United States: A Warning To Private Equity Regarding Potential Liability For Employment Decisions By Portfolio Companies

Last Updated: October 10 2013
Article by David A. Posner

A federal district court in Indiana recently ruled that a plaintiff's class action lawsuit could proceed against both a New York private equity firm and one of its portfolio companies for an alleged violation of the Worker Adjustment and Retraining (WARN) Act when the plastic components manufacturing facility where the plaintiff worked closed. The decision is significant to private equity because it delineates the factors under which a court may determine that a private equity firm itself may be liable for the employment decisions of its portfolio companies.

In Young v. Fortis Plastics LLC, Case No. 3:12-cv-00364 (N.D. Ind. Sept. 24, 2013), the court addressed WARN Act claims arising out of the closing of a Fortis Plastics facility in Fort Smith, Arkansas in October 2011. The plaintiff contended that he and approximately 90 other employees were not provided with the 60-day notice the WARN Act requires. He attempted to assert claims on behalf of the affected employees and also named as a defendant a private equity company that, the complaint alleged, owned Fortis and made employment decisions on its behalf. The employee sought class certification, and the private equity company sought to dismiss the claims against it. The court ultimately denied the motion to dismiss and certified a class of those who had worked at the facility in the 60 days before it closed.

There was no dispute that Fortis Plastics was the plaintiff's employer, but he also sued the private equity firm that owned the company, claiming that it, too, was an "employer" under the WARN Act. The reason for doing so is obvious: Fortis had closed not only the plant at issue, but also several others, suggesting financial trouble. Filing suit to include a solvent private equity firm would allow the plaintiff another avenue to attempt to satisfy a potential judgment.

The Young case exemplifies how employment and labor laws are far less respectful of corporate boundaries than many other areas of the law. Under the WARN Act, a plaintiff need not establish the high standard for piercing the corporate veil under traditional law but can claim that the owner of a company (in addition to the company itself) is liable as a "single employer" based upon having sufficient interrelatedness and control over the employment practices of the company. More specifically, under the WARN Act's regulations promulgated by the Department of Labor:

independent contractors and subsidiaries which are wholly or partially owned by a parent company are treated as separate employers or as a part of the parent or contracting company depending upon the degree of their independence from the parent.

29 C.F.R. § 639.3(2)

The regulations also describe the five (5) factors to be considered when determining whether two entities are sufficiently separate (or not):

Some of the factors to be considered in making this determination are (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) the dependency of operations.


As the court in Young explained, these are simply a list of factors to be balanced together and a plaintiff need not satisfy all of them to assert a viable claim. As to the factor of common ownership, the court observed that while common ownership counts in favor of liability for a corporate parent, stock ownership alone is not grounds for holding a parent liable for its subsidiary's actions. Regarding the factor of common directors and/or officers, the court noted that this factor ordinarily looks to whether the two nominally separate corporations (1) actually have the same people occupying officer or director positions with both companies, (2) repeatedly transfer management-level personnel between the companies, or (3) have officers and directors of one company occupying some sort of formal management position with respect to the second company. The de facto control factor looks to whether the affiliated company was the decisionmaker responsible for the employment practice at issue. The factor assessing the unity of personnel policies emanating from a common source is analogous to a determination of whether the companies had a centralized control of labor operations and considers factors such as centralized hiring and firing, payment of wages, maintenance of personnel records, benefits and participation in collective bargaining. The final dependency of operations factor looks to sharing of administrative or purchasing services, interchanges of employees or equipment, or commingled finances, but the mere fact that a subsidiary's chain of command ultimately results in the top officers of the subsidiary reporting to the parent corporation does not establish the kind of day-to-day control necessary to establish an interrelation of operations.

The Young court found that the plaintiff failed to allege sufficient facts to support the second, fourth and fifth factors, yet concluded that, under the totality of the factors, there were sufficient allegations of common ownership between the company and the private equity firm and of the private equity firm's exercise of de facto control over the company (including regarding the decision to close the facility at issue) to conclude (in a "close call") that there was a reasonable possibility that the private equity firm and the company were a "single employer" under the WARN Act. The court explained that the third "de facto control" factor is perhaps the most important factor in the "single employer" analysis and that, if sufficiently egregious, can be sufficient to warrant liability on its own.

The decision in Young as to the role of the private equity firm is rightly of concern. It not only relates to private equity firms but will likely be argued to apply to management turnaround firms and potentially others who assist struggling operations return to profitability.

But it also has its limits. First, the court itself recognized that the case was "a close call," and it ruled against dismissal of the claim against the private equity firm only because of the lenient standard the plaintiff had to meet at that stage of the case. Second, it all but invited the defendant to move for summary judgment at the close of discovery if the plaintiff could not prove the allegations of control it had made in the complaint. In any event, the Young case makes it clear that those owning or working with failing companies or facilities should not only observe corporate formalities, but also keep their lines of authority sufficiently separate to avoid allegations of joint control.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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