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The General Partner's Commitment: A Potential Increase From 1% to 5%.

Joseph W. Bartlett, Founder of VC Experts.com


As you hire employees and conduct background checks on them, you should be aware of the Fair Credit Reporting Act . and any counterparts of the same under applicable state law. The issue arises if the company uses an investigative service to help in checking the candidates' credit, reputation, and other personal characteristics. The statute impacts background checks produced by a "consumer reporting agency." Accordingly, unless the company conducts its own investigation, then there are notice, consent and reporting obligations. The Company's obligation is to provide the applicant with a document which discloses that a report may be obtained for employment purposes and asks the applicant to authorize the employer to go forward on that basis. There are different standards for "consumer reports," i.e., background checks from public and institutional sources, and "investigative consumer reports" . information found through personal interviews with neighbors, etc. At a recent panel in which I participated, the thrust of the discussion indicated that employers were relying more on spending one-on-one face time with executive candidates rather than going through the cumbersome process of putting a professional investigator on the case. The worst result of the statute's application is that, if the employer decides not to hire the applicant, the employer must, prior to taking the action, provide the applicant with a "pre-adverse action disclosure" that includes a copy of the report and a summary of the rights the applicant has under the Act.**

If that one doesn't spook you, consider the responsibility of CEOs and CFOs under the Fair Labor Standards Act.

In Dole v. Simpson , 784 F. Supp. 538 (S.D.Ind.1991) the President of a company which tumbled into Chapter 11 was held liable under the Fair Labor Standards Act for failure to pay minimum wages and overtime compensation to the hourly employees. The individual was deemed to be a statutory "employer" under the Act because, among other things, he controlled the checkbook and decided which payables would be honored and which would not, from the debtor's (ultimately the bankrupt's) limited funds.

The notion that individuals can be "employers" under Federal labor law has been extended in a recent case, Sigmon v. Recovery Equity Investors L.P. (W.D.N.C. Feb.2004). The investment fund bought into the troubled company, Shelby Yarn. The fund became the sole shareholder when it bought the assets and hired the new management; despite the efforts of the new owner and new management, the company nonetheless tanked.

The court held that the investment fund and its two managers, were "employers" who were liable to the bankruptcy trustee on behalf of the employees for violations of the so-called WARN Act (a requirement of notification before an employer closes a plant) and for the unfunded health plan under the Consolidated Omnibus Budget Reconciliation Act. The Shelby Yarn case has not yet gone to trial; the only reported action so far is the denial of the defendants' motions for summary judgment.

But, it is a troubling case, which indicates that the management of any company, and indeed the controlling shareholders, should pay very close attention to keeping the company's payables up to date vis-…-vis the hourly employees. We have known for a long time, of course, that directors can be personally liable for failure to pay withholding taxes. These cases, however, extend the liability to other federal statutes protecting employees and deserve the close attention of every individual in a management position.


joe@vcexperts.com

** According to recent analysis of the Act: "Obligations under the FCRA may be triggered outside of the employment context. For example, a private equity firm that wants to obtain Consumer Reports or Investigative Consumer Reports for founders or management of a company prior to making an investment also may have obligations under the FCRA. The FCRA does not specifically address the obligations of potential investors in this circumstance. In the absence of definitive guidelines, private equity investors are well-advised to comply with the consent and disclosure obligations applicable to employers under the FCRA in connection with investment-related background checks. Of course, private equity firms also must comply with the FCRA when doing background checks on the firm's own employees." Venture Update, Forman & Kilroy, "Background Checks proceed With Caution," Spring 2004.