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Co-employment Liability of Joint Ventures, Partnering, Strategic Alliances and Outsourcing under Employment Discrimination and Employee Benefit Laws

When two businesses create a joint venture to develop and market a product that draws upon the strengths of both organizations, such joint ventures generally involve “partnering” or the creation of a “strategic alliance” which allows each party to benefit from the strengths that the other partner(s) bring to the joint working relationship. Such partnering or strategic alliances involve contributions by employees of both companies. When these employees are under the common control of both the partners, both companies become joint employers, resulting in potential legal traps for both companies, whether the relationship is labeled a “joint venture”, “partnering” or “strategic alliance”.

Federal laws prohibiting employment discrimination such as Title VII of the Civil Rights Act of 1964, provide employees the right bring a charge of discrimination on the basis of sex, race or religion. In a partnership or other joint venture, it is possible that the individual can be the employee of both partners.

The EEOC has applied a legal theory called “integrated enterprise” which provides that separate business operations may be so integrated that they are considered a single employer for purposes of discrimination laws when two or more independently owned and operated businesses share control over an employee’s working conditions. In such situations both parties are considered joint employers and each risks being held liable for the other party’s unlawful (i.e. discriminatory) acts.

In determining whether joint employment exists, the courts have looked at factors such as:

For example, the EEOC has found a hotel and management company were joint employers of a housekeeper who was discharged by the hotel manager. The employees were paid by the hotel and worked at a facility owned by the hotel. The agency found the management firm that operated the hotel retained authority over the hotel manager’s hiring and termination decisions.

To avoid such risks, potential partners can structure their relationship in a way that minimizes or acknowledges such risks and reduces the chances that adverse employment actions such as firing or discipline do not violate such laws.

Under ERISA and the Internal Revenue Code (IRC), employee benefit plans typically provide benefits only to the employer’s employees. The IRS’s worker status test is used to determine which entity controls the means, manner, timing and income associated with the work and thus whose benefit plan covers each worker as an employee.

Liability for benefit plan coverage arises for partnerships and similar joint ventures and strategic alliances. Each party needs to consider appropriate benefit plan amendments or other measures to insure that benefit plans do not provide unintended coverage to groups of joint employees. Failing to do so can result in each partner facing significant legal liability risks.

While joint ventures, partnering arrangements and strategic alliances are used routinely to achieving efficiencies in today’s business world, careful planning and recognizing the costly legal risks of co-employment is essential to minimize those risks and maximize the benefits for each party involved in such arrangements.

Avoiding a Challenge to Outsourcing under ERISA

Section 510 of ERISA makes it unlawful for an employer to “discharge, fine, suspend, expel, discipline, or discriminate against a participant or beneficiary [of an employee benefit plan]…for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan…” The U.S. Supreme Court, held in Inter-Modal Rail Employees Association v. Atchison, Topeka and Santa Fe Railway Company, 520 U.S. 510 (1997), a landmark case involving an outsourcing dispute by railroad freight handlers, that Section 510 applies to employers’ decisions that eliminate or reduce welfare benefits as well as pension benefits.

To prevail in Section 510 ERISA claim, a plaintiff must demonstrate that an employer made a knowing decision to interfere with the employee’s attainment of benefits. A plaintiff may use direct or circumstantial evidence to show such specific intent. An example of direct evidence under Section 510 is provided in the 3^rd Circuit case of McLendon v. Continental Can Company (3rd Cir. 1990), in which a program that was developed by Continental Can Company (the “Bell System”) to avoid unfunded pension liabilities and was successfully challenged. The “Bell System” (“Bell” was a reverse acronym for “Lowest Level of Employee Benefits” or “Let’s Limit Employee Benefits”) used a sophisticated computer program that identified employees who were close to meeting the age and service requirements for certain pension benefits so that such employees could be targeted for termination. Employees who had already vested in their benefits were protected from workforce reductions. The program assigned computer codes to employees who had not yet vested and alerted the employer with a computer signal when such employees potentially caused pension funding problems. In addition to the computer program, internal documentation included a memo describing “a strategy that involves ‘capping’ the work force in a plant at a level that does not allow any more employees to become eligible for…pensions,” and further stating that “in the ideal situation, we would lay off all employees with 19 or less years of service,” since employees generally needed 20 years of service to qualify for certain pension benefits. Finding that the Bell System was the primary motivating factor in the employer’s decision to terminate certain employees, the 3^rd Circuit held that Continental Can violated Section 510 of ERISA.

More recently, the 3^rd Circuit illustrated that outsourcing may be vulnerable to legal challenge by former employees whose jobs were outsourced. In the case of Makenta v. University of Pennsylvania (No. 03-1354 (3rd Cir. January 13, 2004), an employee who was terminated as a result of an employer’s decision to outsource certain of its operations was allowed to bring a claim against the employer if the decision to outsource was motivated by the desire to prevent the employee from receiving benefits under an employee benefit plan. This case also illustrates how an employer can defend against such a challenge and thus minimize such risks.

In Makenta, the University of Pennsylvania had hired Coopers and Lybrand to provide advice on improving services and decreasing costs. Coopers recommended changes to the administration of the University’s compensation and benefits packages. In 1996, the University’s Executive Vice President noted the need to reduce the costs of benefits and stated that the University would use outsourcing in certain areas. In 1997, the University decided to outsource its Facilities Management division to Trammell Crow Higher Education Services, Inc., which agreed to hire at least 70% of the terminated employees who applied at salaries at least equal to what they had received from the University. The transferring employees would receive benefits from Trammell Crow, rather than from the University. Trammell Crow also agreed to pay the employees an additional amount for any increased out-of-pocket expenses resulting from the difference between the University’s and Trammell Crow’s medical, dental and vision benefits. Trammell Crow retained 77 employees (80% of those who applied). Plaintiff was among five employees who were not offered employment by Trammell Crow.

Makenta claimed that the University violated Section 510 of ERISA by intentionally terminating his employment in order to interfere with his receipt of protected employee benefits, including insurance, retirement and tuition reimbursement benefits. The University argued that its decision to outsource was based on legitimate business objectives, that it went to “extraordinary lengths” to protect affected employees by negotiating comparable salary and benefits for the transferring employees, that its decision was based on the need to improve the quality of services and deliver services more efficiently, that benefits cost savings were an “entirely irrelevant” consideration and that, in fact, no comparative benefits cost savings studies had been prepared.

If the plaintiff does not have any such direct evidence, courts apply a burden shifting analysis similar to the approach used in employment discrimination cases. Under such analysis, the plaintiff must first establish a prima facie case by showing (1) prohibited employer conduct (2) taken for the purpose of interfering (3) with the attainment of any right to benefits to which the employee may become entitled. If the plaintiff succeeds in establishing a prima facie case, the burden shifts to the employer to articulate a legitimate, nondiscriminatory reason for the prohibited conduct. If the employer meets this burden, then the plaintiff must prove by a preponderance of the evidence that the reason offered by the employer is merely pre-textual.

In this case, Mr. Makenta did not present any direct evidence that the University intentionally interfered with his benefits. For example, there was no document or evidence of a conversation indicating that the University determined that reducing benefit costs was its most important concern and that the decision to outsource was based solely on such need. In analyzing Mr. Makenta’s circumstantial evidence, the court generally noted that the economic benefits realized by employers when benefits are canceled can be circumstantial evidence, particularly when other circumstances make the termination of employment suspicious. However, the court also indicated that if the only evidence presented by an employee is that his or her termination resulted in a loss of benefits, this will not be sufficient to establish a prima facie case under Section 510. The court found the circumstantial evidence “too general and too far removed,” noting that the University had hired Coopers for advice three years prior to entering into the outsourcing agreement and that Coopers had emphasized cost efficiencies primarily in the administration, not the substance, of the University’s benefits program. The court found that the evidence supported the University’s intention to reduce the overall costs of administering the benefits program and characterized this goal as a legitimate business goal. Therefore, the court ruled that Mr. Makenta had failed to establish a prima facie case under Section 510 of ERISA and that even if he could, the University had a legitimate, nondiscriminatory reason for its decision to outsource, which he could not show was pre-textual.

The Third Circuit upheld the district court’s decision in favor of the University, stating that “a terminated employee must provide evidence beyond the incidental loss of benefits in order to establish a prima facie case under Section 510.”

In Inter-Modal, the Supreme Court stated that “fundamental business decisions” are not barred by Section 510. Appellate Courts in Makenta and other cases have indicated that reducing overall costs can be a legitimate reason to eliminate certain benefits. While McLendon indicates that benefit costs may not be the determinative or most significant factor in an employer’s decision to outsource, courts have not yet provided any guidance regarding whether or to what extent benefit costs may still be a significant part of an overall plan to reduce costs. Therefore, employers considering whether to outsource certain operations should be aware of potential Section 510 claims and that benefit costs are not, at least, the sole motivating factor for its decision. As with the University of Pennsylvania in Makenta, an employer should be prepared to provide legitimate, nondiscriminatory reasons for its outsourcing decision and appropriate documentation supporting such reasons. In Makenta, the 3^rd Circuit also looked favorably upon the fact that the University went to great lengths to ensure that its former employees would receive, through additional payments, equivalent compensation and benefits from the outsourcing firm.

Therefore, in circumstances where the outsourced employees will retain jobs with the outsourcing company, to the extent that an employer can negotiate comparable benefit arrangements for its terminated employees, such arrangements may be helpful in defending against a Section 510 claim.