Hands-off management?

Employment law regulations may well force GPs to rethink their active involvement in portfolio company affairs. 

We’ve used this column in the past to broadcast warnings about hidden risks in employment law. It’s an area swarming with liability dangers that can easily escape the attention of GPs, who tend to be more focused on high-profile issues like Dodd-Frank. Not long ago, for instance, we warned that employees who use social media like Facebook or Twitter to voice grievances at the firm could be exercising protected speech under federal law.

The risk we’d like to discuss here, however, has broader implications for the private equity model itself.

The US National Labor Relations Board (NLRB) seems ready to classify GPs that get heavily involved in portfolio companies’ hiring and firing practices as 'joint employers' for the purposes of the National Labor Relations Act. The reason that's a scary prospect? Because it means GPs would be legally bound by union collective bargaining agreements struck between portfolio company management and employees. So workers filing suit for unpaid overtime, say, or unfulfilled vacation time promises could bring a company’s private equity owner to court with it. Under current law, that can only happen if the GP directly controls the terms and conditions of employment at the portfolio company, which few sponsors ever do. In the next 12 months or so though, the NLRB will issue a ruling that could potentially widen the scope of that test – an outcome legal sources say is a strong possibility.

“The ramifications if so could be pretty big for the private funds industry,” says Alan Berkowitz of law firm Dechert, who specializes in employment law. “Not only would this change impose significant transaction costs upon firms, but it could result in contractual liability for things like unfair labor practices, breaches of collective bargaining agreements, and health and welfare plan contributions.”

Sound familiar? Long-time readers will notice its parallels to the Sun Capital case, which in its own way, fundamentally questioned how much control GPs could take at a portfolio company before becoming responsible for its unfunded pension plan and other liabilities. In much the same way, a 2013 Delaware court case highlighted the fact that GPs must adequately document their legal separation from their portfolio companies or risk being stung by compensation claims under the Worker Adjustment and Retraining Notification (or WARN) act, which requires big businesses to provide 60 days' advance notice of mass layoffs or plant closings.

The key takeaway from all this is that the courts and policymakers are still figuring out how much a GP can do at a portfolio company before accepting a fair amount of liability for that company’s failure and resulting job losses. And if they’re not willing to take on that kind of responsibility, their actions should be limited to participation at the board level, or perhaps offering consulting and management advice with no strings attached. But in the meantime, until the rule makers can offer greater certainty, managers will just have to try and get the balance right all by themselves.