Wage and Hour Exposure You Inherit From the Seller

If the seller skipped overtime, called hands-on workers "managers" or paid regular staff as contractors, those practices keep running under you. In a stock purchase the company you bought still owes its own past wages, and even in an asset purchase liability for past pay can sometimes follow the business. Insurance rarely helps. Most employment practices liability insurance (EPLI) policies exclude wage and hour claims or pay only a small amount toward defense, so treat this as a compliance problem to find and fix early with employment counsel. This guide is for new owners who want to know what to look for in the seller's payroll before an employee or their lawyer finds it.

What do wage laws require, and how far back can claims reach?

Wage and hour exposure is money owed, or claimed to be owed, because employees were not paid what wage laws require. Under the federal Fair Labor Standards Act (FLSA), nonexempt employees must be paid at least the minimum wage and overtime of one and a half times their regular rate for hours over 40 in a workweek. Many states and some cities add their own rules on overtime, meal and rest breaks, pay timing and final pay. This article stays general; ask employment counsel which rules apply where your people work.

• Exempt status is a test, not a title. To be exempt from overtime under the federal rules, an employee generally must be paid on a salary basis, at or above a minimum salary level, and have a primary duty that fits an exemption such as executive, administrative or professional. The federal salary level has been through rule changes and court challenges, and many states set higher levels or different tests, so check current figures.
• Look-back periods. FLSA claims generally must be brought within two years, or three years for a willful violation. State law periods can be longer.
• Damages multiply. Under the FLSA, employees can recover unpaid wages plus an equal amount as liquidated damages, along with attorney's fees and costs. Claims often come as group actions covering many workers. A court can reduce liquidated damages if the employer shows it acted in good faith with reasonable grounds, which is one more reason to fix practices with counsel once you find them.

Why does it surprise new owners after a sale?

Owner-run businesses often pay people in ways that grew up informally and were never checked. A buyer's quality of earnings review looks at whether earnings are real, not whether pay practices are legal, so these issues can pass through diligence. Practices to watch:

• Technicians or crew paid a day rate or flat amount per job with no overtime premium
• Salaried office or field "managers" who mostly do the same work as the people they supervise
• Unpaid time loading trucks, attending morning meetings or driving from the shop to the first job
• Automatic meal break deductions whether or not anyone took a break
• Overtime calculated on base pay only, leaving out nondiscretionary bonuses or commissions that generally belong in the regular rate
• Long-term workers doing core work under direction but paid as independent contractors

These issues tend to surface after closing because something changes: a new payroll provider asks questions, a new handbook describes rules the old practice broke, an employee you let go talks to a lawyer, or a state or federal agency opens an inquiry.

In a stock purchase, the company's past pay practices remain the company's liability; your protection is the purchase agreement's representations, indemnity and any escrow. An asset purchase is not a complete shield either. Federal courts apply their own successor liability test to some federal employment claims. In Teed v. Thomas and Betts (Seventh Circuit, 2013), a buyer that knew about the seller's pending FLSA lawsuit was held liable for it even though the asset purchase agreement excluded it. Courts in that line of cases weigh factors such as whether the buyer had notice of the claim and whether the business and workforce continued. Whether that reasoning could reach your deal is a question for counsel; successor liability in an asset purchase explains the general rules.

Will EPLI or any other insurance pay for wage claims?

Usually not, and that surprises buyers who assume employment practices liability insurance covers every employee claim. Many policies treat back wages as money the employer owed anyway, not as an insured loss.

A small number of carriers write separate wage and hour coverage for some businesses, usually with significant retentions and close underwriting of pay practices. Ask your broker whether it is available for your class of business, and compare its terms against the cost of simply fixing the practice. For the full EPLI checklist, see the EPLI review for new owners. For contractor classification and the audit bill, see 1099 contractors and the workers' comp audit bill.

What should you check in your first 90 days?

Ideally this happens before closing, when findings can still shape price, escrow and specific indemnities. If you are past closing, do it now.

What should you do if you find a problem?

1. Bring in employment counsel first. Counsel can help you fix the practice going forward and decide whether and how to address past pay. Working through counsel can also help protect your communications.
2. Fix the forward practice. Every pay period the old practice continues adds to the exposure, and once you know about it, continuing can look willful.
3. Check the purchase agreement. Look at the seller's representations about compliance with labor laws, the indemnity, any escrow or holdback and the claim deadlines. See seller indemnity vs insurance.
4. Do not retaliate. Treat employees who raise pay concerns carefully; retaliation claims can be larger than the wage claim.
5. Report claims to your EPLI carrier anyway. A defense sublimit or a related retaliation allegation may still respond.
6. Update your model. Correct pay can raise labor cost, which affects earnings before interest, taxes, depreciation and amortization (EBITDA), debt service coverage and what you tell your lender and board.

A hypothetical example. A buyer acquires a service company in a stock purchase, so the company it now owns carries its own pay history. It has 20 technicians paid $250 a day, five days a week, for about 50 hours. Under the federal method for day rates, each technician's regular rate is $1,250 divided by 50 hours, or $25, and each is owed an extra half-time of $12.50 for each of the 10 overtime hours: $125 a week. Across 20 technicians and 50 working weeks, that is $125,000 a year. Two years of back pay is $250,000, and liquidated damages could double it to $500,000 before attorney's fees, with a third year possible if the violation is found willful. EPLI pays none of the wages. Going forward, if the day rate stays the same, the corrected pay adds about $125,000 a year to labor cost, which at a 5x purchase multiple is about $625,000 of value. State law could change these numbers, and counsel would refine them.

Employee claims tend to cluster after a sale; see why ownership changes trigger employee claims. Morrow can review your employment practices coverage and flag where wage and hour claims fall outside it; the fix itself belongs with employment counsel.

Keep reading

• New Owner Review: Employment Practices Liability (EPLI)
• Why Ownership Changes Trigger Employee Claims (and How EPLI Responds)
• Do 1099 Contractors Count in Your Workers' Comp Audit?
• Successor Liability: When an Asset Purchase Is Not Clean
• Seller Indemnities vs Insurance: What They Are Really Worth
• All guides for new business owners

Frequently asked questions

Does EPLI cover unpaid overtime claims?

Usually not. Most EPLI policies exclude wage and hour claims under federal and state wage laws. Some give a small defense-only sublimit, which pays lawyers but not the wages owed. A few carriers sell separate wage and hour coverage for some businesses.

If I bought assets, aren't the seller's wage claims the seller's problem?

Often, but not always. Federal courts apply their own successor liability test to some federal employment claims, and one appeals court held a buyer liable for the seller's pending overtime claims despite contract language excluding them. Ask deal counsel how your agreement and facts look.

Are salaried employees automatically exempt from overtime?

No. Under the federal rules an exempt employee generally must be paid a salary at or above a minimum level and have a primary duty that is exempt work, such as managing others or professional work. Job titles do not decide it, and states can have stricter tests.

Can I just pay employees the back wages myself?

Sometimes, but how you do it matters. A private payment may not end an employee's right to sue under federal law, and settlements supervised by the Department of Labor or a court are treated differently. Work through employment counsel before you offer or pay anything.

Should I fix the pay practice right away even if it raises costs?

Talk to employment counsel first, then act quickly. Continuing a practice you know is wrong adds to the exposure and can look willful. Build the corrected labor cost into your budget and lender reporting.

References

• U.S. Department of Labor: Overtime Pay
• U.S. Department of Labor: Fact Sheet 17A, Exemption for Executive, Administrative, Professional, Computer and Outside Sales Employees
• Cornell Legal Information Institute: 29 U.S. Code 255 (statute of limitations)
• Cornell Legal Information Institute: 29 U.S. Code 216 (penalties and damages)
• Cornell Legal Information Institute: 29 U.S. Code 260 (liquidated damages)
• Cornell Legal Information Institute: 29 CFR 778.112 (day rates and job rates)
• Stevens and Lee: Buyer Beware, Successor Liability Extended to Fair Labor Standards Act Claims

This article is general information, not legal, tax or financial advice, and not a coverage determination. Coverage depends on the actual policy wording, carrier underwriting, your purchase agreement and your contracts. Ask your attorney and accountant about deal and legal questions.