Who Is Liable For Unpaid Wages Following A Corporate Dissolution

In times of cash scarcity, companies often make the misguided decision to “temporarily” suspend or defer paying wages to employees. Sometimes this effort succeeds and the deferred wages are repaid. The more common result, in my experience, is that this sort of wage deferral is a precursor to a corporate dissolution. This article addresses who, if anyone, an employee can sue to recover wages that her now-bankrupt employer failed to pay.

Federal vs. California Law

Owner-managers of closely-held businesses have often been found personally liable under the federal Fair Labor Standards Act (“FLSA”). Cases under the FLSA have also imposed personal liability on powerful managers and directors at larger companies. But employees usually prefer to seek redress for wage and hour violations under the California Labor Code and wage orders rather than the FLSA. Until a few years ago, however, it seemed that, absent special circumstances like alter ego or failure to observe corporate formalities, courts in California would not impose personal liability for wage and hour claims on the key employees, directors, officers, or investors of a corporate entity.

Recent decisions suggest the tide has turned. Thus, if an employer files for bankruptcy without having paid all wages due to its workforce, employees now have very strong arguments that the major shareholders and/or directors and managers should be liable for the wages due.

“Employer” Liability Under Federal Law

Under the FLSA, a corporation’s officer, director or key employee may be an “employer” and liable for FLSA violations if she “exercises ‘control over the nature and structure of the employment relationship,’ or ‘economic control’ over the relationship.” Lambert v. Ackerly, 180 F.3d 997, 1012 (9th Cir. 1999). To make this determination, courts will look to whether that individual had: a significant ownership interest; operational control over aspects of corporation’s day-to-day functions; the power to hire and fire and set salaries. Id., Boucher v. Shaw, 572 F.3d 1087, 1091 (9th Cir. 2009). Thus, many courts have found that the FLSA requires personal liability for officers and directors in corporations both mid-sized and closely-held. Gilbreath v. Cutter Biological, Inc., 931 F.2d 1320, 1324 (9th Cir. 1991); Chao v. Hotel Oasis, Inc., 493 F.3d 26, 34 (1st Cir. 2007).

“Employer” Liability Under California Wage Law

The test in California is more complicated. The leading case on “employer” liability for a violation of the California wage orders is Martinez v. Combs, 231 P.3d 259 (2010). There, the court held that an “employer” is one who does any of the following:

  • Exercises control over wages, hours or working conditions
  • Suffers or permits an employee to work
  • Engages an employee

Consistent with this broad scope, the California Supreme Court has also written that an employer is “any person … who directly or indirectly, or through an agent or any other person, employs, or exercises control over the wages, hours, or working conditions of [an employee].” Guerrero v. Superior Court, 213 Cal.App.4th 912, 947 (2013).

Although these definitions sound quite broad and would seem to sweep up many potential individuals, until recently when California courts actually applied these tests they refused to extend liability to a party other than the de jure employer listed on the employee’s paycheck. For example, Martinez found that a corporate entity had so much economic control over its business partner that, for all practical purposes it could exercise control over wages, hours and working conditions of the partner’s employees. But because the business partner did not actually exercise that control it was not the “employer” of the controlled-entity’s employees.

In addition, Martinez reaffirmed a prior decision that corporate officers and employees are not personally liable when acting within the scope of their agency. Reynolds v. Bement, 36 Cal. 4th 1075, 1086 (2005). Courts have also held that a payroll provider (PEO) is not an “employer” since it has no control over wages or hiring, just ministerial payroll administration. Futrell v. Payday Cal., Inc., 190 Cal. App. 4th 1419, 1432 (2010).

But a recent Court of Appeal decision suggests courts may now be expanding the situations where personal and indirect liability are found. In Castaneda v. The Ensign Group, Inc., the sole shareholder of a number of portfolio companies, was found to be the “employer” of one of its portfolio company’s employees. Defenses by the parent company that it had contractual and ownership interests in the subsidiary but did not control its business or its employees were rejected by the court which concluded that a trier of fact could infer The Ensign Group was the “employer” of its subsidiary’s employees for the following reasons:

  • An employee of The Ensign Group was responsible for recruiting and hiring some of the employees who were engaged by the subsidiary;
  • The Ensign Group provided an orientation and training to the subsidiary’s employees;
  • The Ensign Group provided centralized IT, HR, payroll and legal services;
  • The Ensign Group circulated “core values” and other standardized policies to the subsidiary’s employees;
  • Various documents at the parent level referred to the subsidiary’s employees as “our employees” and so forth.

The facts of Castaneda are a bit of an outlier because The Ensign Group’s parent-level company clearly exercised pervasive control over its portfolio companies. But, the opinion’s reasoning provides employees with new ammunition in lawsuits for unpaid wages. In particular, employees may sue private equity (PE) and venture capital (VC) funds, and their appointed directors, that hold significant ownership of a given business and exercise control over it.

VC/PE Fund’s Liability To Portfolio Companies’ Employees

It is easy to see how an employee would allege that a PE or VC fund (or its appointed directors) were her employer because the following points are often true about the influence that VC and PE funds exercise on a portfolio company:

  • The partners at the PE or VC fund have significant roles in recruiting, retaining and shaping the management team of the portfolio company;
  • The partners serve as directors of the portfolio company and, in that capacity, have final say on many over major decisions;
  • The PE or VC fund has more subtle control over the company and its employees because major decisions by the company are often with the fund’s prior approval even if it is not legally required;
  • The VC and PE fund will choose the portfolio company’s outside advisors (similar to a centralized HR, payroll and legal team);
  • Some VC funds operate centralized job boards and similar hiring tools for use by all their portfolio companies and, as a result, the employees of a given portfolio company may self-identify as being affiliated with their investor;
  • A PE fund, which generally takes majority control over a portfolio company, has the authority to dictate all major decisions that affect employees.

The points above are all indicia of employment. Therefore, former employees may seek to either directly sue a VC or PE fund to recover unpaid wages (as in Castaneda). Or employees may sue an individual partner of the VC or PE fund who served as a director of the defunct company since that individual may be covered by D&O insurance policies and have more directly exercised control over wages and working conditions.

If the fund is sued directly, then the defenses will be similar to those raised in Castaneda (which were rejected) and Martinez (which were accepted). The result will turn on the level of control the fund exercised over day-to-day employment functions at the portfolio company.

If the individual partner at a fund is sued arising out of her service as a director of the defunct company, then her only real defense will be an argument that the director or officer acted “within the scope” of her agency and therefore cannot be liable under Reynolds v. Bement. But, the employees will likely be able to plead around this defense such that a given claim will survive a summary judgment motion. For example, a partner in a VC or PE fund stands to profit from appreciation in a given portfolio company though both her carried interest in the fund and the nominal stipend paid for service as a director. Accordingly, it may be difficult to convincingly prove she made a given decision solely in her capacity as a director of a portfolio company and not as a partner in the fund.

Thus, at a minimum, a “question of fact” will likely exist as to whether a given VC/PE fund or its appointed director(s) “exercised control” over the employees at a portfolio company such that the fund and/or its personnel are liable for the portfolio company’s wage and hour violations. Given the costs of litigation, this question of fact is often all that is needed to drive the parties to a fair and reasonable settlement.

Additional Sources Of Liability Under California Law

In addition to alleging “employer” liability, employees can recover under the California Private Attorney Generals Act (“PAGA”) from “any person acting on behalf of an employer who violates, or causes to be violated [any of the provisions set forth in Labor Code §§ 500-558]. Labor Code § 558. PAGA provides a $100/pay period penalty for certain ongoing violations of the Labor Code, including overtime, meal and rest periods. An individual officer, director or owner of a business may be personally liable for a PAGA claim. See, e.g. Helm v. Alderwoods Grp., Inc., 696 F. Supp. 2d 1057, 1074 (N.D. Cal. 2009).

Conclusion

Employees who are due unpaid wages from insolvent or bankrupt companies should not assume those wages are not recoverable. The cases above illustrate that the company’s owners, directors and officers may be personally liable. Employees also should not assume these individuals will not have the ability to pay. Rather, D&O, E&O, EPLI and other insurance policies are in place at many companies and one or more of these policies may provide a source to recover a claim for unpaid wages against one of the company’s former directors, officers or shareholders.

If you are owed wages from a former employer, please contact Sebastian Miller Law.

Disclaimer: All materials have been prepared for general information purposes only to permit you to learn more about Sebastian Miller Law, P.C, its services and experience.  The information presented is not legal advice, is not to be acted on as such, may not be current and is subject to change without notice.

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