Indemnification Issues For Acquisition Transactions In The Age Of Independent Contractors
On March 11, 2021, the Biden Administration proposed rescinding the Final Rule, as promulgated on January 7, 2021, regarding the independent contractor (“IC”) classification status under the Fair Labor Standards Act (“FLSA”). The proposed Final Rule enumerated factors to determine if persons are to be classified as ICs or employees. Two core factors governed the Final Rule test: (x) the autonomy of the worker and (y) the worker’s opportunity for profit or loss based on the worker’s performance of the assigned duties. The Biden Administration’s rescission action did not provide a proposed new rule for workers or their employers/contracting parties to look to for guidance. Thus, the previous FLSA rules, prior to the Final Rule, will remain in effect until the Biden Administration proposes any modifications or superseding rules.
For businesses retaining the services of IC’s or buyers seeking to acquire IC-dependent businesses, the current landscape can cause hesitation, confusion, or even termination of negotiations with respect to the liability of the businesses should one or more persons they classified as ICs be reclassified as employees.
At Moritt Hock & Hamroff LLP (MHH), we have drafted and negotiated innovative provisions dealing with such potential liability issues in connection with the sales of IC-dependent businesses.
Traditionally, indemnification clauses are used to provide post-closing protection for the acquiror should any liability for pre-closing matters arise. With the current IC landscape, an acquiror is likely to view all of the target company’s ICs as potential liabilities; that is, they could all sue after the acquisition closing claiming that they should have been classified as employees and seek damages based on the claimed incorrect classification.
Since IC worker classification is a specific business issue, practitioners may not think to create a carveout in the indemnification provisions that govern all potential liabilities for acts and matters occurring pre-closing with its own separate liability cap and basket. Where MHH has acted as counsel for sellers of IC-dependent businesses, we have been successful in the negotiation of a separate carveout to the traditional indemnification provisions in the acquisition agreement. The carveout concept provides for all IC-related claims for pre-acquisition matters to have separate caps and are limited in duration. The key for lawyers is to get the parties to identify and estimate what and when likely IC-related claims could be made post-closing and, then draft the special indemnification provisions with caps and a term that is a reasonable balance of risk and reward for both sides. Additionally, it’s also important to have both the buyer and seller focus on the following:
- Past IC-related claims that have been adjudicated or settled;
- Current actual and threatened litigation involving IC-related claims;
- Pending settlement amounts;
- The size of the pool of ICs that have not made or threatened to bring IC-related claims;
- The target company’s relationship with its ICs (the happier the group, the better);
- Estimate the cost to the target company per average IC if such IC was, in the future, reclassified as an employee;
- The average length of time the ICs have provided services to the target company;
- The extent to which the overall IC compensation relates to the target company’s overall expenses and the IC compensation cost as a percentage of the target company’s overall operating income; and
- The percentage allocated to the general indemnification provisions with respect to the overall purchase price.
At Moritt Hock Hamroff LLP we are poised to help you and your business during this time of uncertainty. If you have any questions regarding the contents of this article or any other matter affecting your business, please reach out to either Keith Braun at (516) 880-7288 or firstname.lastname@example.org or to Tina Kassangana at (516) 265-1164 or email@example.com.