Learn about a case where a buyer of franchise assets fought off a state’s attempt to impose the seller’s high unemployment tax experience rating due to a franchise agreement. Understand the implications and legal outcomes. Read more on our M&A legal blog.
M&A Stories
November 2, 2020
When one company buys the assets of another, the unemployment insurance costs it faces can be affected by the acquired company’s history of employee turnover, known as its experience rating. Normally, buyers start with lower unemployment costs than sellers. However, there’s a risk that the buyer might end up with the seller’s higher experience rating.
For example, let’s consider a situation involving the purchase of several Krispy Kreme stores in Dallas. The seller was a limited partnership, with the main franchise company as the general partner. The buyer signed a franchise agreement as part of the deal. In Texas, if a buyer purchases a business and the seller continues to have significant control over the purchased stores, the buyer might inherit the seller’s experience rating for unemployment insurance. This happened when Texas argued that the franchise company, acting as the seller’s general partner, had considerable control over the buyer’s operations due to the franchise agreement. As a result, the seller’s unemployment insurance experience rating was passed on to the buyer.
This transfer made the buyer responsible for higher unemployment taxes. The buyer paid these taxes and tried to get around $300,000 refunded. However, the Texas trial court rejected the refund request, leading the buyer to appeal to a higher court. The higher court ruled that the franchise company’s role and obligations under the franchise agreement didn’t amount to the necessary level of control over the buyer’s daily operations. Even though the franchise company was mentioned as a seller in the asset purchase agreement, evidence showed that its involvement was limited to its role as a franchisor and didn’t extend to significant control over the buyer’s operations beyond what was specified in the franchise agreements.
In summary, this ruling is unsurprising as it deals with a common acquisition of a franchise-based business, except for the situation where the franchisor was also the general partner of the selling limited partnership. Laws allowing a state to transfer a seller’s unemployment tax experience rating to a buyer are primarily meant to prevent fraud, especially when a seller with a high experience rating transfers assets to a buyer it owns or controls.
This case is referred to as Dulce Restaurants, LLC v. Texas Workforce Commission, No. 07-19-00213-CV, Court of Appeals of Texas, Seventh District, Amarillo, (September 25, 2020)
By John McCauley: I help people manage M&A risks involving privately held companies.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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