Seller was formed in 2007, which operated as a dry cleaning business in Manhattan that did business as Slayton Cleaners. Seller retained seven employees, including one front-desk attendant, one helper, two ironing persons, one spotter, one driver, and one tailor. Employee worked at Seller, and later Buyer, as an ironer from 2004 to about February 5, 2017.
Owner of Buyer formed Buyer in February 2016. Owner of Buyer and Owner of Seller began discussing the purchase of Seller’s dry cleaning business in the beginning of 2016. According to Owner of Buyer, Owner of Seller assured him during the negotiations to purchase Seller’s dry cleaning business that Seller had complied with all applicable laws and was free from any legal liability or debt. Owner of Buyer stated that Buyer did not review any documents or conduct any due diligence research in preparation for the sale. During their negotiations, Owner of Buyer’s investigation into the business appeared to have consisted only of asking Owner of Seller about how much gross income Seller generated.
Seller sold assets consisting of its goodwill, leasehold interest, all equipment, supplies, trade name, fixtures, furnishings and improvements to Buyer on April 5, 2016, for a purchase price of $350,000. In the Bill of Sale, Owner of Seller warranted that there were no pending lawsuits or judgments against Seller or other legal obligations which may be enforced against the transferred assets. $100,000 was paid upon closing and the remaining $250,000 was financed by a promissory note signed by Owner of Buyer, both individually and as a representative of Buyer. Pursuant to this note, Buyer was required to remit monthly payments of about $8.7K to Seller. Seller then assigned the lease of its premises to Buyer with the landlord’s consent.
Buyer, doing business under Seller’s trade name, continued to provide dry cleaning and laundry services in the same manner as Seller, using the same location and, for the most part, the same equipment. Initially, all Seller employees were retained by Buyer except for the driver, whose duties were absorbed by the driver for another cleaning business owned by Owner of Buyer. Owner of Buyer noted that Buyer paid the employees at the same rate as Seller had for the first week after the sale, but then increased their wages the next week. The front desk attendant resigned approximately one month after the sale, and the tailor left approximately one month later following an argument with the new front desk attendant.
On February 21, 2017, Employee sued Buyer and Seller, in a New York City federal court, for, among other claims, federal wage and hour violations. The court noted that Employee’s successor liability claims against Buyer depended upon several factors. But, the court said that Buyer’s responsibility for the federal and hour claims would probably require that Buyer had pre-closing notice of the wage and hour problems and that Seller was unlikely to have the ability to pay off its federal wage and hour debts.
The court had no problem with finding that Seller could handle the wage and hour debts. It then looked at whether Buyer had pre-closing notice of the wage and hour issue.
The court noted that Seller assured Buyer prior to the sale that the business was in compliance with all laws and was debt-free. Also, the acquisition documents included Seller’s warranty that there were no unsatisfied pending lawsuits, judgments, or legal obligations associated with the business.
Employee nevertheless argued that that Buyer should be held to have had constructive knowledge of the Seller’ alleged federal wage and hours law violation because Buyer failed to exercise due diligence which would have disclosed the problem and that a due diligence obligation for Buyer was favored for policy reasons so as to encourage Buyer to get the whole story and adjust Buyer’s offer accordingly (for example, to permit Buyer to pay a portion of the purchase price to satisfy Seller’s wage and hour liability).
The Court was not persuaded by Employee’s argument, saying that there is no general duty of due diligence required of the purchaser of a business, and that imputing such constructive notice is appropriate only when certain red flags, such as the suspiciously low purchase price and uncharacteristically quick closing, would lead a buyer of a business to inquire further into the circumstances of the transaction.
Therefore, the court held that Buyer was not responsible for Seller’s federal wage and hour debt.
This case is referred to as Diaz v. Slayton One Cleaner Inc., No. 17 CV 1311-LTS-KNF, United States District Court, S.D. New York (October 11, 2018).
Comment. This decision makes sense. Buyer handled this relatively small acquisition with prudence. Seller told Buyer there were no legal problems with the business and represented and warranted in the transaction documents that there were no legal problems.
In a small deal in New York the court is saying that you probably don’t have to do due diligence to look for federal wage and hour violations unless there are some red flags which would make a reasonable person dig deeper.
By John McCauley: I help people start, grow, buy and sell their businesses.
Telephone: 714 273-6291
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