Are Private Equity Funds Liable As Employers Under Federal by wyf14327


									JULY 15, 2004

         Are Private Equity Funds Liable As “Employers” Under
         Federal Employment Laws?

         Two recent court decisions have opened the door for private equity funds to be held liable
         as “employers” for violations of federal employment laws. Does this mean that the corporate
         shield that has heretofore protected private equity firms from claims made against a portfolio
         company is about to fall? Perhaps. For now, it appears that employee-plaintiffs may survive
         initial challenges to the pleadings and take their case to the jury. Two federal district courts
         have found that private equity firms may potentially qualify as “employers” under the
         WARN Act and thus be liable for WARN Act violations.1

         In Vogt v. Greenmarine Holdings, LLC, the United States District Court for the Southern
         District of New York applied a five-factor test to determine whether the plaintiff’s
         allegations, if true, established “employer” liability for the defendant private equity firms
         who exercised substantial control over the portfolio company’s decision to effect mass
         layoffs without issuing the prior WARN Act notification. In Shelby v. Recovery Equity Investors,
         L.P., the United States District Court for the Western District of North Carolina used the
         same five factors to conclude that whether the defendant investment entities were liable as
         “employers” under the WARN Act was a triable issue of fact that did not entitle defendants
         to summary judgment.

         Each court adopted the five-factor test that the Department of Labor specifically devised to
         analyze WARN Act liability in the context of parent corporations and their subsidiaries.
         Subsidiaries that are wholly or partially owned by a parent company are either treated as
         separate employers or as part of the parent. If a subsidiary is found as a “separate employer,”
         such finding shields the parent company from liability as an “employer.” Therefore, liability
         is dependent on the “degree of independence” of the subsidiary from the parent. The factors
         that determine the outcome are: (1) common ownership; (2) common directors and/or
         officers; (3) de facto exercise of control; (4) unity of personnel policies emanating from a
         common source; and (v) the dependency of the operations. The most important of these
         factor appears to be the de facto exercise of control.

         1. These two recent decisions primarily concerned the federal Worker Adjustment Retraining Notification Act
           (“WARN”), requiring an employer to give sixty days’ advance warning before any “plant closing” or “mass
           layoff” that causes an “employment loss.” The WARN Act defines an employer as “any business enterprise”
           that employs one hundred or more employees.

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These cases provide a cautionary tale to private equity firms. They should reinforce the
wisdom of maintaining proper corporate formalities in portfolio companies—especially with
respect to board decisions and the use of corporate agents to implement such decisions.
Representatives of private equity firms who maintain board seats should ensure that a
portfolio company properly accounts for and reserves against WARN Act payments and
other retirement benefits when calculating wind-down costs. Otherwise, the investors of
private equity firms who ignore such potential liability may ultimately pay an additional cost
of a bad investment.

It is important to note that the conclusions reached in Vogt and Shelby do not reflect a
decision on the merits. Ultimately, the plaintiffs’ cause of action may fail. Private equity
firms, however, should be mindful of the potential liability they may face from employees
who may bring claims directly against them even though the portfolio company is in
bankruptcy. If the theories for liability espoused by the plaintiffs are successful, private
equity firms might also be liable under other federal and state employment laws. Defending
such claims would be disruptive to a private equity firm’s normal operations, causing the
firm to expend time and money to defend and, in all likelihood, settle the claims.

The plaintiffs were the former employees of Outboard Marine Corporation (“Outboard”) (a
bankrupt outboard motors manufacturer) who sued a group of investment companies that
together owned or controlled a majority of Outboard’s stock. The plaintiffs alleged that
Greenmarine Holdings, II, LLC (“Greenmarine”), Greenlake Holdings II (“Greenlake”),
Quantum Industrial Partners (“Quantum,” together with Greenmarine and Greenlake, the
“Funds”) and the companies that owned or controlled them, together with Outboard, acted
as their “employer” for the purposes of the WARN Act. In response, the defendants
contended that they were merely the investors in Outboard and not joint employers with
Outboard, and that they acted in a way parent companies commonly act in regard to a

In analyzing de facto control, the court explained that this factor “is not intended to support
liability based on a parent’s exercise of control pursuant to ordinary incidents of stock
ownership,” but was instead meant to consider whether “the parent…was the decision-
maker responsible for the employment practice giving rise to the litigation.” The court
pointed to the plaintiffs’ allegation that it was the Funds who decided to effect a mass layoff.

The significance of the de facto control factor alone for determining WARN Act liability was
acknowledged by the court, noting that “if the parent corporation has ‘disregarded the
separate legal personality of its subsidiary’ in directing the subsidiary to act, such evidence
alone may be enough to warrant liability.” The court found that the plaintiffs sufficiently
alleged that Quantum and Greenmarine controlled the decision to effect a mass layoff of
Outboard’s employees without regard to the WARN Act notification time period. The court
noted the following allegations in support of plaintiffs’ claims:

     •    Quantum hired Outboard’s CEO;
     •    Quantum was a signatory to the CEO’s employment contract;

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     •    Quantum caused the preparation of and participated in the resolution by the
          Outboard board to file for bankruptcy;
     •    Quantum entered into an agreement with the CEO to have the CEO coordinate
          Outboard’s bankruptcy filing; and
     •    Greenmarine’s management committee, which committee was identical to
          Outboard’s board of directors, made the decisions that resulted in the mass layoff.

In Shelby, plaintiffs alleged violations of the WARN Act when Shelby Yarn Company closed
its plant and laid off its employees without the requisite sixty-day advance warning. Jeffrey
Lipkin and Joseph Finn-Egan formed Recovery Equity Partners II, LP (“REP II”), a fund
that invests in underperforming companies. Lipkin and Finn-Egan were the sole general
partners in REP II. REP II was the sole general partner of Recovery Equity Investors II,
L.P. (“REI II”), a limited partnership that was an investment fund specializing in
rehabilitating troubled companies. On a motion for summary judgment, defendants Lipkin,
Finn-Egan, and the REI entities and the CEO, Sydney Kosann, lost their argument that they
were not “employers” under the WARN Act, ERISA, COBRA, and the North Carolina
Wage and Hour Act.

In analyzing the complaint, the court reached the conclusion that “[t]here was no
question…REI II had de facto control over Shelby Yarn.” The court listed various actions
taken and decisions made by Lipkin and Finn-Egan such as having authority to approve an
employee bonus, pressing Kosann to hire a replacement CEO, deciding to take responsibility
for Doran’s (Shelby’s predecessor entity) unpaid health insurance claims, being intricately
involved in decisions relating to new product lines, competition, and patents, insisting on
more board of director meetings when Kosann wanted fewer such meetings. Even though
Kosann admitted that he consciously determined not to send WARN notices to employees
(because “it would have been a death knell to the company”), the REI entities, Lipkin and
Finn-Egan, were not “powerless or without responsibility to comply with WARN.” Finding
that REI, Lipkin, and Finn-Egan were intricately involved in almost every aspect of
management in the normal commercial sense, and that they “specifically carried out the
actual plant closing,” the court held that REI II “was clearly an employer.” Important to the
court was deposition testimony from Shelby employees that said “Kosann could not make
any decision of import without REI II’s ‘blessing’” and notes of Lipkin and Finn-Egan
detailing conversations, decisions, and meetings regarding Shelby.

We will continue to track the status of these two cases and issue a new client alert as material
developments occur.


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If you have any questions or require further information regarding these or other matters,
please call your regular Nixon Peabody contact or feel free to contact one of the attorneys
listed below:

     •    In our San Francisco office, Matthew P. Fisher 415-984-8446, Jeffrey M.
          Tanenbaum 415-984-8450, and Marjorie Fochtman 415-984-8443.
     •    In our Boston office, David S. Rosenthal 617-345-6183, and William E. Kelly 617-
     •    In our New York offices, Charles P. Jacobs 716-853-8107
The foregoing summary is provided by Nixon Peabody for education and informational
purposes only. It is not a full analysis of the matter summarized and is not intended and
should not be construed as legal advice. This publication may be considered advertising
under applicable laws.

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