• In considering whether two entities should be considered a “single employer” for purposes of the WARN Act, the Fifth Circuit concluded that “the question of de facto control is of such importance that liability might be warranted even in absence of the other factors.”
• The Court found that the instant case—which involved the closure of a steel mill in advance of a bankruptcy filing without advance notice to employees—was one in which the exercise of de facto control alone could provide the basis for imposition of liability on a PE sponsor.
• The decision highlights the need for private equity firms to carefully document their involvement (or lack thereof) in the decisions of their portfolio companies so that factual disputes about the decision-making process don’t create unnecessary liabilities.

In its recent decision in Fleming v. Bayou Steel BD Holdings II L.L.C., No. 22-30260 (Sept. 27, 2023), the United States Court of Appeals for the Fifth Circuit held that a private equity sponsor could be held liable for a portfolio company’s failure to comply with the Worker Adjustment and Retraining Notification Act (the “WARN Act”) based solely upon the sponsor’s exercise of control over the portfolio company’s decision-making. As discussed below, this decision highlights the risks to private equity firms that can arise from the exercise of significant control over a portfolio company’s operations, particularly in cases involving a portfolio company’s economic distress.

Background

BD LaPlace, LLC, doing business as Bayou Steel, was a small producer of steel products in Louisiana. In 2016, Black Diamond Opportunity Fund IV, LP (the “Fund”) acquired Bayou Steel. The Fund was managed by an affiliated advisor, Black Diamond Capital Management (“BDCM”). As Bayou Steel had been managed by its prior owner’s management, upon acquiring the company, BDCM installed a new management team at Bayou Steel. BDCM also established a board of directors for Bayou Steel, consisting of two BDCM employees and three independent non-BDCM employees. A sixth member, another BDCM employee, later joined the board.

Toward the end of 2017, Bayou Steel experienced significant financial difficulties due to fluctuations in the steel market. This required Bayou Steel to receive additional infusions of cash from the Fund and its affiliates, as well as to take on substantial third-party debt. By August 2019, Bayou Steel was in default of its loan covenants. In September 2019, the Fund decided that it would not provide further capital to Bayou Steel. Shortly thereafter, Bayou Steel’s lender notified the company that they were accelerating repayment of its outstanding loans. As a result, Bayou Steel’s outside law firm and restructuring advisor advised that the company “had no alternatives other than filing for bankruptcy.” The three independent directors then consulted their own counsel regarding the bankruptcy, after which they signed a formal resolution on September 30, 2019, to put Bayou Steel into bankruptcy. That same day, Bayou Steel notified its employees that the company would be closing its plant and that all employees were terminated effectively immediately. Bayou Steel filed for bankruptcy the next day.

The affected Bayou Steel employees initially filed a putative class action under the WARN Act in Delaware bankruptcy court. In that suit, the employees alleged that Bayou Steel had ordered a “plant closing” without providing the required notice under the WARN Act. The employees subsequently dismissed their bankruptcy suit and filed a class action in Louisiana federal court against BDCM and BD Holdings II, the holding company within the Fund that owned Bayou Steel (“BD Holdings”) under the WARN Act.

The WARN Act

The WARN Act is a federal statute that generally requires employers with 100 or more full-time employees to provide 60 days’ advance notice of a “plant closing” or “mass layoff” to affected employees, their collective bargaining representatives, and certain governmental actors. Under the WARN Act, a “plant closing” is defined as “the permanent or temporary shutdown of a single site of employment, or one or more facilities or operating units within a single site of employment, if the shutdown results in an employment loss at the single site of employment during any 30-day period for 50 or more employees excluding any part-time employees.” A “mass layoff” is defined as a reduction in force that is not a plant closing that results in employment losses for: (i) at least 500 full-time employees; or (ii) 50 or more full-time employees that comprise at least 33% of the total full-time workforce at a site of employment, in each case excluding certain recent hires.

An employer that fails to provide required notice of a plant closing or mass layoff must provide each affected employee with pay and benefits for the period of the violation, as well as civil penalties and attorneys’ fees. There are limited exceptions to the WARN Act’s notice requirements for “faltering” companies, employers “actively seeking capital,” and shutdowns caused by natural disaster, although those exceptions were not applicable in this case.

The Fifth Circuit Finds that BDCM Could Be Held Liable as a Single Employer with Bayou Steel

In this case, there was no question that Bayou Steel did not provide the required notice of its plant closure. The issue, therefore, was whether BDCM could be held liable for Bayou Steel’s violations.^[1] Under the WARN Act, liability is imposed on an “employer who orders a plant closing or mass layoff.” BDCM argued both that 1) it was not an “employer” of Bayou Steel’s employees under WARN; and 2) it did not “order” the plant closing at issue. The Court quickly disposed of the second question on the basis that BDCM had failed to raise this argument in the district court and had therefore waived its right to do so. Thus, the Court concluded, “WARN Act liability turns on whether Defendants are considered to have been Plaintiffs’ employer.”

The Court analyzed BDCM’s and BD Holdings’ potential liability by evaluating whether it was a “single employer” with Bayou Steel. Noting that “[t]he WARN Act does not address when a related entity may be held liable under a single employer theory,” the Court looked to regulations issued by the Department of Labor (“DOL”). Pursuant to the DOL’s regulations, determining whether entities are a single employer requires consideration of five factors: (i) common ownership, (ii) common directors and/or officers, (iii) de facto exercise of control, (iv) unity of personnel policies emanating from a common source, and (v) dependency of the operations.

Finding that the Plaintiffs had not made any attempt to apply the factors to BD Holdings, the Court affirmed summary judgment in favor of BD Holdings. The Court thus focused on the claims against BDCM and conducted an analysis of how each factor weighed for or against a finding of single employer status between BDCM and the actual employer, Bayou Steel.

• Common ownership – The Court emphasized that because “ownership entails possession, not mere control,” “[w]hatever BCDM’s degree of control over Bayou Steel’s operations, that alone does not satisfy the common ownership factor of the single-employer test.” The Court disagreed with the lower court, however, that “direct” ownership is required to satisfy this element, noting “there may be circumstances where a significant financial relationship short of direct ownership nonetheless amounts to common ownership” (e.g., where there are fraudulent transfers). After reviewing the Defendants’ “labyrinthine” ownership structure, and noting that BDCM held only a 2.5% investment stake in the Fund, the Court of Appeals concluded that there was no common ownership between Bayou Steel and BDCM, and therefore “[t]his factor weighs against a finding of liability for BDCM.”
• Common directors/officers – The Court found that this factor weighed against liability for BDCM as well. Although BDCM and Bayou Steel had some common directors, they were never a majority of Bayou Steel’s board, and there were no common officers.
• De facto control – This factor, the Court said, was “the hinge of this case.” In determining whether this factor supports a finding of single employer status, a court must “’consider whether the defendant has specifically directed the allegedly illegal employment practice that forms the basis for the litigation.’” What made this case unusual, the Fifth Circuit noted, was that there was a genuine dispute of fact concerning who ordered the closure of Bayou Steel’s plant. This included evidence that “BDCM was intimately involved in any number of significant decisions at Bayou Steel, so much so that Bayou Steel’s CEO felt micromanaged by BDCM employees.” At the same time, the Court found, “[b]izarrely, Bayou Steel’s own officers and directors deny knowing who decided to close the LaPlace mill.” Accordingly, “the evidence gives rise at least to an inference that BDCM directed the LaPlace mill closure and layoffs just as it made other decisions at Bayou Steel.” Therefore, this factor supported a finding of single employer status.
• Unity of personnel policies – This factor, the Court stated, “look[s] to whether Bayou Steel and BDCM ‘had separate policies regarding personnel issues.’” The Court of Appeals agreed with the district court that “there was no unity of personnel policies between BDCM and Bayou Steel because directing personnel policies on a handful of occasions does not rise to unity of personnel policies.”
• Dependency of operations – The Court concluded that because there was no “comingling of finances” between Bayou Steel and BDCM, this factor did not support a finding of single employer status.

In assessing how the balancing of factors weighed in favor of or against a finding of liability for BDCM, the Fifth Circuit noted that it had “previously declined to decide the relative importance of the five WARN factors.” However, recognizing that only one factor supported a finding of single employer status in this case, the Court found that it now needed to make this determination. concluded, in alignment with the Third Circuit’s decision in Pearson v. Component Tech. Corp., 247 F.3d 471 (3d Cir. 2001), that “the question of de facto control [is] of such importance that ‘liability might be warranted even in absence of the other factors.’” Such a rule, the Court noted, “comes closest to the text of the WARN Act, which imposes liability on an ‘employer who orders a plant closing or layoff.’” Thus, “if BDCM ‘specifically directed’ the closing of the mill without proper notice, the company may be liable for Bayou Steel’s WARN Act violation even absent the other factors.” It left that ultimate determination to the district court on remand.

Impact and Practical Guidance for PE Sponsors

The Fifth Circuit’s decision highlights the risks associated with a private equity sponsor’s exercise of significant control over the employment-related decisions of its portfolio companies, as well as the need to ensure that such decisions are made in compliance with applicable employment laws. Further, private equity firms should ensure that the decision-making processes of its portfolio companies, especially those made when such companies are in financial distress (and, therefore, potential plaintiffs ultimately may be forced to search for alternate sources to satisfy legal liabilities), are made in accordance with existing protocols and are well documented. This may include ensuring that the independent directors of the portfolio company’s board seek independent legal counsel regarding potential employment liabilities of significance.

[1] The Court also considered whether a plaintiff under the WARN Act is entitled to a jury trial and concluded that the statute does not afford plaintiffs such a right.