Business Law by Tom Ramsey
December 18th, 2012 – The process of purchasing a going business generally includes deciding whether to purchase the capital stock or the memberships of the seller (if the seller is a corporation or a limited liability company) or only the assets of the seller. The determination is traditionally influenced by the following: On the one hand, the purchase of corporate stock or limited liability company memberships comes with it the existing corporation or limited liability company with a possible history of problems that the buyer will eventually be required to resolve. On the other hand, the purchase of only the assets of the seller is probably less risky to the buyer since the ownership of the selling entity (the corporation or the limited liability company) stays with the seller.
Although this should be considered when purchasing a business, a successor business can also become liable for the actions of a predecessor business which the successor did not purchase and with which the successor had absolutely no relationship, as illustrated below.
Auto Spa operated a carwash on Sunset Boulevard in Los Angeles. Auto Spa was indebted to Sunset Alvarado Investors LLC, a lender. The debt was secured by a trust deed on the property where Auto Spa operated its carwash. Auto Spa defaulted on the note. The lender foreclosed and ended up owning the property. Once Auto Spa was history, the lender then leased the property to Sunset Car Wash LLC.
It is important to note that Sunset’s connection to the business location was based only upon its being the lessee of the lender. There was no contractual nexus of any kind between Auto Spa and Sunset.
However, once Sunset opened its business, the California Attorney General filed a lawsuit against Sunset. The attorney general claimed that Auto Spa, the predecessor business at the location and not remotely related to Sunset, failed to pay its employees minimum wage and overtime, and denied its employees rest breaks. The attorney general’s action sought to hold Sunset liable for the sins of Auto Spa.
The claimed basis for the lawsuit was a rather strange section of the California Labor Code. Apparently, the California legislature had determined that the car wash industry followed practices that sometimes resulted in violation of the state’s labor laws and that previous attempts to enforce the law had been ineffective.
The legislature dreamed up Labor Code §2066, which provides as follows: The successor to an employer engaged in the car washing/polishing business that owed wages and penalties to its former employees is liable for those wages and penalties if the successor meets any of the following criteria: The successor uses substantially the same facilities or workforce to offer substantially the same services; the successor shares with the seller the ownership, management, control of the labor relations; the successor employs, in a managerial capacity, the person the seller used to control employee wages, hours or working conditions; the successor is an immediate family member of the seller. This approach would appear as an attempt to impose successor liability based on some kind of business, family or contractual relationship with the predecessor. Of course, no such relationship existed here.
Sunset tried to convince the trial court that it was not a successor as defined in Labor Code §2066. That argument fell on deaf ears. The court ruled that inasmuch as Sunset operated at the same location and performed the same services as Auto Spa, notwithstanding the fact that it purchased absolutely nothing from and assumed no liabilities created by Auto Spa, Sunset was determined to be a successor under the Labor Code and therefore liable.
Sunset appealed the trial court’s decision. It was unsuccessful.
The Court of Appeal concluded as follows: “In the context of the car washing industry, section 2066 provides the necessary notice of the potential for successor liability for labor law violations. Any entity commencing business in the industry is presumptively aware of the requirements of section 2025, et seq. ‘California law attributes to all citizens constructive knowledge of the content of state statutes [citation to a California Supreme Court case].’ Presumptively aware of the potential for liability, a person or entity considering commencing a car washing business is placed on notice in section 2066 of the liability potential and may protect itself by the exercise of due diligence, indemnity agreements, or insurance.”
Of course, the only other party with assets was the lender. Unfortunately, it was only Sunset’s lessor. It never operated a carwash on the premises. Assuming that an indemnity agreement with Auto Spa had been made, Auto Spa was more than likely judgment proof. That conclusion probably played a role in the attorney general’s decision to go after Sunset rather than Auto Spa.
One must wonder how many other draconian measures can be found lurking in one of the approximately one hundred volumes containing the various California codes. As stated in the opinion above, all citizens have at least constructive knowledge of their content.
Good luck meeting that obligation.
The case is entitled People v. Sunset Car Wash, LLC. It was decided in 2012.
(Tom Ramsey is a Long Beach attorney who has specialized in business law for more than 40 years. He may be reached at email@example.com.)