To bring their full financial and operational expertise to portfolio companies, private equity firms frequently adopt an active approach to overseeing their investments. However, the greater a firm’s involvement in the day-to-day operations of its portfolio companies, the greater the risk that the firm will be deemed an “employer” of the portfolio companies’ employees, and be potentially liable under a host of federal and state laws. This article discusses some of the potential employment law liabilities that private equity firms can face, and offers some tips for avoiding liability when walking the fine line between prudent oversight and excessive entanglement in the day-to-day operations of portfolio companies.
While the risk of employment liability has always been present for private equity firms, there are signs that these risks may be increasing. The National Labor Relations Board (the “Board”) recently announced its intention to revisit its standard for determining whether an entity that does not directly employ a group of workers is nevertheless a “joint employer” with collective bargaining and other obligations under the National Labor Relations Act (“NLRA”).1 Under current law, two entities are joint employers only if they each direct and control the terms and conditions of the employment by making decisions concerning issues like hiring, firing, discipline and day-to-day direction of work. However, certain current and former Board members have suggested that this standard is too narrow because it allows entities that provide “capital” to avoid bargaining obligations under the NLRA.2 Accordingly, the Board may adopt a more liberal standard that treats entities as joint employers if they exercise indirect control over wages and other terms and conditions of employment.
If adopted, such a change could result in the imposition of affirmative union bargaining obligations on private equity firms and require firms to become directly bound by union collective bargaining agreements. Not only would this change impose significant transaction costs upon firms, but it could result in contractual liability for things like health and welfare plan contributions and pension plan withdrawal liability.
The Board is not alone in adopting standards that would increase the risk that a private equity firm could be held responsible for its portfolio companies’ employment-related liabilities. In recent years, many courts have taken an expansive view of the circumstances in which firms can be held responsible for portfolio companies’ employment liabilities, particularly where those companies are facing insolvency or other financial difficulties. For instance, in July 2013, the U.S. Court of Appeals for the First Circuit sent shockwaves through the legal community with its decision in Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund.3 In that case, the First Circuit held, as a matter of first impression, that a private equity investment fund constituted a “trade or business” subject to withdrawal liability to a union pension fund under the federal Multiemployer Pension Plan Amendments Act (“MPPAA”). Under the MPPAA, “all employees of trades or businesses…which are under common control shall be treated as employed by a single employer and all such trades and businesses as a single employer.”4 According to the court, a private equity fund is a trade or business—and therefore liable as a single employer with a portfolio company—if the fund’s interest in the company is not purely passive, but instead involves an investment, “plus” some level of involvement in the management and operation of the companies.5
In addition, several courts have addressed the potential liability of private equity firms under the Workers Adjustment and Retraining Notification Act (“WARN Act”). The WARN Act requires that “employers” provide 60 days’ notice of a “plant closing” or “mass layoff.”6 Several courts have held that a private equity firm that takes an active role in overseeing the wind-down of a company can be held liable for failure to comply with the WARN Act’s notice requirements. In Guippone v. BH S&B Holdings LLC,7 for instance, the court applied a “single employer” analysis to conclude that a holding company created by two investment firms could be liable for the failure of the purchaser of a clothing retailer in bankruptcy to comply with the WARN Act. To reach this conclusion, the court focused on whether the parent company “was the decision-maker responsible for the employment practice giving rise to the litigation.” Because the bankruptcy purchaser “was so controlled [by the parent] that it lacked the ability to make any decision independently,” up-the-chain liability was warranted.8
In light of these developments, private equity firms must be cognizant of potential employment law liabilities in overseeing their portfolio companies, particularly in times of financial distress. While taking an active role in the day-to-day operations of an entity may be necessary to allow an entity to survive and succeed, the decision to play such a role must be made after careful analysis of the accompanying risks. Although there is no sure-fire way that a firm can insulate itself from the risk of liability, there are a number of ways to mitigate this risk. For instance:
Firms should, if possible, limit their involvement to participation at the Board level. Direct appointment or control of officers and other company executives significantly increases the risks of a finding of employer status;
In the context of unionized workforces, firm representatives should not sit at the bargaining table or otherwise become directly involved in union negotiations; and
The best way to avoid WARN Act liability is through careful planning. Layoffs and plant closings can in many cases be structured in ways that do not trigger WARN Act obligations. Portfolio company management should be trained to recognize situations where the WARN Act may come into play and work with counsel to assess and limit risks under the law.