Why Private Equity Funds Face Employment Risk

Guest Post by Dianne LaRocca – Assistant General Labor & Employment Counsel at PSEG Services Corporation

Suddenly, the advance sheets show a wave of litigation targeting private equity funds. See, e.g., Guippone v. BH S&B Holdings LLC, 737 F3d. 221 (2d Cir. 2013) (private equity funds potentially liable for WARN Act liability); Oaktree Capital Management, L.P. v. National Labor Relations Board, 452 Fed. Appx. 433 (5th Cir. 2011) (same for unfair labor practices under National Labor Relations Act); Board of Trustees, Sheet Metal Workers’ National Pension Fund v. Palladium Equity Partners, LLC, 722 F. Supp. 2d 854 (E.D. Mich. 2010) (same for multiemployer pension plan liability of a portfolio company).

Let’s take a deep breath and sort this out.

Private equity funds usually consist of: (1) partners (aka investors) who belong to a limited partnership and (2) general partner(s) who belong to a limited liability corporation. The partners invest money into the fund with the general partner(s) responsible for managing the fund, including determining in which targets to invest. Once a target is selected, the fund acquires a controlling interest in that portfolio company with the general partners (or their officers, directors, employees, affiliates, or representatives) sitting on the acquired company’s board of directors, directing the company’s business, and affecting policy at the company level. It is that intervention that potentially exposes the private equity fund to being held liable as a co-employer.

But, there are certain exposures that matter more than others.

While the target remains a portfolio company and remains solvent, the potential for being named as an extra defendant is no more than an annoyance and a cost of doing business. Whether it is a claim for unpaid overtime under the Fair Labor Standards Act, a claim for discrimination under Title VII, or alleged unfair labor practices as in Oaktree Capital Management, the cost of defending, settling, or paying judgments routinely will be handed by the portfolio company. The claim’s existence may be a wake-up call on the need to orchestrate the appropriate indemnity provisions in advance, but not a cause for insomnia among the fund’s investors.

Conversely, the claims that matter – and hurt the most– are those that arise either because the portfolio company is failing or after the portfolio company has been flipped. For example, Palladium Equity Partners is illustrative of an expensive issue – withdrawal liability – which arises where an employer participates in but then completely or partially withdraws from (by dissolving or selling the business) an underfunded multiemployer defined benefit pension plan. In Palladium Equity Partners, the amount of withdrawal liability at stake was over $9 million. In BH S&B Holdings, where the triggering issue was the implementation of a reduction in force at a failing entity without 60 days’ notice as required by the WARN Act, the search for upstream pockets to supplement the near- empty pockets of the failing entity was inevitable.

The takeaway? First, going in, set the ground rules clearly in the portfolio company’s by-laws and other corporate governance agreements on indemnification and limit direct (and indirect) investments in any portfolio company that participates in multi-employer pension plans to less than 80 percent to avoid withdrawal liability. Second, structure the involvement to respect corporate formalities; it is the micromanagement of the portfolio company that opens the door to exposing the private equity fund to the portfolio company’s employment liabilities and litigations. Finally, plan the exit from a portfolio carefully:

  • if it is closing, make sure that there has been WARN compliance;
  • if there are pending or asserted claims, consider the likelihood of being named as a defendant; and
  • incorporate proper protection (whether financial or legal: e.g., indemnities) into any sale agreement.

Dianne LaRocca, Assistant General Labor & Employment Counsel at PSEG Services Corporation

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