At a time of heightened awareness of workplace misconduct and harassment, many organizations are assessing their workplace environments and any associated legal and reputational risks. For private equity funds, hedge funds, other “active” investors, secured lenders and “families” of related business entities, it is important to remember that these risks may include exposure for misconduct committed by other entities’ employees or that occurred at other entities’ workplaces. This is because anti-discrimination law allows for claims that two formally distinct entities (such as corporate affiliates) should be treated as a “single” or “joint” employer and thus share responsibility and potential liability for workplace misconduct.

Title VII of the Civil Rights Act of 1964 (like analogous state-level anti-discrimination statutes) prohibits discrimination in employment on the basis of protected characteristics such as sex and race. Prohibited discrimination includes quid pro quo sexual harassment (using a position of authority to make sexual demands), the existence of a sexually hostile work environment, and retaliation for complaining about discrimination or harassment. Moreover, when the individual bad actor is a supervisor or other high-ranking employee, the victim of discrimination usually is not limited to suing the individual: An “employer” will often be vicariously liable for its supervisors’ discrimination or misconduct. So the question sometimes becomes, who exactly is the “employer” to whom liability may attach?

Single- and Joint-Employer Liability Under Title VII

Claimants use “joint employer” and “single employer” theories of liability for essentially the same purpose: To say that an entity that is not formally their employer is nonetheless functionally their employer, and thus should share liability for Title VII violations. The difference is that the “single employer” theory attempts to show that one entity so controlled the direct or “formal” employer that the two entities should be considered one combined employer, while the “joint employer” theory attempts to show that two or more entities each asserted enough control over the claimant’s workplace that each entity separately was the claimant’s and the wrongdoer’s employer.

Corporate actors are used to the idea that they may be held liable for the acts of another entity when the two are so closely intertwined as to be “alter egos” of one another, allowing the piercing of the “corporate veil.” Veil-piercing liability is limited, however, to the relatively rare situation in which, for example, a parent corporation creates a sham or undercapitalized subsidiary for the purpose of misleading creditors, or where the funds of two entities are intermingled and used interchangeably, or where corporate formalities such as separate board meetings are not kept. In contrast, joint employer and single employer liability can arise even when two corporations are entirely separate as a corporate matter (such as an investor and the company in which it invests) and even when the entities scrupulously maintain their corporate separateness.

Single Employer Liability

Courts generally determine single-employer liability under Title VII by looking at four factors:

  1. Common management;
  2. Interrelation between operations;
  3. Centralized control over labor relations/employment decisions; and
  4. Common ownership.

See, e.g., Torres-Negron v. Merck & Co., 488 F.3d 34, 42 (1st Cir. 2007). None of these factors is dispositive, though courts typically place the most weight on the control of employment decisions. Id.; see also Knowlton v. Teltrust Phones, Inc., 189 F.3d 1177, 1184 (10th Cir. 1999). In EEOC v. 704 HTL Operating, LLC, for example, a court reviewed a Title VII claim of religious discrimination filed against a hotel company (the formal employer) and the investment company that held a majority stake in the hotel company. No. 11-CV-845-JCH/LFG, 2013 BL 219397 (D. N. M. Aug. 16, 2013). In that case, (1) officers of the investment company also served as officers of the hotel company and in those roles made decisions about hotel company personnel; (2) the investment company made recommendations about hotel company hiring standards; (3) the investment company administered the hotel company’s employee benefits; and (4) the investment company owned 90% of the hotel company. The claimant asserted, and the court agreed, that the hotel company and the investment company could therefore be treated as a “single employer.” (The case ultimately settled, with both defendants subject to a consent decree with the EEOC.)

Joint Employer Liability

Courts considering joint employer liability under Title VII apply a fact-intensive analysis that differs slightly in different federal circuits. Some courts use a common law agency test that focuses on whether an entity alleged to be a “joint employer” controls the individual employee’s day-to-day work. See, e.g., Faush v. Tuesday Morning, Inc., 808 F.3d 208, 214 (3d Cir. 2015). Some use an “economic realities” test that focuses on whether the putative joint employer actually provides the employee’s pay and substantive work. See, e.g., Phillips v. Bd. of Trustees of the Univ. of Ala., 218 F. Supp. 3d 1297, 1307 (N. D. Ala. 2016). And other courts use a “hybrid” of these two tests. See, e.g., Butler v. Drive Automobile Insurance of America, 793 F.3d 404 (4th Cir. 2015).

What these tests have in common is an on-the-ground inquiry that goes beyond merely which corporate entity signs an employee’s paycheck. Relevant questions include:

  • Does the entity have authority to hire and fire?
  • Does the entity supervise and discipline?
  • Does the entity provide the equipment and place of work?
  • Is the entity responsible for payroll and employment records?
  • Are the individual’s duties akin to the duties of the entity’s other employees?
  • Which entity or entities benefit from the individual’s work?

Courts most commonly find joint employer liability in the context of employee sharing/leasing arrangements or staffing agency placements. In Butler v. Drive Automobile Insurance of America, for example, a worker technically employed by a staffing agency claimed that the company that operated the factory where she worked should be jointly liable for harassment she suffered from a supervisor at the factory. The court ruled in the claimant’s favor on the joint employer issue, observing that the manufacturing company effectively exercised day-to-day control over the claimant’s work, that she performed her work alongside the factory’s own employees, and that the claimant’s formal employer, the staffing agency, had terminated her employment at the direction of the factory.

Applying These Tests: Examples of Fact Patterns to Watch

In the specific context of private equity funds, hedge funds, other “active” investors, secured lenders and “families” of related business entities, one might consider how the following everyday employment relationships could lead to claims of single- or joint-employer liability:

  • A managing partner of an investment fund takes a seat on the board of one of the fund’s wholly-owned portfolio companies. During a period of transition, the portfolio company is without a head of HR, so the investment fund’s HR director pitches in and fulfills that role for the portfolio company. When allegations of sexual harassment arise against the portfolio company’s CEO, the managing partner/board member investigates, decides that the allegations are without merit, and directs the firing of the complaining employee.
  • An asset management company finds itself temporarily short-staffed in its accounting department. One of the operating companies in which the asset manager has invested has excess accounting capacity, and, as a show of corporate goodwill, assigns one of its employees to work out of the asset management company’s offices every other day. That employee later alleges that she was treated unfairly on account of her race by one of the asset management company’s executives.
  • For a transition period of three months post-closing, the seller of a subsidiary agrees to keep the subsidiary’s employees on its payroll and to lease their services to the buyer while the buyer sets up its payroll function. The buyer directs all of the work performed by the leased employees. During the transition period, one of the leased employees complains of a sexually hostile work environment at what is now the buyer’s place of business.
  • A private equity firm consistently requires newly acquired portfolio companies to hire as CFO a particular turnaround executive. The CFO in turn provides regular detailed updates on the portfolio company’s finances directly to the private equity firm. When the CFO raises concerns that she is paid less than male CFOs at peer companies, the private equity firm directs the portfolio company to fire her.

Additionally, keep in mind that similar single- and joint-employer risks can arise under other employment statutes – such as wage payment and plant closing laws – and that such risks are of particular concern when dealing with a formal employer that is on the verge of insolvency, since the other “employer” may be the only source of recovery available.

Suggestions

There are a variety of measures that investors, lenders, parent corporations and other potential “non-obvious employers” can take to limit their exposure to these risks. Among these liability-limiting measures are the following:

Observe Corporate Formalities. While the single- and joint-employer tests are not identical to veil-piercing tests in corporate law, there is significant overlap. Keeping company finances separate, observing proper corporate governance practices, and setting up clear lines of employee supervision will go a long way.

Board Members Should Stay Out of the Employment Weeds. Board members should be involved in high-level strategy, but generally should not be involved in day-to-day management of the company. In particular, board members generally should not be involved in day-to-day human resources decisions (though this may be impossible to avoid in connection with misconduct by a CEO, and difficult in connection with any C-suite employee concerns).

While Retaining An Appropriate Distance, Hold “Formal” Employers Responsible. As stakeholders in the business, investors and corporate affiliates should ensure that management is appropriately responsive to workplace concerns, and that management is held accountable for deficiencies. Staying out of the weeds should not mean avoiding the issue entirely.

Indemnification and Insurance. When entering into employee leasing arrangements or staffing agreements, always carefully consider which party should bear the risk of employment-related claims. Also, review insurance policies to ensure that D&O, employment liability, or umbrella provisions are broad enough to cover single- and joint-employer claims by other entities’ employees.

Transactional Diligence. One way to avoid having liability for bad acts flow up to investors or other corporate affiliates is to minimize the likelihood of those bad acts occurring on the investor’s watch in the first place. Work with experienced counsel to carefully vet prospective acquisitions for workplace misconduct issues. Look carefully at efforts that have been made (or that are in progress) to increase the representation of women in positions of authority. Consider requiring detailed representations and indemnification from sellers.