are designed primarily to prevent fraud where a business with a high experience rating sells the assets to a buyer which the seller owns or controls.

By John McCauley: I help people manage M&A risks involving privately held companies.

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291 

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