Following the Second Circuit’s recent decision in Guippone v. BH S & B Holdings LLC, et al., 737 F.3d 221 (2d Cir. 2013), private equity, venture capital, and hedge funds should be more vigilant than ever to distance themselves from the employment practices of their operating portfolio companies. Otherwise, affiliates of such companies may face potential liability for their portfolio companies’ missteps, including – at issue in Guippone – liability under the Worker Adjustment Restraining and Notification Act (the “WARN Act”) for failure to provide the requisite sixty days’ advance notice of mass layoffs or plant closings to employees.
The facts of Guippone provide a cautionary tale regarding the importance of implementing and observing corporate formalities with respect to a portfolio company. Following the chapter 11 bankruptcy of Steve & Barry’s (a retail chain of department stores), a group of hedge funds created a parent limited liability company (“Holdings”) and a subsidiary acquisition vehicle limited liability company (“Opco”) to purchase Steve & Barry’s assets and business. Holdings was the sole managing member of Opco; Opco lacked a board of directors of its own. Following the asset purchase, Opco continued to employ several former Steve & Barry’s employees, including plaintiffs and putative class members in the Guippone lawsuit (“Plaintiffs”), until Holdings liquidated Opco after Opco faced its own liquidity crisis. Around that time, Holdings terminated Opco’s senior management and replaced them with a consulting firm, RAS Management Advisors, LLC (“RAS”), to manage the wind-down. Holdings then approved RAS’s plan to conduct immediate mass layoffs and send WARN Act notices to affected employees. WARN Act notices were sent only two days before Opco filed for bankruptcy, and Guippone filed the lawsuit the day after his termination.
On a motion for summary judgment, the question before the Second Circuit was whether Holdings could be held liable under the WARN ACT as a single employer with Opco.1 In answering this question, the Second Circuit adopted the Department of Labor’s five-part test (which has also been adopted by the Third Circuit Court of Appeals), whereby parent companies and subsidiaries are treated as separate employers, or single employers, depending upon the “degree of independence from the parent,” as demonstrated by: (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 (5) the dependency of operations. Applying these factors, the Second Circuit found a question of fact for trial regarding Holdings ’ liability as a single employer with Opco under the WARN Act. It observed that Opco did not have its own board of directors or managers; Holdings managed Opco as the sole member and manager, going so far as to select Opco’s CFO; the two entities shared common officers; and Holdings board participated in the decision to terminate Opco’s employees. Although no one of the five factors is controlling, the Second Circuit stated that the core factor is whether one company was the decision maker allowing “the factfinder to consider whether the parent has specifically directed the allegedly illegal employment practice that forms the basis for the litigation.” 737 F.3d at 227 (citation omitted). Importantly, the Second Circuit opined that “[a]uthorizing layoffs is not just a prerogative of ownership—it’s a function of being an employer.” Id. at 227.2
Guippone thus highlights the risk that direct control over the operations of a subsidiary can entail. There are obviously times when a parent may seek to review and provide input regarding the operations of a subsidiary, but Guippone teaches that to minimize the risk of being held accountable for the subsidiary’s employment practices and missteps, it is important to preserve the operating company’s independence and, to the extent possible, observe corporate formalities. Particularly in the context of avoiding WARN Act liability, Guippone underscores the importance of having established processes and corporate structures that insulate the parent from meddling with the human resources management of the operating entities. Independent boards and officers, with independent control over employment practices and policies, may go a long way to protect the parent from potential liability and unnecessary litigation.