A not-for-profit corporation that was awarded a grant to operate a federal Head Start program on an interim basis could not be held liable for unpaid wages and benefits as a successor to a defunct Head Start provider under the Fair Labor Standards Act (“FLSA”), the Employee Retirement Income Security Act of 1974 (“ERISA”) or Arkansas law, a federal district court in Arkansas has ruled. Paschal, et al. v. Child Development, Inc., et al., No. 4:12-CV-0184 KGB (E.D. Ark. Jan. 7, 2014). 

Background

Sadie Paschal and others worked for Child Development, Inc., a Head Start provider in Arkansas, when Child Development notified the U.S. Department of Health and Humans Services (“HHS”) on January 31, 2012, that it could not maintain the program. Child Development relinquished its grant and ceased operating the program on two days later. On February 10, 2013, Paschal and the other employees were terminated from employment with Child Development. Child Development subsequently filed for receivership and dissolution. 

HHS contracted with Community Development Institute Head Start (“CDIHS”), another corporation, to provide an interim Head Start program in the region formerly serviced by Child Development until a new provider could be obtained through the competitive grant process. 

On February 11, 2012, CDIHS began serving as the interim provider, operating the Head Start program in many of the facilities formerly used by Child Development and paying rent to Child Development for certain facilities. It hired a majority of the former employees of Child Development, who began working for CDIHS on February 13, 2012.

Paschal and the other employees alleged that Child Development failed to pay them from January 9, 2012, to February 10, 2012, and failed to fund their retirement and health insurance benefits from November 15, 2011, to January 9, 2012. They sued both Child Development and CDIHS, as its successor, for unpaid wages and benefits under the FLSA, ERISA, and Arkansas law. CDIHS moved for summary judgment, arguing that it was not a successor to Child Development and could not be held liable for the unpaid wages and benefits. The district court agreed.

Applicable Law

In general, a corporation is not responsible for a predecessor’s debts or liabilities except where: (1) the purchaser expressly or impliedly agrees to assume the obligations; (2) the purchaser is merely a continuation of the selling corporation; or (3) the transaction is entered into to escape liability. Golden State Bottling Co., Inc. v. N.L.R.B., 414 U.S. 168 (1973). Beginning with Golden State and other cases arising under the National Labor Relations Act, “federal courts have developed a federal common law successorship doctrine that now extends to almost every employment law statute.” Steinbach v. Hubbard, 51 F.3d 843, 845 (9th Cir. 1995). To determine successor liability under federal law, courts will examine whether the successor company had notice of the charge, the ability of the predecessor to provide relief, and whether there has been a substantial continuation of business operations, among other factors.

Likewise, under Arkansas law, a corporation may be held liable as a successor if it is a “mere continuation” of the predecessor corporation. Courts considering this would “emphasize a common identity of officers, directors, and stock between the selling and purchasing corporations.”

Not Successor

CDIHS argued that it did not have adequate notice of the liabilities for unpaid wages and benefits. Although CDIHS had some knowledge that Child Development had failed to pay its employees, it had no access to Child Development’s records and, thus, could not account for that liability. More important, however, CDIHS’s contract with HHS did not provide for the payment of a predecessor grantee’s wages, which was not permitted under an interim grant. Due to the nature of CDIHS’s role as an interim provider, it would be unreasonable to impose upon it successorship liability, for as the court noted, CDIHS “could not shift the potential liability in a bargained-for transaction or seek an indemnification agreement from Child Development.” Further, “[t]he deficiency of the notice here which, when coupled with the nature of the transaction itself,” persuaded the court that successor liability was “inappropriate.”

CDIHS argued that it should not be held liable as a successor of Child Development because there was no substantial continuity between the organizations’ operations. The court agreed. It noted that, although CDIHS used many of the same facilities and hired most of Child Development’s workforce, its business was “fundamentally different.” Child Development was a permanent, long-term grantee of the Head Start program; had it operated appropriately in accordance with HHS standards, it could have operated a Head Start program indefinitely. By contrast, under CDIHS’s contract with HHS, CDIHS could be assigned to provide only interim services throughout the U.S., typically for one year or less, until HHS selected a new long-term provider through the competitive grant process. Given these differences, the court could not find substantial continuity between the two organizations’ operations. 

The court acknowledged that there was a strong federal policy favoring the payment of wages and benefits and that, unless successor liability was imposed, the employees likely would be without a meaningful remedy. Nevertheless, there was a “competing federal interest” under the Head Start program of promoting the “school-readiness of low income children.” The court concluded that to impose successor liability on CDIHS would impede the federal policy underlying the Head Start program. 

Last, under Arkansas law, the court found that CDIHS was not a “mere continuation” of Child Development because no stock was transferred between the entities and there was no overlap in the organizations’ officers and directors. Thus, finding no successor liability under Arkansas law, the court granted summary judgment in favor of CDIHS.

This case is a positive development for not-for-profit corporations that receive federal grants for the provision of services. The court recognized that grant recipients have little ability to negotiate the terms of their grants or to indemnify themselves for prior grantee’s liabilities. However, these special circumstances are not typical. Entities taking over an ongoing business should review closely the potential for liability for a predecessor’s nonpayment or improper payment to employees and take appropriate action before stepping into the shoes of the predecessor. Such precautions should include an audit of pay practices and an assessment of whether minimum wage and overtime obligations have been met. Mitigation tools during negotiations could include hold backs, indemnity agreements and agreements to defend.