Of Partners And Employees

In January, the Equal Employment Opportunity Commission (EEOC) sued Sidley Austin Brown & Wood LLP, alleging discrimination in connection with that firm's demotion of a group of equity partners. EEOC v. Sidley Austin Brown & Wood, No. 1:05-cv-00208 (N.D. Ill. filed Jan. 13, 2005). The suit highlights an area of potential uncertainty for law firms and other businesses organized as professional corporations and limited liability partnerships ' whether the shareholders and partners of such businesses are entitled to the protections afforded “employees” under federal and state employment laws. Although the outcome of the EEOC's case may not be known for some time, recent decisions illustrate a developing legal standard that will likely impact the organization of many professional service businesses.

In Clackamas Gastroenterology Assocs., P.C. v. Wells, 538 U.S. 440 (2003), the Supreme Court shed some light on the issue when it considered whether four physician-shareholders practicing in a professional corporation were “employees” for purposes of the Americans with Disabilities Act's 15-employee threshold. The Court noted that professional corporations present “a new type of business entity that has no exact precedent in the common law,” but that “the common law's definition of the master-servant relationship does provide helpful guidance.” Id. at 447-48. Drawing from the common law definition of the term “servant” as one “whose work is controlled or is subject to the right to control by the master,” the Court held that “employee” status should turn on “whether shareholder-directors operate independently and manage the business or instead are subject to the firm's control.” Id. at 448 (quotations and citations omitted). Rejecting a categorical approach, the Court endorsed a multi-factor test suggested by the EEOC and framed in terms of the following inquiries:

• Whether the organization can hire or fire the individual or set the rules and regulations of the individual's work.
• Whether and, if so, to what extent the organization supervises the individual's work.
• Whether the individual reports to someone higher in the organization.
• Whether and, if so, to what extent the individual is able to influence the organization.
• Whether the parties intended that the individual be an employee, as expressed in written agreements or contracts.
• Whether the individual shares in the profits, losses, and liabilities of the organization.

Id. at 449-50 (quoting 2 EEOC Compliance Manual '605:0009 (2000)).

Presence of the first three factors ' which assess the organization's control over the individual's work ' weigh in favor of employee status, while the fourth factor ' the individual's ability to control the entity's business ' can be viewed as the converse of the first three. In contrast, the sixth factor ' participation in profits and losses ' is a typical indicia of ownership that supports a finding of “master” or non-employee status. The fifth factor ' intent of the parties ' may support either conclusion, but may also be considered less significant if not consistent with the “realities” of the position. (“The mere fact that a person has a particular title ' such as partner, director, or vice president ' should not necessarily be used to determine whether he or she is an employee or a proprietor.” Id. at 450; see also, Devine v. Stone, Leyton & Gershman, P.C., 100 F.3d 78, 81 (8th Cir. 1996) (one “may not avoid Title VII by affixing a label to a person that does not capture the substance of the employment relationship”)).

Finally, the Court noted that the list of six factors was not exhaustive and that whether a shareholder-director is an employee depends on ” 'all of the incidents of the relationship … with no one factor being decisive.' ” Id. at 451 (quoting Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 324 (1992)).

Decisions since Clackamas have followed the Supreme Court's admonition that “the common-law element of control is the principal guidepost” in determining employee status. Id. at 448.

In Ziegler v. Anesthesia Assocs. of Lancaster, Ltd., 74 Fed. Appx. 197 (3d Cir. 2003) (unpublished opinion), the Third Circuit held that shareholder-physicians in a professional corporation were employers and not employees for purposes of coverage under Title VII. The shareholders shared ownership and equal voting rights, each made a capital contribution, shareholder compensation was not tied to job performance, no shareholder was evaluated or supervised by anyone, each shareholder but one received compensation based on profits, only licensed anesthesiologists could be shareholders, and shareholders were liable for acts of professional negligence as well as the conduct of those acting under their supervision. Id. at 200. (This exception proved immaterial, since even if the shareholder receiving a fixed salary was considered an employee, the business would not have had enough employees for Title VII's application. 74 Fed. Appx. at 200 n.6.)

In Arbaugh v. Y&H Corp., 380 F.3d 219 (5th Cir. 2004), the Fifth Circuit held that a pair of restaurant owners and their wives were not employees of the restaurant for purposes of coverage under Title VII. First, the court found it unlikely that the owners and wives could have been hired or fired in light of their ownership interests. Id. at 230. Although the wives performed limited advertising work for the restaurant, there was no evidence that they were supervised in that work, no indication that they reported to someone higher in the organization, and no written agreements in which they were designated as employees. Id. Finally, the wives and their husbands shared in the restaurant's profits, losses and liabilities. Id.

In Solon v. Kaplan, 398 F.3d 629 (7th Cir. 2005), the Seventh Circuit held that a general partner (and former managing partner) in a small law firm was not an employee entitled to sue for retaliation under Title VII. As one of four general partners, the lawyer exercised substantial control. Id. at 633. “In addition to his voting rights, [he] held an equity interest in the firm, shared in its profits, attended partnership meetings, and had access to private financial information.” Id.

In Mustari v. New Hope Academy, No. 03 C 4507, 2005 WL 221240 (N.D. Ill. Jan. 28, 2005), the court concluded that shareholder-operators of a therapeutic day school were not employees for purposes of coverage under Title VII. The shareholders ran the corporation, divided management responsibilities, and shared profits, losses and liabilities, and neither was supervised nor reported to someone higher. Id. at 2. Although one shareholder stated that the salary she received was based on her job duties and not the profit of the corporation and that she was held responsible for her performance by the board of directors, the court dismissed such facts. Id. The court observed that “shareholders in service companies often perform the work of the company and pay themselves for this work.” Id. “If there are neither profits nor losses, this will be their only pay; but they are still employing themselves.” Id. With respect to control by the board of directors, the court noted that if such control rendered a shareholder-officer an employee, then “all shareholders who hold less than 50% of the shares would not be employers,” a proposition that the court characterized as “clearly not true.” Id.

Notably, these post-Clackamas decisions each dealt with relatively small business entities. In those cases, ownership was concentrated among a few shareholders who also functioned as executive officers or the equivalent. Under such circumstances, it is unsurprising that the courts found alignment of the Clackamas factors favoring non-employee or “master” status. Such decisions offer limited guidance, however, in predicting how Clackamas will be applied where ownership interest ' and control over the business ' is more widely dispersed among a larger number of shareholders or limited partners.

In contrast to the small firms at issue in these post-Clackamas decisions, large professional service organizations with dozens ' or perhaps hundreds ' of working shareholders or partners often share organizational characteristics with traditional corporations. There may be “tiers” of partners or shareholders, with certain classes enjoying more or less ability to participate in management decisions or profits and losses. Even among those with full profit and loss participation, there may be levels of management, review, and supervision. Thus, unlike the smaller organizations examined in recent decisions, the Clackamas factors may not line up neatly on the side of non-employee status.

When Clackamas is applied to large partnerships and professional corporations, it seems likely that courts will require at least some evidence of both profit and loss participation and independent control over the business. Absent profit and loss participation and responsibility for potential liabilities, even considerable independence may not be enough to establish “master” or non-employee status. For example, a corporate executive may enjoy considerable autonomy and control over management of the business and even compensation tied to its success. Nevertheless, absent direct profit and loss participation and responsibility for corporate liabilities, an executive officer typically remains an employee or “servant” of the business. See, eg, Lenhardt v. Basic Inst. of Technology, 55 F.3d 377, 381 (8th Cir., 1995) (“Every circuit that has considered the issue ultimately has concluded that an employee, even one possessing supervisory authority, is not an employer upon whom liability can be imposed under Title VII.”). Accordingly the status of “non-equity partners” ' even those with considerable autonomy and control over business activities ' may be suspect under Clackamas.

Conversely, profit and loss participation alone may not be enough to convert a worker with little or no autonomy or control over business operations into a non-employee “master.” In a traditional corporate setting, many workers share in the ownership ' and thus the profits and losses ' of their employer through equity compensation programs, employee stock ownership plans, and similar arrangements. Without significant day-to-day control over the operations of the business, such ownership typically does not render the workers “masters” rather than employees. See, eg, Collins v. Franklin, 142 F. Supp.2d 749 (W.D. Vir. 2000) (although the defendant-employee “is also alleged to be a shareholder, that alone does not make him an employer” under Title VII); see also, Gerzog v. London Fog Corp., 907 F. Supp. 590 (E.D.N.Y. 1995) (defendant who was majority shareholder and controlled board of directors, but who exercised no control over conditions of employment, not an “employer” for purposes of age discrimination claims). By extension, a partner or shareholder with virtually no independent control over his or her partnership or professional corporation may be deemed an employee despite holding a partial ownership interest in the business.

In Clackamas, the Supreme Court noted that “the answer to whether a shareholder-director is an employee depends on 'all of the incidents of the relationship.'” 538 U.S. at 627 (quoting Darden, 503 U.S. at 324). Accordingly, where both profit and loss participation and autonomous control over significant business matters are present to some degree, Clackamas suggests a sliding scale between the two, with greater profit and loss participation potentially offsetting relatively less autonomy and control, and vice versa. Presumably the EEOC's current litigation with Sidley will help clarify how such factors are to be balanced. Until then, however, the existence of the litigation alone raises significant issues that law firms and other professional corporations must carefully consider.

In January, the Equal Employment Opportunity Commission (EEOC) sued Sidley Austin Brown & Wood LLP, alleging discrimination in connection with that firm's demotion of a group of equity partners. EEOC v. Sidley Austin Brown & Wood, No. 1:05-cv-00208 (N.D. Ill. filed Jan. 13, 2005). The suit highlights an area of potential uncertainty for law firms and other businesses organized as professional corporations and limited liability partnerships ' whether the shareholders and partners of such businesses are entitled to the protections afforded “employees” under federal and state employment laws. Although the outcome of the EEOC's case may not be known for some time, recent decisions illustrate a developing legal standard that will likely impact the organization of many professional service businesses.

In Clackamas Gastroenterology Assocs., P.C. v. Wells , 538 U.S. 440 (2003), the Supreme Court shed some light on the issue when it considered whether four physician-shareholders practicing in a professional corporation were “employees” for purposes of the Americans with Disabilities Act's 15-employee threshold. The Court noted that professional corporations present “a new type of business entity that has no exact precedent in the common law,” but that “the common law's definition of the master-servant relationship does provide helpful guidance.” Id. at 447-48. Drawing from the common law definition of the term “servant” as one “whose work is controlled or is subject to the right to control by the master,” the Court held that “employee” status should turn on “whether shareholder-directors operate independently and manage the business or instead are subject to the firm's control.” Id. at 448 (quotations and citations omitted). Rejecting a categorical approach, the Court endorsed a multi-factor test suggested by the EEOC and framed in terms of the following inquiries:

• Whether the organization can hire or fire the individual or set the rules and regulations of the individual's work.
• Whether and, if so, to what extent the organization supervises the individual's work.
• Whether the individual reports to someone higher in the organization.
• Whether and, if so, to what extent the individual is able to influence the organization.
• Whether the parties intended that the individual be an employee, as expressed in written agreements or contracts.
• Whether the individual shares in the profits, losses, and liabilities of the organization.

Id. at 449-50 (quoting 2 EEOC Compliance Manual '605:0009 (2000)).

Presence of the first three factors ' which assess the organization's control over the individual's work ' weigh in favor of employee status, while the fourth factor ' the individual's ability to control the entity's business ' can be viewed as the converse of the first three. In contrast, the sixth factor ' participation in profits and losses ' is a typical indicia of ownership that supports a finding of “master” or non-employee status. The fifth factor ' intent of the parties ' may support either conclusion, but may also be considered less significant if not consistent with the “realities” of the position. (“The mere fact that a person has a particular title ' such as partner, director, or vice president ' should not necessarily be used to determine whether he or she is an employee or a proprietor.” Id. at 450; see also , Devine v. Stone, Leyton & Gershman, P.C. , 100 F.3d 78, 81 (8th Cir. 1996) (one “may not avoid Title VII by affixing a label to a person that does not capture the substance of the employment relationship”)).

Finally, the Court noted that the list of six factors was not exhaustive and that whether a shareholder-director is an employee depends on ” 'all of the incidents of the relationship … with no one factor being decisive.' ” Id. at 451 (quoting Nationwide Mut. Ins. Co. v. Darden , 503 U.S. 318, 324 (1992)).

Decisions since Clackamas have followed the Supreme Court's admonition that “the common-law element of control is the principal guidepost” in determining employee status. Id. at 448.

In Ziegler v. Anesthesia Assocs. of Lancaster, Ltd. , 74 Fed. Appx. 197 (3d Cir. 2003) (unpublished opinion), the Third Circuit held that shareholder-physicians in a professional corporation were employers and not employees for purposes of coverage under Title VII. The shareholders shared ownership and equal voting rights, each made a capital contribution, shareholder compensation was not tied to job performance, no shareholder was evaluated or supervised by anyone, each shareholder but one received compensation based on profits, only licensed anesthesiologists could be shareholders, and shareholders were liable for acts of professional negligence as well as the conduct of those acting under their supervision. Id. at 200. (This exception proved immaterial, since even if the shareholder receiving a fixed salary was considered an employee, the business would not have had enough employees for Title VII's application. 74 Fed. Appx. at 200 n.6.)

In Arbaugh v. Y&H Corp., 380 F.3d 219 (5th Cir. 2004), the Fifth Circuit held that a pair of restaurant owners and their wives were not employees of the restaurant for purposes of coverage under Title VII. First, the court found it unlikely that the owners and wives could have been hired or fired in light of their ownership interests. Id. at 230. Although the wives performed limited advertising work for the restaurant, there was no evidence that they were supervised in that work, no indication that they reported to someone higher in the organization, and no written agreements in which they were designated as employees. Id. Finally, the wives and their husbands shared in the restaurant's profits, losses and liabilities. Id.

In Solon v. Kaplan , 398 F.3d 629 (7th Cir. 2005), the Seventh Circuit held that a general partner (and former managing partner) in a small law firm was not an employee entitled to sue for retaliation under Title VII. As one of four general partners, the lawyer exercised substantial control. Id. at 633. “In addition to his voting rights, [he] held an equity interest in the firm, shared in its profits, attended partnership meetings, and had access to private financial information.” Id.

In Mustari v. New Hope Academy, No. 03 C 4507, 2005 WL 221240 (N.D. Ill. Jan. 28, 2005), the court concluded that shareholder-operators of a therapeutic day school were not employees for purposes of coverage under Title VII. The shareholders ran the corporation, divided management responsibilities, and shared profits, losses and liabilities, and neither was supervised nor reported to someone higher. Id. at 2. Although one shareholder stated that the salary she received was based on her job duties and not the profit of the corporation and that she was held responsible for her performance by the board of directors, the court dismissed such facts. Id. The court observed that “shareholders in service companies often perform the work of the company and pay themselves for this work.” Id. “If there are neither profits nor losses, this will be their only pay; but they are still employing themselves.” Id. With respect to control by the board of directors, the court noted that if such control rendered a shareholder-officer an employee, then “all shareholders who hold less than 50% of the shares would not be employers,” a proposition that the court characterized as “clearly not true.” Id.

Notably, these post-Clackamas decisions each dealt with relatively small business entities. In those cases, ownership was concentrated among a few shareholders who also functioned as executive officers or the equivalent. Under such circumstances, it is unsurprising that the courts found alignment of the Clackamas factors favoring non-employee or “master” status. Such decisions offer limited guidance, however, in predicting how Clackamas will be applied where ownership interest ' and control over the business ' is more widely dispersed among a larger number of shareholders or limited partners.

In contrast to the small firms at issue in these post-Clackamas decisions, large professional service organizations with dozens ' or perhaps hundreds ' of working shareholders or partners often share organizational characteristics with traditional corporations. There may be “tiers” of partners or shareholders, with certain classes enjoying more or less ability to participate in management decisions or profits and losses. Even among those with full profit and loss participation, there may be levels of management, review, and supervision. Thus, unlike the smaller organizations examined in recent decisions, the Clackamas factors may not line up neatly on the side of non-employee status.

When Clackamas is applied to large partnerships and professional corporations, it seems likely that courts will require at least some evidence of both profit and loss participation and independent control over the business. Absent profit and loss participation and responsibility for potential liabilities, even considerable independence may not be enough to establish “master” or non-employee status. For example, a corporate executive may enjoy considerable autonomy and control over management of the business and even compensation tied to its success. Nevertheless, absent direct profit and loss participation and responsibility for corporate liabilities, an executive officer typically remains an employee or “servant” of the business. See , eg , Lenhardt v. Basic Inst. of Technology , 55 F.3d 377, 381 (8th Cir., 1995) (“Every circuit that has considered the issue ultimately has concluded that an employee, even one possessing supervisory authority, is not an employer upon whom liability can be imposed under Title VII.”). Accordingly the status of “non-equity partners” ' even those with considerable autonomy and control over business activities ' may be suspect under Clackamas.

Conversely, profit and loss participation alone may not be enough to convert a worker with little or no autonomy or control over business operations into a non-employee “master.” In a traditional corporate setting, many workers share in the ownership ' and thus the profits and losses ' of their employer through equity compensation programs, employee stock ownership plans, and similar arrangements. Without significant day-to-day control over the operations of the business, such ownership typically does not render the workers “masters” rather than employees. See , eg, Collins v. Franklin , 142 F. Supp.2d 749 (W.D. Vir. 2000) (although the defendant-employee “is also alleged to be a shareholder, that alone does not make him an employer” under Title VII); see also , Gerzog v. London Fog Corp. , 907 F. Supp. 590 (E.D.N.Y. 1995) (defendant who was majority shareholder and controlled board of directors, but who exercised no control over conditions of employment, not an “employer” for purposes of age discrimination claims). By extension, a partner or shareholder with virtually no independent control over his or her partnership or professional corporation may be deemed an employee despite holding a partial ownership interest in the business.

In Clackamas, the Supreme Court noted that “the answer to whether a shareholder-director is an employee depends on 'all of the incidents of the relationship.'” 538 U.S. at 627 (quoting Darden, 503 U.S. at 324). Accordingly, where both profit and loss participation and autonomous control over significant business matters are present to some degree, Clackamas suggests a sliding scale between the two, with greater profit and loss participation potentially offsetting relatively less autonomy and control, and vice versa. Presumably the EEOC's current litigation with Sidley will help clarify how such factors are to be balanced. Until then, however, the existence of the litigation alone raises significant issues that law firms and other professional corporations must carefully consider.