Amy Knapp and Alexander Thomas

Purchase agreements almost always attempt to limit potential successor liability for the purchaser in the deal.  However, in EEOC v. Roark-Whitten Hospitality 2 et al. (“EEOC v. RW2”), the Tenth Circuit determined that a purchaser of a business could face a Title VII lawsuit for alleged successor liability where the purchase agreement provided for a due diligence period and the purchaser did not discover Title VII claims against the predecessor. Employers should be aware that the federal Equal Employment Opportunity Commission (EEOC) and other Title VII plaintiffs now have an easy pleading standard to allege successor liability sufficient to survive motions to dismiss.

In 2009, Roark-Whitten Hospitality 2 (“RW2”) purchased a hotel in New Mexico. At the time of purchase, the hotel had several long-term Hispanic employees. RW2’s owner fired or demoted several of the employees and made derogatory remarks about the workers’ races/ethnicities, among other things. In 2014, the federal Equal Employment Opportunity Commission (“EEOC”) filed a complaint against RW2 on behalf of several of the former Hispanic workers alleging discrimination in violation of Title VII of the Civil Rights Act of 1964 (“Title VII”).  Also, in 2014, Jai Hanuman, LLC (“Jai”) purchased the hotel from RW2, and about two years after that SGI, LLC (“SGI”) purchased the hotel from Jai. Upon discovery of each sale, the EEOC added the new hotel owner as a defendant in the lawsuit. The district court dismissed both SGI and Jai as defendants, reasoning the EEOC had not sufficiently plead successor liability. The EEOC appealed.

In EEOC v. RW2, the Tenth Circuit Court of Appeals held that the EEOC had properly alleged that SGI, but not Jai, could be liable as a successor. It began by explaining that the successor liability standard in Title VII cases is less stringent than in a typical case.  Specifically, in a Title VII case, successor liability focuses on three primary factors: (1) whether the successor had prior notice of the claim; (2) whether the predecessor is able, or prior to the purchase was able, to provide the relief requested, and (3) whether the predecessor and successor engaged in continuous business operations. The factor at issue in EEOC v. RW2 was whether the EEOC had adequately alleged that SGI and Jai had notice of the EEOC action against RW2. The Tenth Circuit found that the EEOC had sufficiently alleged that SGI had constructive notice (meaning SGI should have known), as opposed to actual notice, of the EEOC action. Specifically, it reasoned that the EEOC plead that SGI’s purchase agreement with Jai included a due diligence period allowing SGI 30 days in which to investigate the liabilities of the business. The EEOC  further reasoned that SGI’s president, who was experienced in purchasing hotels, admitted he did not conduct a thorough review of the business during the due diligence period and could have discovered the EEOC action with such a review. Based on these facts, the Tenth Circuit found that the EEOC had adequately plead successor liability against SGI sufficient to survive a motion to dismiss. However, the Court made no such finding concerning Jai, as the EEOC had not plead any similar facts concerning a due diligence provision, and instead only made the conclusory allegation that Jai “had notice.”

In her partial dissent, Judge Eid disagreed with the majority on the question of SGI’s liability as the successor of the successor. Specifically, the dissent deviated from the majority in finding constructive notice due to the purchase agreement’s inclusion of a due diligence period. She opined that constructive notice requires specific facts to put a party on notice that it should inquire further and that those specific facts were missing in this case. Additionally, the dissent noted that SGI’s broker stated he conducted “typical and thorough” due diligence before the purchase, which included asking the seller about any liabilities that SGI should be aware of. Judge Eid’s primary concern stemmed from the prevalence of due diligence clauses in purchase agreements. Without additional guidance, Title VII plaintiffs simply have to allege that the buyer was insufficient in their search during the due diligence period. In the opinion of Judge Eid, this amounts to strict liability. The dissent concluded by noting that a finding of liability in this case may impose a “freestanding and indeterminate duty of due diligence on all successors.”

This case reiterates the need for careful due diligence review and careful drafting of indemnity provisions. Going forward, buyers should include specific indemnification for known liabilities and representation and warranties related for undisclosed liabilities. That said, indemnity provisions will not immunize purchasers from the time and expense of defending a case like EEOC v. RW2; instead, it would only provide post-lawsuit compensation. At the very least, buyers should consider adding Title VII searches to their due diligence review.