There is a recent tendency for workers who lose employment at a private equity fund’s portfolio company as a result of a plant closing or a layoff to sue the private equity fund for violations of the federal Worker Adjustment and Retraining Notification Act (WARN Act) and similar state statutes. Since it is likely a portfolio company that takes such actions may be failing financially, the terminated employee often looks to the private equity firm as the “deep pocket” source of compensation, claiming that the private equity firm is liable because it made the termination decision with the portfolio company as a “single employer” under the WARN Act. As discussed below, courts will typically apply a test to determine potential “single employer” liability to the specific facts of the case.

Generally speaking, the WARN Act offers protection to employees, their families and communities by requiring employers to provide written notice to such affected employees 60 days in advance of covered plant closings and covered mass layoffs. Such notice is also required to be delivered to appropriate local government units. Below is a brief discussion of the WARN Act, including the legal test generally employed by courts to determine whether “single employer” liability applies. Following this discussion are some practical steps that a private equity firm can take to decrease potential liability under the “single employer” doctrine and increase the chances of a successful motion to dismiss, or of winning a lawsuit if sued by former employees of one of its portfolio companies.

What employers are subject to the WARN Act?

In general, employers are covered by the WARN Act if they have 100 or more employees, exclusive of employees who have worked less than six months in the last 12 months and employees who work an average of less than 20 hours a week (collectively, “exempt employees”).

What triggers the notice requirement?

For plant closings, a covered employer must give written notice if an employment site (or one or more facilities or operating units within an employment site) will be shut down, and the shutdown will result in an “employment loss” for 50 or more non-exempt employees during any 30-day period. The exempt employees, however, are also entitled to such notice.

A covered employer must also give written notice if there is to be a mass layoff. A mass layoff is one which results in an employment loss at the employment site during any 30-day period for 500 or more employees, or for 50 to 499 employees if they make up at least 33 percent of the employer’s workforce. Again, this is exclusive of exempt employees, though such exempt employees are still entitled to such notice.

An “employment loss” occurs if there is (i) an employment termination, other than a discharge for cause, voluntary departure or retirement; (ii) a layoff exceeding six months; or (iii) a reduction in an employee’s work hours of more than 50 percent in each month of any six-month period.

Certain narrow exemptions (such as a natural disaster) may apply, but even in those cases the employer must give as much notice as is practicable.

What are the penalties for violation of the WARN Act?

An employer that violates the WARN Act is liable to each aggrieved employee for an amount including back pay and benefits for the period of violation, up to 60 days. An employer that fails to provide notice as required to a unit of local government is also subject to a civil penalty not to exceed US$500 for each day of violation.

How are private equity firms impacted by the WARN Act? 

As discussed above, in many instances, former employees of a private equity fund’s portfolio company may sue the fund under a “single employer” doctrine because a portfolio company has not provided the requisite notice of an employment loss.

Often in these situations, the portfolio company has ceased operations or is on the verge of doing so, and it may be difficult to obtain a meaningful recovery from such company. So, the former employees assert their WARN Act claims against the private equity owner of the failed company looking for “deep pockets.” If the “single employer” claim is successful, the former employees will be able to recover from the defendant private equity firm.

The “single employer” test

US Department of Labor (DOL) regulations have set out five factors to be considered when evaluating the “single employer” doctrine with respect to WARN Act liability: (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 operations.

Courts in various jurisdictions, including Delaware courts and the US Court of Appeals for the Second Circuit, have adopted a five-factor balancing test based on the above, and generally apply the same test. Inquiries into the specific facts and circumstances of each case have driven the courts’ analysis under the “single employer” test.

The above five factors are meant as a non-exhaustive list so as to allow courts to exercise flexibility. The DOL balancing test is thus not a “mechanical exercise”1 and is “ultimately an inquiry into whether the two nominally separate entities operated at arm’s length.”2 Generally, if only the first two factors are present—common ownership coupled with common management—liability is not established. Typically, the last three factors are the determinative ones. Among these, de facto exercise of control is the most important.

According to the Third Circuit, a “particularly striking” showing of de facto control can warrant “single employer” liability even in the absence of the other factors. The de facto control factor involves a determination as to whether one company “was the decision-maker responsible for the employment practice giving rise to the litigation.”3 A recent Delaware District Court decision held that de facto control is not present where the parent corporation exercises control pursuant to the ordinary instances of stock ownership, but exists only where “the parent has specifically directed the allegedly illegal employment practice that forms the basis for the litigation.”4

The fourth factor looks to whether there was unity of personnel policies, and is “analogous to a determination of whether the companies had a centralized control of labor operations.”5

The fifth factor considers whether there was a dependency of operations between the two companies. Courts will look to the existence of arrangements such as the sharing of administrative or purchasing services, interchanges of employees or equipment and commingled finances. This factor cannot be established merely by the parent company’s exercise of its ordinary powers of ownership, i.e., to vote for directors and set general policies. Instead, this factor requires that plaintiffs establish the existence of what was known at common law as a master-servant agency relationship.6

Finally, it is important to note that the standard for crossing corporate entity boundaries to create liability under the WARN Act is not as high of a standard as is used for “piercing the corporate veil” under traditional law, so it is not prudent to solely rely on “veil piercing” protections in this context.

Protective measures

“Single employer” liability risk can be mitigated with proper advance planning and structuring.

Below is a non-exhaustive list of some of the protective measures that a private equity fund may want to consider (to the extent practicable) in order to reduce the chances of facing WARN Act liability as a “single employer” in connection with layoffs or plant closings at a portfolio company:

  • The portfolio company should have and be responsible for creating its own human resources, labor, employment and personnel policies, rules and procedures; ensure decision-making in this area is independent
  • The portfolio company should negotiate its own labor and employment agreements
  • Allow the portfolio company to have at least one or more independent directors and independent officers; directors and officers should act on behalf of the portfolio company
  • Management-level personnel should not be repeatedly transferred between the fund and the portfolio company
  • With board oversight and input from the fund, the portfolio company’s management team should strive to control day-to-day operations of the company and decisions as to potential layoffs or plant closures, as well as other major decisions
  • Professional advisors to the portfolio company’s board and management team should be hired directly by the portfolio company as opposed to relying on advisors to (or hired by) the private equity fund, especially regarding layoff or plant closing decisions
  • Each company should maintain its own books and records, have its own bank accounts and prepare its own financial statements

Seeking outside legal counsel as early as possible in the structuring process is advisable to ensure that appropriate decisions and structures are made and implemented in order to protect the private equity fund from WARN Act liability under the “single employer” doctrine. While lawsuits are often inevitable, if proper steps are taken, the private equity fund should have a much greater chance of winning the lawsuit or getting it dismissed.