Successor Employer Liability in North Carolina: Navigating Employee Misclassification and Risks after an Acquisition

Purchasing a business in North Carolina can be a lucrative and exciting opportunity, but it also comes with a web of legal, financial, and operational risks. One of the most significant, and overlooked, risks is that of successor employer liability. This risk is particularly relevant when the seller has engaged in employee misclassification, treating workers as independent contractors (1099) when the law requires them to be classified as employees (W-2). In my practice as an M&A attorney, I see employee misclassification all the time. It’s more relevant than one may think, and it can create substantial exposure for buyers. Understanding your obligations as a potential successor employer is absolutely essential to avoid costly surprises, penalties, and even litigation. Additionally, business purchasers must take this issue into account when evaluating any potential acquisition, as misclassification can materially impact the value and long-term viability of the business

Here, we will explore successor employer liability in North Carolina, focusing on employee misclassification, the distinctions between asset and stock sales, the automatic application of successor employer status, possible exemptions, and the legal ramifications under both state and federal law. Whether you are an entrepreneur, investor, business broker, or attorney, this resource will help you navigate the complexities of North Carolina labor law and assist in making informed decisions when acquiring a business.

What Is a Successor Employer? How Automatic Application and Exemptions Work

Before diving into the details of misclassification and liability, let's first understand what successor employer is, how this status can apply automatically, and the circumstances in which exemptions may exist.

Definition and Automatic Application

A "successor employer" in North Carolina is generally defined as an individual or business entity that acquires all or part of another employer’s business and continues its operations. This concept is a cornerstone of the state’s employment security laws, especially regarding unemployment insurance contributions and liabilities. The successor employer doctrine is designed to ensure that statutory obligations, such as unemployment taxes, are not evaded through simple changes in ownership or structure.

North Carolina General Statutes § 96-11.7 specifically addresses this issue. Under this law, a successor employer is automatically recognized when:

• An employer acquires all of the business of another employer. In such cases, the predecessor’s unemployment insurance account is transferred to the successor as of the acquisition date, and this account is then used to determine the successor’s contribution rate for unemployment taxes. This means, if you have an existing business with your own unemployment insurance rate and roll the new entity into your existing - your unemployment insurance rate may change.

  
  

• If a portion or divisions of a business is acquired, and the successor continues to operate that portion. Here, the transfer of the relevant portion of the account can occur with the approval of the Division of Employment Security and by mutual consent.

This means that in most standard business acquisitions, the successor steps directly into the shoes of the predecessor for purposes of unemployment insurance, inheriting both the account balance and the experience rating, which affects future tax rates.

Legal Rationale

The rationale for this automatic application is to protect employees and the integrity of the unemployment insurance system. By ensuring the successor employer inherits the predecessor’s account and obligations, the law prevents employers from escaping liabilities, such as unpaid contributions or negative experience ratings, by simply shifting ownership. This approach aligns with federal labor policy, which aims to shield employees from the negative effects of business transfers beyond their control.

Exemptions and Limitations

Despite the general rule of automatic application, North Carolina law provides for certain exemptions and limitations:

• Bankruptcy Sales with No Common Ownership: If there is no common ownership between the predecessor and the successor, and the successor acquires the assets through a sale in bankruptcy, the automatic transfer of the unemployment insurance account does not apply. Buyers in bankruptcy sales can avoid inheriting the predecessor’s experience rating and certain liabilities.

  
  

• Partial Business Transfers: When only a portion of a business is acquired, the transfer of the relevant part of the account is not automatic. It requires approval by the Division of Employment Security and mutual consent between the predecessor and successor. If the successor is a related entity, further restrictions may apply according to rules set by the Division.

  
  

• Relief from Liability for Unpaid Contributions: According to North Carolina Division of Employment Security interpretation, a purchaser does not automatically become a successor employer for all purposes. However, under NCGS § 96-10(d), if the predecessor owes unpaid contributions, the purchaser must withhold enough of the purchase price to cover those liabilities. If the purchaser fails to do so, they can be held personally liable for the unpaid contributions to the extent of the assets acquired - even if not otherwise deemed a successor employer under the statute.

  
  

• Ceasing to Be an Employer: No transfer may be made to the account of an employer who has ceased to be an employer under the statute (NCGS § 96-11.9). This limits the ability to transfer accounts to entities that are no longer operating as employers under North Carolina law.

Administrative Review

If a successor employer disagrees with a determination regarding the transfer of an experience rating account or the assigned tax rate, they have the right to challenge the decision through administrative procedures. This provides a mechanism for review if the successor believes the automatic application of the law is incorrect or unfair in their particular situation.

Successor Employer Status by State: Comparison to North Carolina

State	Successor Status Automatic?	Notes/Process (if different from NC)
Alabama	Application	Requires application and approval.
Alaska	Automatic	Automatic for full business transfers.
Arizona	Automatic (full); Application (partial)	Automatic for full; application for partial/portion transfers.
Arkansas	Application	Requires application and approval.
California	Automatic (full); Application (partial)	Automatic for full; partial requires application/agreement.
Colorado	Application	Requires application and approval.
Connecticut	Automatic (full); Application (partial)	Automatic for full; partial requires application/agreement.
Delaware	Application	Requires application and approval.
Florida	Automatic	Automatic for full business transfers.
Georgia	Application	Requires application and approval.
Hawaii	Automatic	Automatic for full business transfers.
Idaho	Automatic (full); Application (partial)	Automatic for full; partial requires application/agreement.
Illinois	Application	Requires application and approval.
Indiana	Automatic	Automatic if statutory criteria are met; only notice required.
Iowa	Automatic	Automatic for full business transfers.
Kansas	Application	Requires application and approval.
Kentucky	Automatic	Automatic for full business transfers.
Louisiana	Application	Requires application and approval.
Maine	Automatic	Automatic for full business transfers.
Maryland	Application	Requires application and approval.
Massachusetts	Automatic	Automatic for full business transfers.
Michigan	Automatic	Automatic for full business transfers.
Minnesota	Automatic	Automatic for full business transfers.
Mississippi	Application	Requires application and approval.
Missouri	Application	Requires application and approval.
Montana	Automatic	Automatic for full business transfers.
Nebraska	Application	Requires application and approval.
Nevada	Automatic	Automatic for full business transfers.
New Hampshire	Application	Requires application and approval.
New Jersey	Automatic (full); Application (partial)	Automatic for full; partial requires application/agreement.
New Mexico	Application	Requires application and approval.
New York	Automatic	Automatic for full business transfers.
North Carolina	Automatic (full); Application (partial)	Automatic for full; partial requires approval/mutual consent.
North Dakota	Application	Requires application and approval.
Ohio	Application	Requires application and approval.
Oklahoma	Application	Requires application and approval.
Oregon	Automatic	Automatic for full business transfers.
Pennsylvania	Application	Requires application and approval.
Rhode Island	Automatic	Automatic for full business transfers.
South Carolina	Application	Requires application and approval.
South Dakota	Application	Requires application and approval.
Tennessee	Application	Requires application and approval.
Texas	Application	Must apply for transfer within 30 days; not automatic.
Utah	Automatic	Automatic for full business transfers.
Vermont	Application	Requires application and approval.
Virginia	Application	Requires application and approval.
Washington	Automatic	Automatic for full business transfers.
West Virginia	Application	Requires application and approval.
Wisconsin	Automatic	Automatic for full business transfers.
Wyoming	Automatic	Automatic for full business transfers.

Asset Sale vs. Stock Sale: Does the Structure Matter?

One of the most common misconceptions among buyers is that an asset sale automatically insulates them from the seller’s liabilities. While it is true that, in general, a stock sale transfers all assets and liabilities (known and unknown) to the buyer, whereas an asset sale allows the buyer to pick and choose which assets and liabilities to assume, the reality is far more nuanced; especially in North Carolina given the automatic application of successor employer status.

Asset Sale: The Illusion of Safety

In an asset sale, the buyer acquires only specific assets such as equipment, inventory, customer lists, and goodwill and may expressly exclude certain liabilities in the purchase agreement. However, courts and regulatory agencies frequently impose successor liability in asset sales if the transaction is, in substance, a continuation of the same business. This is especially true in employment law, where public policy favors the protection of workers and the integrity of statutory schemes such as wage and hour laws, unemployment insurance, and workers’ compensation.

Key factors that may trigger successor liability in an asset sale include:

• The buyer continues the same business operations with little or no interruption.

• The buyer retains a substantial portion of the seller’s workforce.

• The buyer uses the same facilities, equipment, or trade name.

• The buyer serves the same customer base.

If these factors are present, North Carolina courts and agencies may disregard the formal structure of the transaction and hold the buyer responsible for the seller’s employment related liabilities, especially if the acquisition fits the automatic application rules under NCGS § 96-11.7.

Why Asset Purchases Don’t Protect You from Successor Employer Status

It is a common but dangerous misconception that by structuring a transaction as an asset sale, a buyer can avoid inheriting the seller’s employment related liabilities. In North Carolina, as in many other jurisdictions, the substance of the transaction, continuity of business, workforce, and operations, matters more than the form.

Regulatory agencies and courts will look at whether the business continues in substantially the same form, not merely at the legal paperwork.

This means that even if your purchase agreement states that you are not assuming any of the seller’s liabilities, you can still be held responsible by the state or federal government for unpaid payroll taxes, wage violations, workers’ compensation premiums, and other employment related obligations. The state’s interest in protecting employees and ensuring compliance with employment laws overrides private agreements between buyer and seller.

The Role and Limits of Indemnity Agreements

Given that asset sales do not shield you from successor employer status and related liabilities, your only real financial protection is to negotiate a specifically tailored indemnity agreement within your asset purchase agreement. An indemnification provision is a legal clause in which the seller agrees to reimburse or “indemnify” the buyer for certain losses, claims, or liabilities that arise from the seller’s past actions or omissions.

How Indemnification Works:

• If you, as the buyer, are sued by a government agency or a former employee for violations that occurred before your purchase (such as unpaid wages, misclassified employees, or unpaid taxes), you will likely still be required to pay or settle those claims.

  
  

• After paying, you then make a demand for reimbursement from the seller under the indemnity provision in your purchase agreement.

  
  

• If the seller refuses or is unable to pay, you may have to sue the seller to recover those amounts. This process can be lengthy, expensive, and uncertain, especially if the seller has already spent the proceeds or is insolvent.

  
  

It is critical to understand that indemnification only shifts the financial burden between buyer and seller. It does not prevent the state, the IRS, or other agencies from holding you directly liable. You are still on the hook to the government or claimants; your only recourse is to seek repayment from the seller after the fact.

Best Practices for Indemnification:

• Negotiate for a broad, well defined indemnity clause that specifically covers employment law violations, wage claims, tax liabilities, and penalties.

  
  

• Consider requiring the seller to place part of the purchase price in escrow to cover potential claims.

  
  

• Conduct thorough due diligence to identify risks before closing.

  
  

• Understand that indemnity is only as valuable as the seller’s ability and willingness to pay.

  
  

Stock Sale: Inheriting the Whole Entity

In a stock sale, the buyer acquires the shares of the selling corporation, thereby stepping into the shoes of the previous owner. All assets, contracts, and liabilities, whether disclosed or undisclosed, remain with the corporation. The buyer, as the new owner, is responsible for all obligations, including those arising from employee misclassification or wage violations. While possible to provide indemnity within your stock purchase agreement, remember this only shifts the burden of financial responsibility.

Case Law and Regulatory Guidance

Courts have consistently held that the form of the transaction is less important than its substance. In NLRB v. Burns International Security Services, Inc., 406 U.S. 272 (1972), the U.S. Supreme Court held that a successor employer may be bound by certain obligations of the predecessor, especially where there is continuity of operations and workforce. North Carolina courts have followed similar reasoning, focusing on the practical realities of the business transition rather than the legal formalities.

1099 vs. W-2: The Legal Distinction

One of the most significant risks facing buyers is the misclassification of workers as independent contractors (1099) when they are, in fact, employees (W-2). This distinction is not merely academic; it has far reaching implications for tax liability, wage and hour compliance, workers’ compensation, and unemployment insurance.

Federal Law: IRS Employee Classification

The Internal Revenue Service (IRS) uses a multifactor test to determine whether a worker is an employee or an independent contractor. The primary focus is on the degree of control and independence in the working relationship. The IRS considers three broad categories:

1. Behavioral Control: Does the company control or have the right to control what the worker does and how the worker does their job? This includes instructions, training, and evaluation systems.

   
   

2. Financial Control: Are the business aspects of the worker’s job controlled by the payer? This includes how the worker is paid, whether expenses are reimbursed, and who provides tools and supplies.

   
   

3. Type of Relationship: Are there written contracts or employee type benefits, such as pension plans, insurance, or vacation pay? Will the relationship continue, and is the work performed a key aspect of the business?

   
   

If the employer provides supplies, requires uniforms, sets schedules, and trains workers, these are strong indicators of an employer-employee relationship.

North Carolina Law: Common Law Test

North Carolina follows a similar common law test, focusing on the right to control the manner and means by which the work is performed. The North Carolina Industrial Commission and Department of Labor look at factors such as:

• The extent of control exercised by the employer

• Whether the worker is engaged in a distinct occupation or business

• The skill required for the work

• Who supplies the tools, materials, supplies and place of work

• The length of time for which the person is employed

• The method of payment (by time or by job)

• Whether the work is part of the regular business of the employer

If the facts show that the employer exercises significant control over the worker’s activities, provides the tools and supplies, and integrates the work into the regular business, the worker is likely an employee.

Example of Clear Misclassification

In this scenario, let's say you have a seller who has all 1099 contractors performing work for the business. The seller provides each worker a weekly schedule, provides work supplies and tools, requires all workers to wear company shirts while on the job and trains each worker once they start working for the company for consistency standards among all workers.

Here, the seller has engaged workers as 1099 contractors, but the company:

• Provides supplies

• Requires workers to wear company shirts

• Trains workers

• Assigns schedules with required work hours

  
  

These facts strongly indicate that the workers are employees, not independent contractors, under both IRS and North Carolina law. This misclassification is not a mere technicality—it is a violation with significant legal, tax, and financial consequences.

Legal Ramifications of Employee Misclassification

The consequences of misclassifying employees as independent contractors are severe and multifaceted. They include liability for unpaid taxes, wage and hour violations, workers’ compensation claims, unemployment insurance contributions, and potential administrative penalties.

Federal Tax Consequences

If the IRS determines that workers have been misclassified, the employer is liable for:

• Unpaid federal income tax withholding: Employers must withhold federal income tax from employees’ wages. Failure to do so results in liability for the unpaid taxes, plus interest and penalties.

  
  

• Unpaid Social Security and Medicare taxes: Employers must pay both the employer and employee portions of FICA taxes. Misclassification results in liability for the full amount, plus penalties and interest.

  
  

• Federal unemployment tax (FUTA): Employers are required to pay federal unemployment taxes for employees. Misclassification leads to liability for unpaid FUTA taxes.

  
  

• Penalties and interest: The IRS can impose additional penalties for intentional disregard or fraud.

  
  

The IRS has the authority to conduct audits and impose significant financial penalties for misclassification. In some cases, criminal charges may be brought for willful violations.

North Carolina Tax and Employment Law Consequences

Unemployment Insurance

Under the North Carolina Employment Security Law (NCGS § 96-1 et seq.), employers must pay unemployment insurance taxes for employees. Misclassification results in:

• Liability for unpaid unemployment taxes

• A penalty of 10% of the taxes due

• Monthly interest on the principal tax

The Division of Employment Security may also transfer the predecessor’s account and related liabilities to the successor employer if the business continues in substantially the same form, as per the automatic application discussed earlier.

Wage and Hour Act

The North Carolina Wage and Hour Act (NCGS §§ 95-25.1 to 95-25.25) requires employers to pay minimum wage, overtime, and maintain proper records for employees. Misclassification can result in:

• Liability for unpaid wages and overtime

• Liquidated damages up to double the amount of unpaid wages

• Reimbursement of attorneys’ fees and costs

• Civil penalties of up to $250 per worker, with a maximum of $2,000 per investigation

  
  

There is no general safe harbor for employers who unintentionally misclassify workers, although courts may reduce damages if the employer acted in good faith and had reasonable grounds for the classification.

Workers’ Compensation

North Carolina law requires employers to provide workers’ compensation coverage for employees. Misclassified workers who are injured may file claims, and the employer (or successor) can be held liable for unpaid premiums, benefits, and penalties. The North Carolina Industrial Commission will carefully review the facts to determine employment status.

Administrative Actions

State agencies, including the Department of Labor and Division of Employment Security, actively investigate misclassification through audits and employee complaints. Employers found in violation may face administrative penalties, orders to pay back taxes and wages, and public listing as violators.

Successor Employer Liability for Misclassification

The critical question for a purchaser is whether you, as the buyer, will be liable for the seller’s past misclassification of workers. The answer depends on several factors:

• Continuity of Business: If you continue the business in substantially the same form, use the same workforce, and serve the same customers, you are likely to be deemed a successor employer for many employment-related liabilities, even in an asset sale.

  
  

• Transfer of Accounts: North Carolina law specifically allows for the transfer of unemployment accounts and related liabilities to a successor employer if the business continues.

  
  

• Federal Law: Under the NLRA and related federal statutes, a successor employer may inherit liability for unfair labor practices and wage claims if there is continuity of operations and workforce.

While asset sales can sometimes limit liability, courts and agencies may disregard the form of the transaction if the substance is a continuation of the business. Attempts to avoid liability through contractual provisions may be ineffective if the law imposes successor liability as a matter of public policy.

North Carolina Wage and Hour Act: Statutory Overview

The North Carolina Wage and Hour Act (NCGS §§ 95-25.1 to 95-25.25) governs wage payment, minimum wage, overtime, and record keeping for employees. Employers who misclassify workers as independent contractors may be liable for:

• Unpaid minimum wage and overtime: Employers must pay at least the minimum wage and overtime for hours worked over 40 in a workweek.

  
  

• Liquidated damages: Courts may award double damages for willful violations.

  
  

• Attorneys’ fees and costs: Prevailing employees are entitled to recover their legal fees.

  
  

• Civil penalties: The Department of Labor may impose civil penalties for violations.

The Act provides for a private right of action, allowing employees to sue for unpaid wages and damages. The statute of limitations is generally two years, but may be extended to three years for willful violations.

North Carolina Workers’ Compensation Law

The North Carolina Workers’ Compensation Act (N.C. Gen. Stat. §§ 97-1 et seq.) requires employers with three or more employees to provide workers’ compensation insurance. Misclassification of employees as independent contractors can result in:

• Liability for unpaid premiums: Employers must pay premiums for all employees, including those misclassified as contractors.

  
  

• Liability for benefits: Injured workers may file claims for medical expenses, lost wages, and disability benefits.

  
  

• Civil penalties: The Industrial Commission may impose penalties for failure to provide coverage.

  
  

• Personal liability: Corporate officers may be held personally liable for failure to secure workers’ compensation insurance.

  
  

The Act is interpreted broadly to protect workers, and the Industrial Commission will examine the facts to determine employment status, regardless of how the parties label the relationship.

North Carolina Employment Security Law

The North Carolina Employment Security Law (NCGS § 96-1 et seq.) requires employers to pay unemployment insurance taxes for employees. The law provides for the transfer of employer accounts in the event of a business acquisition (NCGS § 96-11.7). Successor employers may inherit the predecessor’s unemployment account, including any outstanding liabilities, if the business continues in substantially the same form.

Misclassification of employees as independent contractors can result in:

• Liability for unpaid unemployment taxes

• Penalties and interest

• Transfer of liabilities to successor employer

The Division of Employment Security conducts audits and investigations to enforce compliance.

Federal Law: IRS and Department of Labor

The IRS and U.S. Department of Labor have overlapping jurisdiction over employee classification. The IRS focuses on tax withholding and reporting, while the Department of Labor enforces wage and hour laws under the Fair Labor Standards Act (FLSA).

IRS Section 3509

Under IRC § 3509, if an employer misclassifies employees as independent contractors, the IRS may assess back taxes, penalties, and interest. The employer may be eligible for reduced penalties if the misclassification was not willful.

Department of Labor Enforcement

The Department of Labor may investigate misclassification under the FLSA, which requires payment of minimum wage and overtime. Employers found in violation may be liable for back wages, liquidated damages, and civil penalties.

Case Law: Successor Liability and Employee Misclassification

NLRB v. Burns International Security Services, Inc., 406 U.S. 272 (1972)

The U.S. Supreme Court held that a successor employer may be bound by certain obligations of the predecessor, especially where there is continuity of operations and workforce. The Court emphasized the importance of protecting employees’ rights and preventing employers from evading statutory obligations through changes in ownership.

Practical Steps for Buyers: Due Diligence and Risk Mitigation

If you are considering purchasing a business in North Carolina where the seller has misclassified employees as independent contractors, you should:

• Conduct thorough due diligence: Review all payroll records, tax filings, and worker classification practices.

  
  

• Engage experienced counsel: Consult with attorneys and accountants familiar with North Carolina employment law.

  
  

• Negotiate indemnification provisions: Require the seller to indemnify you for any liabilities arising from past misclassification, but recognize the limitations if the seller becomes insolvent.

  
  

• Address past liabilities: Consider negotiating with state and federal agencies to resolve outstanding liabilities before closing.

  
  

• Properly classify workers going forward: Implement compliant payroll and HR practices to avoid future violations.

  
  

• Factor potential liabilities into the purchase price: Adjust the purchase price to account for potential exposure.

Navigating Successor Employer Liability in North Carolina

Purchasing a business in North Carolina presents unique challenges and risks, particularly when the seller has engaged in employee misclassification. The doctrine of successor employer liability is designed to protect employees, ensure compliance with statutory schemes, and prevent businesses from evading their obligations through changes in ownership or structure.

Both federal and state law impose successor liability in many situations, even in asset sales, especially where the business continues in substantially the same form. The facts described in our above example (company provided supplies, uniforms, training, and scheduled work hours) the workers are employees, not independent contractors. Failure to address these issues can result in liability for unpaid taxes, wages, penalties, and administrative sanctions under North Carolina and federal law.

Careful due diligence, proper worker classification, and legal compliance are essential to protect your investment and ensure a smooth transition. By understanding the legal landscape—including the automatic application and exemptions for successor employer status, and the real-world limitations of indemnification—you can minimize your risk and position your business for long-term success.

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Howard Law is a business, regulatory and M&A law firm in the greater Charlotte, North Carolina area, with additional services in M&A advisory and business brokerage. Howard Law is a law firm based in the greater Charlotte, North Carolina area focused on business law, corporate law, regulatory law, mergers & acquisitions, M&A advisor and business brokerage. Handling all business matters from incorporation to acquisition as well as a comprehensive understanding in assisting through mergers and acquisition. The choice of a lawyer is an important decision and should not be based solely on advertisements. The information on this website is for general and informational purposes only and should not be interpreted to indicate a certain result will occur in your specific legal situation. Information on this website is not legal advice and does not create an attorney-client relationship. You should consult an attorney for advice regarding your individual situation. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.