Owner Exclusion from Title VII

A recent case from the Third Circuit, the federal appellate court covering Pennsylvania, clarifies the limitations of employment laws for owners of closely-held corporations.

Mariotti v. Mariotti Building Products, Inc., No. 11-3148, 2013 WL 1789440 (3d Cir. April 29, 2013).

Plaintiff, Robert Mariotti, was an officer, shareholder, and director of Mariotti Building Products, Inc. (MBP) which was a closely held family business started by Plaintiff’s father, Louis Mariotti.  The Plaintiff served as both vice-president and secretary to the company.  Plaintiff and his brothers were employed in the business pursuant to an agreement which provided for termination “only for cause.”  In 1995, Plaintiff had a “spiritual awakening” which he claimed resulted in “systematic antagonism” from the company’s officers, directors, and some employees. 

In early 2009, after the death of Plaintiff’s father, Eugene Mariotti, Plaintiff’s brother, derided Plaintiff and his faith.  At the funeral, Plaintiff gave a eulogy, which included comments about his faith, which upset some family members.  Two days later, the shareholders of MBP convened without the Plaintiff and voted unanimously to terminate his employment.  On January 10, 2009, the Plaintiff received notice of his termination in a letter that explained that certain benefits would cease, including health insurance and access to company credit cards.  The letter further indicated that Plaintiff would continue to receive a draw from the corporation.

After his termination, Plaintiff remained a member of MBP’s board of directors until August 2009 when the shareholders did not reelect him as a director.  The Plaintiff then filed a charge of religious discrimination and hostile work environment in violation of Title VII of the Civil Rights Act of 1964 against MBP.  MBP moved to dismiss the claim, arguing that the Plaintiff was not an employee under Title VII and therefore could not invoke its protections.  The District Court granted the motion and Plaintiff appealed.

The Third Circuit upheld the District Court’s dismissal, holding that the Supreme Court’s test in Clackamas Gastroenterology Associates, P.C. v. Wells, 538 U.S. 440 (2003) applies to business entities that are not professional corporations.  The Third Circuit, applying Clackamas, looked to the following six factors from the Equal Employment Opportunity Commission (EEOC) to determine whether Plaintiff was an employee for purposes of Title VII:

[1.] Whether the organization can hire or fire the individual or set the rules and regulations of the individual's work

[2.] Whether and, if so, to what extent the organization supervises the individual's work

[3.] Whether the individual reports to someone higher in the organization

[4.] Whether and, if so, to what extent the individual is able to influence the organization

[5.] Whether the parties intended that the individual be an employee, as expressed in written agreements or contracts

[6.] Whether the individual shares in the profits, losses, and liabilities of the organization.

The Third Circuit concluded that the Plaintiff was not an employee for purposes of Title VII.  The court noted that the analysis focused on the amount of control and the source of the individual’s authority.  After reviewing the Plaintiff’s complaint, the Third Circuit found that his status as a shareholder, director, and corporate officer gave him significant control and authority at MBP.  As a director and corporate officer, Plaintiff had the ability to participate in fundamental decisions of the business. In addition, the Plaintiff continued to serve on the board of directors after his termination until August 2009. The court further noted that the termination letter did not cease Plaintiff’s salary.  The Third Circuit therefore concluded that the Plaintiff was not an employee for purposes of Title VII.

Take Away

Business owners do not receive all of the legal protection of employees.  The Clackamas / Mariotti line makes clear that business owners do not receive the protections of the Americans with Disabilities Act (“ADA”) or Title VII.  Similarly, a business owner is not entitled to collect unemployment compensation upon termination.  Whether a person is a “business owner” for these purposes depends on the level of control they can exert over the business and ownership alone is not dispositive.

The business owner need not be at the mercy of a group of fellow shareholders however.  There are contractual ways for an owner to protect him or herself.  Shareholder agreements that require other shareholders to purchase the shares of a terminated shareholder is one such alternative.  Employment agreements that incorporate the ADA and Title VII by reference may also create a breach of contract claim that is co-extensive with the statutory rights that the business owner would otherwise be ineligible.

Assets or Stock: The Form of Purchase DOES Make a Difference

Purchasing or selling a business can be accomplished in a number of ways. While the objective of the transaction is always the same – transfer of ownership from a seller to a buyer – the form of the transaction does make a difference. When it comes to the purchase or sale of a business, the form of the sale has significant implications, not only at the time of sale but with regard to operations going forward.

The purchase or sale of a  business is generally accomplished by either a stock sale or a sale of substantially all of the assets of the company. The form of the transaction has important implications for both buyers and sellers in several key areas:

Liability

Purchasers of stock essentially “step into the shoes” of the seller. This means that the purchaser assumes all of the liabilities of the acquired business – whether known or unknown, whether past or future. Such liabilities may be extensive and include liability for debt or purchases; losses arising from injuries caused by products or services provided by the purchased entity; claims of trademark or patent infringement; and liabilities based on employment discrimination, wrongful termination or violation of wage and hour laws.

Constructing the transaction as a purchase of assets of the company may enable a purchaser to avoid some potential liabilities inherent in a stock transaction. Yet, even asset purchases carry some risk of assumption of unknown liabilities. Asset purchasers may be responsible for undisclosed liabilities if it appears that they have implicitly accepted liabilities, or where there is sufficient continuity of enterprise that the transaction can be considered a de facto merger.

Scope of Purchase

One of the advantages of an asset purchase agreement is the opportunity it affords the buyer to “pick and choose” the assets that the buyer deems most desirable for the business. Obsolete inventory or redundant equipment can remain with the seller, in contrast to a stock purchase that transfers every and all assets owned by the business. Asset buyers, however, must be careful to ensure that the asset purchase agreement has a complete and comprehensive description of all of the assets necessary to operate the business or they will face some unwelcome surprises at closing.

Taxes

Tax and accounting treatment for asset purchases vary significantly from that afforded stock transactions. Purchasers of stock continue to carry assets on the books on the same basis as the seller. Stock sellers recognize a gain to the extent the sale price for the stock exceeds their basis.  In contrast, an asset sale requires the buyer to adjust the basis of the assets that are acquired based on the fair market value. This may result in an increase or decrease in the book value and depreciation for such assets.

What is clear is that no form of transaction – stock purchase or asset purchase – is inherently “good” or “bad.”  Each form has advantages and disadvantages for buyers and sellers and the decision of which form to adopt can be difficult – especially since what advantages one party may be disadvantageous to the other. In many cases, other elements of the transaction can be used to reduce risk and to satisfy the core objectives. 

Five New Year’s Resolutions For Family Business

January is over and we have already stopped going to the gym, started eating ice cream and gave up on organizing our sock drawers.  Now is a perfect time to set some more realistic business resolutions for the upcoming year.  Most family businesses set sales or profitability goals but sometimes overlook the more mundane items that come back to bite them.  We propose five simple, specific and achievable goals for 2015:

Plan Your Exit (Or Your Escape) – Many of our family business clients have never seriously considered what will happen to the business if key family members involved in the business were unable to continue because of retirement, death or disability.  Many more of our family business clients have never seriously considered what would happen to the business if family members begin feuding.  Perhaps it is not surprising that some of the nastiest shareholder disputes arise between family members. 

Failure to plan for these contingencies can result in significant and avoidable taxes when transferring ownership of a business to the next generation.  It can deprive a disabled family member or their heirs from being able to capture any value of a business they helped develop.  It can destroy the value of a business with fighting between family members who cannot stand to work together and have no fiscally viable exit.

Keep An Eye On The Money – If you are a passive owner (i.e. not engaged in the operations) of a family business, you have a statutory right to look at the book and records of the company.  You should do that once and a while.  Books and records (or the lack of them) can provide a wealth of information about how the business is being run and whether you are getting the income that is owed to you.  It also helps to keep operating family members honest.

Clean Up That Corporate Binder – Our family business clients tend to take two approaches to corporate record keeping – the overstuffed corporate binder where some, but not all, of the three hole punched paper holes have torn through such that five pages hinge out when you hold it up or the “what are you talking about” corporate binder that never existed in the first place.

If you are a corporation, you need to make at least one entry into your corporate record book each year.  Major business events should also trigger minute entries in your books, for example, the sale or purchase of significant assets.  If you are an LLC, the annual administrative record keeping requirements are more relaxed but major business events should be reflected in the corporate minutes. 

Fresh Faces, Fresh Ideas, Reduced Liability – Consider inviting non-family members to become involved in your family’s board of directors or advisory board.  As a matter of good corporate governance, non-family members tend to bring less baggage and can offer a fresh perspective than family members.  The existence of “disinterested” board members (i.e. ones who have no personal interest in the particular matter before the board) allows a family business to proceed with less risk of shareholder litigation from family member owners disenchanted with a particular action of the board
 
Sharpen Your “Bread and Butter” Contracts – Almost every business uses and reuses “bread and butter” form agreements to buy things, sell things, license things, employ people or mitigate risk.  When was the last time a C-level person or the company’s general counsel reviewed them?  Have any of the form agreements been tested with litigation and, if so, are there any modifications that could have prevented the litigation in the first instance.

Get your former boss to sue you in three easy steps

 

We spend a good deal of time advising clients on how to stay out of court.  Some clients, however, find this approach too conservative, stodgy or dull and would prefer to be involved in otherwise avoidable litigation.  They often complain "things are just going too well for me" or "I need some drama in my life."  Since we do not want to alienate any client or potential client with practical, financially sound legal solutions, we are offering some tips on how to end up in court, lose money and dismantle that which you worked hard to build.  Of course, if you are like most of our clients, we strongly suggest that you disregard everything that follows.

 

You have been with your current employer for some time and you are good at what you do.  It's time to leave the nest to start your own company.  You like to challenge yourself, so rather than focusing solely on your new endeavor, you want to leave your current employer in such a way that you can be sure they will initiate distracting, time-consuming and expensive litigation against you.  Here are a few suggestions to assure this result:

 

Steal things.  Nothing makes your former employer happier than when you steal things before you leave.  Staplers and mouse pads are a nuisance but customer lists, proposals to clients, pricing information, form documents or product specifications should get you into court quickly.  Since most of these items are stored electronically, downloading them to a thumb drive or emailing them to your personal Gmail account should leave an easy trail for your employer's IT department to track. 

 

If you are clever enough to steal these items, you should expect your employer to seek a preliminary injunction - an order from a court to do or not do something - prohibiting you from working.  Because of the emergency situation you have created for your employer, you should expect to incur significant legal fees quickly to prepare for significant court events early in the litigation.

 

Breach your non-compete.  Restrictive covenants that limit a person's ability to make a living are enforceable under Pennsylvania law but are disfavored and courts look closely at them to determine whether they are really necessary to achieve an employer's legitimate business interests.  In light of the opaque legal standard and the desire the avoid litigation, a negotiation between the former employer, employee and new employer regarding the scope of the employee's employment is often a reasonable solution.  The strength of the restrictive covenant, the employee's role in the company and the job responsibilities at the new company would all inform this negotiation.  But what's the fun in that?

 

The adventurer leaves his employment by providing no notice to the former employer.  He immediately begins work with the direct competitor located just down the street doing the same job he did with the former employer. 

 

"Soften" your transition by diverting opportunities.  Even absent any employment agreement, Pennsylvania law imposes a duty on employees to be loyal to their employers.  This means that diverting customers, projects or opportunities that come to you because of your job may be a problem if you want to stay out of court.  Although an employee may make plans and take steps to start a new venture while still employed, they may not do it on the employer's time or using the employer's resources.

 

The buccaneer business person will tell their customer contacts and subordinates that they are leaving months before they alert their employer.  Since the departing employee wants to make sure she has the best employees for her new venture, she makes employment offers to all her subordinates.  She will quietly promote her new venture at trade shows and other events that she is attending on behalf of the employer.

 

Take Away

 

If you are considering leaving your employment, engaging in this type of behavior carries a significant risk of litigation.  The law is generally reluctant to restrain the free movement of labor but there are limits.