The buyer wanted to acquire the seller’s car wash business. The buyer conducted due diligence and learned that there was a federal employment discrimination claim pending before the U.S. Equal Employment Opportunity Commission (or “EEOC”).
However, the buyer never received any of the details of the claim; nor did the buyer investigate the claim. That was partly because the seller’s lawyer told the buyer ” that … (the seller) … had an Employment Practices Liability Insurance policy with $1,000,000 in coverage and that [he] would be `surprised’ if … … (the seller’s) … damages would exceed $1,000,000.”
The buyer and the seller signed an asset purchase agreement and the transaction closed, with the buyer paying $15 million to the seller at closing. The agreement also said that the buyer was only assuming liabilities of the seller listed on a schedule attached to the agreement.
The employment discrimination liability was not listed on the schedule as an assumed liability. The agreement went on to say that all other liabilities of the car wash were the responsibility of the seller; and the seller agreed to indemnify the buyer for any loss the buyer suffers connected with these unassumed liabilities.
After the closing the EEOC sued the seller for employment discrimination in a federal court. The EEOC also sued the buyer because it was the “successor” owner of the car wash business. The judge describes how the seller treated its Hispanic employees:
the EEOC stated that it had “determined that … (the seller) … violated Title VII by discriminating against … (its Hispanic employees) … with regard to harassment, intimidation, unequal terms and conditions of employment, lower wages, denial of promotional opportunities, disparate discipline and discharge because of their national origin (Hispanic) and in retaliation for engaging in protected activity.” …
The EEOC’s … alleged that Hispanic employees … were “relegated” to lower paid positions, denied overtime, and denied their fair share of tips. … It alleged that … (the seller) … would require … its Hispanic employees … to perform additional tasks that it did not request of its non-Hispanic employees, such as cleaning the “car tunnel and machinery, powerwash[ing] the property, perform[ing] landscaping duties,” and performing tasks at … (the seller’s) … manager’s homes, all without additional compensation. … Furthermore, the EEOC alleged that … (the seller) … treated … its Hispanic employees … differently at work, forcing them to eat outside, “drink unfiltered water, and utilize an unlocked unisex bathroom which needed repair.” … It alleged that … (the seller) … would not let them take full lunch breaks or take other work breaks, and that … (the seller) … did not provide them with access to the indoor facilities or proper equipment to perform their work. … The complaint described verbal harassment as well, alleging that Managers at … (the seller) … would swear at … its Hispanic employees …, “bark[] commands to them,” and threaten to fire them.
The buyer argued that it was not responsible for the seller’s actions because it did not assume the seller’s employment discrimination liabilities in the asset purchase agreement. The Court said that the buyer’s responsibility for these actions would not be imposed by the asset purchase agreement but by federal law. And under federal law, the buyer can be held responsible for the seller’s federal employment discrimination actions under certain circumstances:
The Court finds that … (the buyer) … had some actual notice as well as constructive notice of the pendency of the EEOC’s charges against … (the seller) … when … (the buyer) … purchased … … (the seller’s) … assets, that … (the seller) … (is not) …capable of providing all of the relief that the EEOC has requested, and that … (the buyer) … is running largely the same business as … (the seller) …. For these reasons, the Court finds it equitable to hold … (the buyer) … liable for any liability that … (the seller) …, may incur in this case.
This United States District Court case from Maryland is referred to as U.S. Equal Employment Opportunity Commission v. Phase 2 Investments Inc, Civil No. JKB-17-2463, United States District Court, D. Maryland (April 17, 2018).
Comment. A buyer of a business likes to buy the assets of the business and not the corporation or LLC that owns the business. In an asset deal, the buyer can generally pick and choose the liabilities of the business that buyer will be responsible for.
There are certain of the seller’s liabilities that an asset buyer may be responsible for even though the buyer expressly disclaims responsibility for those liabilities in the asset purchase agreement. This can be true in the case of the seller’s federal employment discrimination liability.
How does the buyer manage this risk? Well, due diligence is crucial. The buyer needs to know about it. If there is a problem, then the buyer can reduce the price, provide for some escrow or holdback. The buyer can also look at insurance solutions.
It is clear, though, that it is more likely for the buyer to be stuck with this sort of liability if he knows about it or should have known. You can’t just stick your head in the sand and say you never knew about the problem if reasonable due diligence would have smoked the problem out. The best practice is to identify and manage the risk.
By John McCauley: I help people start, grow, buy and sell their businesses.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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