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Who Should Hold the Bag for Employment Liabilities When the Portfolio Company Goes “Belly-Up”? The private equity firm, maybe.

Written by Jessica Catlow

In the world of private equity, vast sums of money are raised by private investors who pool their money into collective funds in order to acquire companies, i.e., a “portfolio company”, with the goal of eventually flipping the portfolio company at a significant profit. Sometimes, however, that bet goes wrong, and the portfolio company is sold at a loss or, worse, liquidated in bankruptcy. In August, we reported on a court decision holding that a private equity fund could be liable for its portfolio company’s unfunded pension liabilities following the portfolio company’s bankruptcy. And now, in Young v. Fortis Plastics, a court has held that the private equity firm itself could be liable for WARN Act liability when the portfolio company goes belly up.

In the cases of mass layoffs or plant closings, the federal Worker Adjustment and Retraining Notification Act (or “WARN Act”) requires covered employers to give terminated employees at least 60 days advance notice of termination. If the employer fails to do so, the employer may be liable for the wages and benefits that the affected employees would have received if they had been given proper notice. But just who is an “employer” under the WARN Act?

Private equity firms make their money from a management fee of 1.5-2.0% charged by the funds, and the rake of 20% of the profits when the portfolio company is sold. One of the hallmarks of the private equity model is the firm’s close involvement in the operations and management of the portfolio company, and investment professionals from the private equity firm often sit on the board of the portfolio company. In a recent decision in the United States District Court in Indiana, the court held that such close management oversight of the portfolio company could result in “single employer” liability under the WARN Act.

Fortis Plastics, located in Indiana, owns and operates plastics manufacturing facilities, and is owned by Monomoy Capital Partners, L.P., a private equity firm. In connection with the closing of one if its facilities, Fortis Plastics failed to provide 60 days’ notice to employees who were terminated in connection with the closing. An employee sued Fortis Plastics claiming that Fortis Plastics, as the direct employer, was responsible for the wages and benefits due for the 60 day period. The employee also, however, sued Monomoy for the wages and benefits under the theory that, although Monomoy was not the direct employer, it was a “single employer” for purpose of the WARN Act.

Under the “single employer” doctrine, WARN Act liability can extend to certain affiliated companies other than the direct employer if certain conditions are met. The Indiana District Court followed other courts in using the Department of Labor’s 5 factor test for determining whether such an affiliated company may have WARN Act liability. Normally, independent contractors and subsidiaries which are owned, all or in part, by a parent company are treated as separate employers. But they may be treated as a “single employer” with the subsidiary or affiliate depending on the degree of their independence from each other. The 5 factors used by the DOL in analyzing the dependence are (1) common ownership, (2) common directors/officers, (3) de facto exercise of control, (4) unity of personnel polices emanating from a common source, and (5) the dependency of operations. As the court in the Fortis Plastics case noted, “de facto control” over the operations of the company is one of the most important factors and may warrant liability even in the absence of the other factors.

According to the allegations in the complaint, Monomoy investment professionals had a continuous presence at the facility, had weekly calls with management, and ultimately made the decision to close the facility. The court held that these allegations were sufficient to establish “de facto control” of Monomoy over Fortis Plastics and that factor in combination with the common ownership, could result in single employer liability. Notably, the court held that the former employee plaintiff could not establish the other 3 factors, but allowed the case to go forward because the employee had made allegations satisfying the common ownership and “de facto control” factors.

While the Fortis Plastics case is still in its early stages, it is clear that courts may be more likely to find that private equity firms that are so closely involved with the management and operations of the portfolio company are a “single employer” with the portfolio company, resulting in potential liability under not only WARN but also under state mini-WARN acts and other employment statutes and regulations that extend liability to entities beyond the direct employer. The Fortis Plastics case should be a reminder to private equity firms to ensure that their relationship with the portfolio companies is indeed advisory, and if they have board oversight, they should ensure that the management team is primarily responsible for employment-related decisions.

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