As private equity firms become more involved in the operations of their portfolio companies, they are increasingly at risk of being deemed joint employers of their portfolio companies’ employees, leaving private equity firms jointly and severally liable for violations of employment laws and vulnerable to disruptive obligations ranging from ongoing litigation to potential union bargaining obligations. One such area of risk is wage and hour laws. Recent years have brought an uptick in litigation by employees under the Fair Labor Standards Act (“FLSA”), the federal wage-and-hour law of general application, and its state law counterparts. Employees are increasingly looking beyond their official “employer” for recoupment (and to potentially expand the class of plaintiffs in a class or collective action), seeking to hold parents, franchisors, service recipients, individual management personnel, and other affiliated entities jointly and severally liable for any alleged violations. If an entity is found to be a joint employer of an employee under employment laws such as the FLSA, each joint employer is jointly and severally liable for any violations of the applicable law.

The definition of “employer” under the FLSA is exceedingly broad and includes “any person acting directly or indirectly in the interest of an employer in relation to an employee.” In turn, the definition of “employ” includes to “suffer or permit to work” and the definition of “employee” means “any individual employed by an employer,”1 which has been described as “’the broadest definition that has ever been included in any one act.’”2 These broad definitions have led the federal Department of Labor (“DOL”) to conclude that the concept of joint employment under the FLSA should be correspondingly broad, meaning the DOL (and courts subscribing to a similarly broad view of "employment" under the FLSA) is hesitant to dismiss entities related to an official employer from a wage-and-hour dispute.

In instances where an employee performs work for both a private equity firm and one or more of its portfolio companies, it is certainly likely that the private equity firm will be found to be a joint employer of the employee, at least under the FLSA. Such a finding is less certain where an employee does not directly perform services for a private equity firm or other parent, but the private equity firm or other parent is involved in the operation of its portfolio company or subsidiary. Courts and the DOL look to the economic realities of the situation to determine how economically dependent the employee is to the alleged joint employer in these circumstances, but tests differ among the courts and the DOL.

The Third Circuit Court of Appeals, for example, says the key inquiry is whether the alleged employer exerts “significant control,” and requires the court to consider all the relevant factors in that inquiry, including “1) the alleged employer's authority to hire and fire the relevant employees; 2) the alleged employer's authority to promulgate work rules and assignments and to set the employees' conditions of employment: compensation, benefits, and work schedules, including the rate and method of payment; 3) the alleged employer's involvement in day-to-day employee supervision, including employee discipline; and 4) the alleged employer's actual control of employee records, such as payroll, insurance, or taxes.”3 In the Enterprise case in which this test was announced, for example, the court found that a parent was not a joint employer of its subsidiaries’ employees. Although the boards of each subsidiary were composed of the same three individuals who sat on the parent’s board, and the parent provided certain back office functions for the subsidiary, this was not sufficient to establish a joint employer relationship. In reaching its conclusion, the Third Circuit focused on the fact that policies and procedures given by the parent to the subsidiaries were recommendations, not requirements, that the subsidiaries could choose to follow or not.

Other courts and the DOL, however, have applied broader tests. The DOL issued a detailed administrative interpretation earlier this year addressing joint employment under the FLSA and concluded that focusing too much on control, like the Third Circuit did, “is not consistent with the breadth of employment under the FLSA.”4 The DOL noted that other factors should be considered, such as the permanency and duration of the relationship, the repetitive and rote nature of the work, the degree to which the employee’s work is an integral part of the alleged joint employer’s business, whether the employee performs his or her work on the alleged joint employer’s premises, and whether the alleged joint employer performs administrative functions for the employee (e.g., handling payroll and providing workers’ compensation insurance). Courts within the Second Circuit, which includes federal courts in New York and Connecticut, similarly apply a test that looks beyond the control exerted by the alleged joint employer over the employee. Under these tests, it may have been a closer question as to whether the relationship addressed by the Third Circuit constituted joint employment.

The FLSA is not the only employment law with which private equity firms should be concerned. Joint employment can arise under many employment laws. In August 2015, for example, the National Labor Relations Board (“NLRB”) dealt another blow to the employer community with its long-awaited decision in Browning-Ferris Industries of California, Inc., 362 NLRB No. 186 (Aug. 27, 2015). In Browning-Ferris, the NLRB considered what standard should apply in determining which entities employ a worker and are thus obligated to bargain with the labor representative of such worker. It loosened its existing joint employment standard, making private equity firms and other alleged joint employers more easily susceptible to union organizing efforts, bargaining obligations, and the jurisdiction of the NLRB. The new standard proceeds through two inquiries, both focused on the degree of control the putative joint employer exercises:

  1. Is there a common law employment relationship between the alleged joint employer and the workers in question, and

  2. If so, does the alleged joint employer possess sufficient control over the workers’ essential terms and conditions of employment. Essential terms and conditions of employment include matters such as wages, hours of work, and discipline.

Departing from its existing standard, and particularly alarming for the management community, was the NLRB’s pronouncement that the alleged joint employer need not actually exercise control directly. Retained, but unexercised, control can be sufficient, as noted in the dissent’s argument that the new standard threatens to treat every parent as an employer of its subsidiaries’ employees. An entity can now be deemed a joint employer under the National Labor Relations Act if it has the ability to control essential terms and conditions of employment, even if the control is rarely or never exercised. In addition, such control can be exercised indirectly through intermediaries.

The application of these principles was well demonstrated by the facts presented in Browning-Ferris, which involved an owner and operator of a recycling facility that contracted with a temporary services firm to provide employees for the facility. Central to the NLRB’s determination that the owner and operator was a joint employer with the staffing agency was the parties’ contract. Although that contract provided that the workers were solely employed by the staffing agency, the contract gave the facility certain rights that are typical in a staffing services agreement, including the right to reject personnel, determine the operating hours and shifts at the facility, specify the number of employees needed, and require certain minimum qualifications and screenings for provided workers. The NLRB’s decision is currently on appeal before the U.S. Court of Appeals for the D.C. Circuit.

As a practical matter, as long as a portfolio company is sufficiently solvent, it may not matter much from a purely financial perspective whether a private equity firm is found jointly and severally liable with its portfolio company as a joint employer. The bigger risk is the inevitable disruption caused by being named in a lawsuit, which imposes obligations relating to document preservation, discovery, and time devoted to matters other than running the business. In addition, while any particular portfolio company may have few to no employment disputes at any given time, the disruption can be magnified for the private equity firm if it is named in lawsuits of multiple portfolio companies and may have a small staff to start, or if it is determined to have union bargaining obligations. Indirect financial impacts may also be felt, such as in increased insurance premiums.

There are several steps private equity firms and other potential joint employers can take now to help prevent a lawsuit later, or, at minimum, increase the likelihood of an early exit if named as a defendant in an employment suit based on a joint employment theory. They include:

  • Take a break. The strongest indicia of joint employment under many employment laws is the degree of involvement and control by the alleged joint employer in the operations of the official employer, especially the operations relating to the official employer’s employees. To the maximum extent possible, portfolio companies should be free to set their policies and procedures and make decisions regarding their workforce, including decisions relating to compensation, discipline, and hiring. If a private equity firm makes employment policies available to its portfolio companies, such as an employee handbook for use at the portfolio companies, use of the policies should be discretionary.

  • Make your paperwork work for you. If a contract between parties is determined to be necessary, to the extent possible, include provisions that will not increase the likelihood of a joint employment finding. By way of example, in a services agreement where a private equity firm contractually agrees to provide certain back office functions for a portfolio company, limit the contractual decision-making authority granted to the private equity firm. Contractual language reserving ultimate authority to the private equity firm can be used by plaintiffs in seeking to hold the private equity firm liable for alleged shortcomings of the portfolio company, perhaps regardless of whether such authority is actually exercised. On the other hand, contractual language can help to limit the likelihood that one entity will be deemed a joint employer with another entity with respect to employees. The contract should make clear that the portfolio company is the sole employer of its workers and that there is no employment relationship between the private equity firm and the portfolio company’s employees. This language is not dispositive, and the DOL has gone so far as to say that a provision of this type “is not relevant” to its inquiry of whether a joint employment relationship exists, but inclusion of the language certainly does not diminish the likelihood of defeating an allegation of joint employment. In addition, the portfolio company should retain full discretion to make all employment decisions with respect to its workforce.

  • Apportion the risk upfront. Consider including an indemnification clause in any contracts whereby the official employer agrees to indemnify the potential joint employer for any liabilities arising from the employment of any employee. While such clauses may not always be effective in shifting liability, depending on the allegations and laws at issue, they can help to limit liability in certain contexts.