Published in March, 1999 edition of The PEO Insider,
The official publication of the National Association Professional Employer Organizations
Imagine the struggling salesman's joy when he lands a huge new account for an emerging PEO. Four hundred-fifty employees, 3 plants with a cumulative payroll of $23 million annually. In addition, this new super account wants the Cadillac version of all employee benefits. The salesman can barely restrain himself as he bursts into the CEO's office to announce the big score.
There is only one problem: although the client company is a longstanding, well established business, it regularly undergoes financial booms and busts. In addition, approximately 375 of its workers are covered by a union contract. When the Chief Financial Officer is called into the meeting to discuss this potential new client, she insists that the deal be structured in such a way to ensure that the PEO is a successor for all tax purposes.
In their haste to land this new account and save money from a tax perspective, these PEO executives may be walking into other liabilities. While successorship status may be a good thing from a tax perspective, it is not desirable under most labor and employment laws.
A successor employer means different things to different federal and state agencies, depending upon which statute they are charged with enforcing. The National Labor Relations Board has a very clear and unique definition of a successor employer, which all PEO's should be keenly aware of when taking on unionized clients. What our salesman and, possibly, the CEO do not realize is that if their client should somehow fail and become insolvent, the PEO may be deemed a successor employer liable for all prior judgments or unfair labor practice remedies existing prior to the time the PEO entered into the relationship with the client company. Even though the PEO would insist on indemnification before taking on this client, that clause may be meaningless if the client company ends up in bankruptcy or is otherwise uncollectible.
The successorship doctrine is normally applied under the NLRA following the sale of a company. Under established labor law, the purchaser who is found to be a successor employer not only inherits the predecessors obligations under a collective bargaining agreement, it is responsible for remedying unfair labor practices committed by the predecessor. In other words, the purchaser has to pay any judgments and take all remedial action ordered.
The successorship determination is based on a number of related factors all of which focus on the degree of continuity between the old and new employers businesses, including: (1) whether the business of both employers is essentially the same; (2) whether the employees of the new company are doing the same jobs under the same working conditions and the same supervisors; (3) whether the same production processes and customers exist; and, most importantly, (4) whether the new employer has hired a majority of the employees of the old employer. Although this test is normally applied where the assets of a business are sold to a new purchaser, the test appears to fit the situation where a PEO enters into a contract with a new client.
While a PEO may be willing to readily assume the fringe benefit and other obligations existing under a union contract, the PEO may not be aware of or particularly interested in prior unfair labor practices and resulting monetary obligations of the client. In addition, the PEO normally assumes it has insulated itself from prior liabilities, judgments or debts of the client through a contractual indemnity clause with the client. However, in the event of bankruptcy or uncollectibility, the successorship doctrine may render a PEO liable for prior unfair labor practice judgments or remedies which occurred before its involvement with the client.
Under federal labor law, a successor employer is liable for unfair labor practice remedies where it takes over the operations with actual or constructive knowledge of pending unfair labor practice proceedings or outstanding NLRB orders. See Golden State Bottling Co vs NLRB, 414 U.S. 168 (1973). If the purchaser knew or should have known of these matter, it is liable.
In Golden State Bottling, the Supreme Court held that where a purchaser with notice of a pending unfair labor practice proceeding acquired or continued the business without a substantial change in operations or employees, it had joint and several liability for monetary damages and back pay even though it was the predecessor that committed the unfair labor practices. In addition, the successor was required to offer unlawfully discharged employees immediate reinstatement to their former or substantially equivalent positions.
Golden State Bottling was based on the reasoning that employees who remain with a successor employer have a legitimate expectation that unfair labor practices will be remedied by the successor and that any failure to do so could result in labor unrest. The Court noted that a successor must have notice of these unfair labor practices before liability can be imposed. Accordingly, the courts have placed the burden on purchasers to inquire into prior unfair labor practices and to negotiate a different price in the event such potential liabilities are existing. As stated by the Supreme Court, a purchasers potential liability for remedying the unfair labor practices is a matter which can be reflected in the price he pays for the business, or he may secure an indemnity clause in the sales contract which will indemnify him for liability arising from the sellers unfair labor practices.
It is not necessary for the NLRB to initiate a new unfair labor practice proceeding to consider whether an entity has successorship liability. For example, in Computer Sciences Corp vs NLRB, 667 F.2d. 804 (CA 11 1982), the Board instituted a civil contempt proceeding seeking to hold the new employer in violation of the unfair labor practice order directed at the predecessor.
A new employer may raise as a defense that it did not possess the knowledge, either actual or constructive, required as a Golden State successor. The burden will be on the new employer to prove that it did not know of the liability and could not have reasonably discovered it under the circumstances.
The Board has held that one obstacle to meeting its burden to show lack of knowledge might be that the new employer had, at the time of purchase, obtained an indemnification clause in its sale agreement regarding any obligations incurred as a result of unfair labor practice proceedings against the predecessor. See Am-Del-Co., Inc., 234 NLRB 1040 (1978).
As a result of these rulings, in any sales transaction where due diligence is performed, or required, successor liability will be the likely result. The only options available to a successor is to negotiate for a reduced sales price or obtain an indemnity clause.
A recent decision in the United States Court of Appeals for the Sixth Circuit set forth an exception to the successorship doctrine finding that a purchaser was not liable to remedy the original employers unfair labor practices. In Peters vs NLRB, 153 F.3rd. 289 (CA 6 1998), the NLRB initially issued an order requiring the purchaser to remedy unfair labor practice charges against the prior employer, including reimbursing all delinquent contributions to pension funds and reimbursing employees for any expenses they may have incurred as a result of the predecessor. On appeal, the Sixth Circuit Court of Appeals held, in a case of first impression, that the new employer would not be held liable for remedying these unfair labor practices.
The Court noted that the purchaser was a second generation entity which purchased a business out of a bankruptcy proceeding. Since the purchaser bought the assets after the original employer had gone through a receivership, there was no ability for the purchaser to obtain or negotiate for an indemnity clause or bargain for a price that would capture the risk associated with any unfair labor practices. Accordingly, the Court held that this second generation purchaser would not be liable for the monetary and other relief ordered against the original employer.
No court has specifically analyzed whether a PEO would incur successor liability under federal labor and employment laws. Although the tests set forth above for determining whether an entity is a successor would appear to fit in a PEO-client context, there may be arguments available to the PEO to avoid successorship liability. In Steinbach vs Hubbard, 51 F.3rd. 843 (9th Cir 1995), an ambulance service was interested in purchasing a failing ambulance companys business and taking on its employees. Since the failing company was involved in a bankruptcy, and the parties could not reach an outright sale agreement, the two companies agreed to a one year lease of assets and the hiring of some of the failing companys employees. The bankruptcy court never approved the sale and after a year, the leasing company discontinued its efforts to purchase the failing companys assets. The lease was terminated and the assets were returned. Based on these facts, the Ninth Circuit Court of Appeals refused to apply the successorship doctrine. The Court recognized that previous cases have held that the form of the transfer from one business to another whether by sale, merger, or other transaction was of no consequence to the successorship inquiry. However, in the case before it, since the transfer of employees was only temporary, and the assets were only leased, it would serve no purpose to attach successorship liability to the surviving company.
The decisions in Steinbach and Peters may be of some assistance if a court or administrative agency argues that a PEO is a successor and is responsible for the clients judgements or liabilities. All PEO arrangements are arguably temporary, and the assets and other liabilities are never actually transferred to the PEO in an arms length transaction.
Although it is unclear whether the labor law successorship doctrine applies in a PEO context, a PEO must always undertake due diligence whenever it enters into an agreement with a new client that has a unionized work force. This due diligence should include a search of court and agency records, including the Equal Employment Opportunity Commission and the NLRB, to determine if any prior administrative proceedings or remedies have been issued against the client. Additionally, representations and warranties must be obtained from the client affirming that there are no outstanding liabilities, lawsuits or charges pending under federal and state labor laws, civil rights acts or other employment related legislation. Finally, a strong indemnity clause must be obtained.
In addition, due diligence should also include an analysis whether the client might be a failing company which may end up protected from liability under federal bankruptcy laws, thereby transferring liability for prior judgments and orders to the PEO. In such a case, an indemnity clause and representations and warranties will afford little or no protection to the PEO. If a PEO is considering a relationship with a company that has a shaky economic forecast or may be a potential failing venture, the PEO should consider personal guarantees from the owners or shareholders or obtain other security or liens that will allow for collectibility even in the event of bankruptcy.
Lawyers should never be known as deal killers. However, returning to our scenario with the excitable salesman, a prudent CEO would not only call in the CFO to analyze successorship liability from a tax perspective, experienced counsel should also be consulted to best insulate and protect the PEO from potential successorship liability arising under federal labor and employment laws.