In Second Circuit, “Economic Reality” and Degree of Control to Determine Whether an “Employer” Faces “Single Employer” Liability

In a recent decision on motions for summary judgement in the TransCare case, the SDNY bankruptcy court addressed the test for the imposition of liability under the US and New York Worker Adjustment and Retraining Notification Acts (together, the “WARN Acts”) and state wage laws on the debtors’ private equity funds affiliates under the single employer doctrine.  

In determining whether the defendants met the Second Circuit’s test for “single employer,” the Court placed particular significance on de facto control. Thus, the Court found no “single employer” liability where a defendant, while having direct ownership interests in TransCare, was a “funder of last resort” and exercised its rights as a lender. 

As for claims made under New York wage claim laws, the Court determined whether a particular defendant was an “employer” by applying an “economic reality” test, looking to factors such as a defendant’s operational control, its hypothetical versus actual power over TransCare, and its ability to determine employment conditions. In re TransCare Corp., 2020 WL 2278172 (Bank. S.D.N.Y. May 7, 2020).

Background

TransCare was a private ambulance operator that had been controlled by its sole director Lynn Tilton, who owned and directly or indirectly controlled each of the entity defendants, including the private equity firm Patriarch Partners. Tilton also owned a majority of the TransCare equity stake through her personal investment funds (the “Funds”). The Funds were the vehicles through which Tilton made secured loans to the debtors.

In 2015, TransCare reached a point of severe financial distress and could not continue to operate without a significant capital investment from Patriarch Partners, headed by Tilton. Patriarch Partners declined to provide the investment, and, in January 2016, the employment of TransCare’s CEO was terminated without replacement. As TransCare’s financial condition continued to deteriorate, Tilton devised a plan (the “Tilton Plan”) under which TransCare would be divided into two groups. One would be wound down through Chapter 11 proceedings, and the second would continue to operate, but its assets would first be foreclosed on and transferred to two new entities. When the initial group filed for Chapter 7 relief, the Trustee refused to continue operations for the period required to transfer its employees and certain assets to the second group absent assurance that the affected employees would be paid. Without the Trustee’s cooperation, the Tilton Plan failed, and notice of a second set of layoffs was sent to TransCare’s employees. The second group of companies eventually filed for Chapter 7 bankruptcy as well.

The Plaintiff commenced an adversary proceeding, alleging that Tilton was the sole director, officer or manager of each entity defendant and that TransCare was dependent on Patriarch Partners and its affiliates for operational management and funding. Both sides moved for summary judgement, with the entity defendants seeking dismissal of the WARN Act claims, contending that (1) they are not subject to “single employer liability” and (2) even if they were, the layoffs were a result of “unforeseeable business circumstances.” Under New York state wage claims, the defendants argued that they did not constitute the employer and, thus, were not liable for the unpaid wages.

Test for “Single Employer”

Under the US WARN Act, an employer must give employees 60-days’ written notice of a mass layoff, and under the New York WARN Act, a 90-days’ notice is required. The threshold question with regard to the WARN Acts was whether the entity defendants could be considered “a single employer,” along with TransCare.

The Second Circuit’s “Single Employer” Liability Test

To make its determination, the Court looked to the Second Circuit’s approach to “single employer” liability and to its adoption of the following five non-exclusive factors: (1) common ownership, (2) common directors and/or officers, (3) de facto exercise of control, (4) unity of personnel policies, and (5) dependency of operations. Although no one factor is controlling, the Court noted that the “factors are accorded different weights and de facto control is the ‘key’ factor.”

De Facto Control

The key inquiry into whether de facto control existed is whether one company was the decision-maker that was responsible for the employment practice that gave rise to the litigation. The Court also noted that this factor “is not intended to support liability based on a parent’s exercise of control pursuant to the ordinary incidents of stock ownership.”

The Court found that there was a triable issue of fact whether Tilton and Patriarch Partners exercised de facto control over TransCare, remarking that Tilton had directed the execution of the Tilton Plan, which included the foreclosure on and transfer of TransCare’s assets, along with the termination of its employees. The Court also noted that a number of other employees of Patriarch Partners played considerable roles in executing the Tilton Plan. Ultimately, the Court found a disputed issue of material fact whether Tilton had acted in her capacity as sole director of TransCare, or whether she was directing the execution of the Tilton Plan through Patriarch Partners and its employees.

With regard to the Funds, although Tilton owned a majority of TransCare equity through them, their only involvement was their foreclosure on the collateral securing their loans. As a result, the Court applied a different test, as outlined by the Second Circuit to determine de facto control when the defendant is a creditor or lender. Under this test, the Second Circuit has held that “the dispositive question is whether a creditor is exercising control over the debtor beyond that necessary to recoup some or all of what is owed, and is operating as the de facto owner of an ongoing business.” Coppola v. Bear Stearn & Co., 499 F.3d 144, 150 (2d Cir. 2007). After TransCare defaulted, the Funds foreclosed on their collateral to collect a portion of the debt owed to all lenders under the 2003 Credit Agreement. The Court held that the foreclosure was not evidence of de facto control but, instead, was merely an exercise of the Funds’ right to collect unpaid debt upon default.

Other Factors

The Court held that a finding of common ownership or common directors/officers was of “limited importance” since stock ownership alone is not grounds for holding a parent liable for the actions of its subsidiary. Similarly, the Court noted that it is “entirely appropriate for directors of a parent corporation to serve as directors of its subsidiary.”

As to unity of personnel policies, the Court concluded that the decision to execute a mass layoff is the single most important personnel policy in the WARN Act context. The Court found there was a material question of fact as to whether Patriarch Partners participated in the execution of the Tilton Plan, which entailed mass layoffs of TransCare’s employees. Further, employees of Patriarch Partners appeared to have directed TransCare’s Human Resources department and overseen labor and WARN Act issues related to the Tilton Plan, justifying denial of the summary judgement motion.

On the final factor, the Court concluded that whether TransCare was operationally dependent on Patriarch Partners was a disputed material question of fact, in light of evidence in the record showing that, after the employment of TransCare’s CEO was terminated, no replacement was made, and TransCare was “entirely dependent on Patriarch Partners for its day-to-day operations and decision making.” Further, the record showed that employees of Patriarch Partners worked out of TransCare offices and routinely issued directives to TransCare officers, which included directing TransCare to repay loans to Patriarch affiliates and prohibiting it from seeking payment deferment, rendering TransCare financially dependent on Patriarch Partners, as well.

Unforeseeable Business Circumstances

The “unforeseeable business circumstances” exception (“UBC”) is a defense, which shields an employer from WARN liability if the mass layoff was caused by business circumstances that were “not reasonably foreseeable as of the time that notice would have been required." The UBC test looks to whether an employer exercised “such commercially reasonable business judgement as would a similarly situated employer in predicting the demands of its particular market.”

As the Second Circuit has not yet ruled on the test for reasonable foreseeability under the UBC defense, the Court adopted the “probability” standard first set forth by the Fifth Circuit in Halkias v. Gen. Dynamics corp., which requires that employers provide employees with WARN notice when mass layoffs are probable, rather than a “mere possibility.” 137 F. 3d 333 (5th Cir. 1998).

Denying Patriarch Partners’ UBC defense, the Court concluded that, at some point, the mass layoffs became reasonably foreseeable, considering TransCare’s severe financial distress, the failure of the Tilton Plan, and TransCare’s move to liquidate through Chapter 7 bankruptcy. The Court found that the precise point at which the layoffs became reasonably foreseeable to Patriarch Partners is a question of material fact that cannot be resolved on a motion for summary judgement.

New York Unpaid Wage Claims

The defendants contended that they are entitled to summary judgement on Plaintiff’s New York unpaid wage claims because none of them were “employers” under New York law, which defines an employer as any “person, corporation, limited liability company, or association employing any individual.”

The Court noted that courts within the Second Circuit have “consistently interpreted the definition of ‘employer’ under the [NY Labor Law] coextensively with the definition used by the [Fair Labor Standards Act],” which has been liberally construed to broadly define “employ,” expanding the meaning of “employee” to cover parties who wouldn’t otherwise qualify as such under strict application of agency law principles.

Thus, the Court concluded that whether an employer-employee relationship exists depends on “economic reality rather than technical concepts.” Under the “economic reality” test, the Court looks to factors, such as whether the alleged employer (1) held hiring/firing power, (2) supervised or controlled conditions of employment, (3) determined the rate or method of payment, and (4) maintained employment records. The test calls for a case-by-case review of the totality of the circumstances, rather than emphasis on a single factor.

To determine whether an individual is an “employer,” the economic reality test must consider the individual’s degree of “operational control” over the company, including authority over management, supervision, and oversight of a company’s general affairs. The test must also address the question of “hypothetical versus actual power,” and look to see whether an individual exercised power over the employment of a company’s employees.

While the Court denied summary judgement for the defendants, it granted summary judgement against Tilton, concluding that Tilton exercised both operational and financial control over TransCare. Tilton was authorized to direct TransCare and its employees to take any actions, orchestrated the foreclosure of TransCare’s assets, funded TransCare’s operations, made the “ultimate hiring/firing decisions,” and, significantly, was the only individual authorized to make the decisions related to the layoffs. Despite the fact that the second and fourth factors of the economic reality test were not met, the Court concluded that satisfaction of the first and third prongs, and the showing of both operational and financial control over TransCare, were sufficient to satisfy the test.

On similar grounds, the Court denied Patriarch Partner’s motion for summary judgement on the New York unpaid wages claim, holding that there remained a triable issue of fact concerning the extent to which Tilton financially controlled TransCare in her capacity as CEO of Patriarch Partners, and in light of the fact that Tilton was assisted in her operational control of TransCare by her employees at Patriarch Partners who routinely worked out of TransCare’s offices and were involved in TransCare’s operations.

Conclusion

TransCare reminds us of the minefield one has to be mindful of when managing the affairs of distressed and non-distressed portfolio companies. The single employer doctrine and the broad scope of what constitutes an employment relationship must be reviewed and analyzed carefully to minimize the imposition of liability on private equity sponsors and their principals.

Read the TransCare opinion >>