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E.D.Cal.: Plaintiff Could Simultaneously Be Part-Owner of Closely-Held S-Corp. and Its FLSA-Covered Employee

Hess v. Madera Honda Suzuki

This case was before the Court on the defendant’s motion for summary judgment regarding all of plaintiffs’ claims. As discussed here, one of the issues the court was asked to resolve was whether someone can simultaneously be a part-owner of a closely held s-corporation and an employee thereof. The court distinguished the case from one concerning a business structured as a partnership, and held indeed the plaintiff could simultaneously be a part-owner of the defendant and its employee. Thus, the court denied defendant’s motion for summary judgment with regard to her FLSA claim for unpaid wages on this ground.

As relevant to this discussion, the court recited the following facts (following a period of employment where the plaintiff was solely defendant’s employee):

As support for the contention Plaintiff was not their employee, Defendants point to evidence in the record, primarily from Plaintiff’s deposition testimony, establishing the following. After investing $100,000 ($50,000 allocated to stock and $50,000 as a business loan) with her husband, Terry Hess, Plaintiff became a co-owner of Madera Honda Suzuki, controlling 24 percent of the 100,000 shares of common stock originally issued by Harry D. Wilson, Inc. (Terry controlled 25 percent; defendant Robert Wilson controlled 26 percent while his wife, Lisa, controlled 25 percent.) Plaintiff was then elected as a director and chief financial officer of the corporation. Pursuant to their investment, it appears Plaintiff and her husband provided personal guarantees to Central Valley Bank for money presumably borrowed by the company. Plaintiff further stated she and her husband provided personal guarantees to American Honda and Suzuki, presumably to cover debts and obligations that might be incurred by the company through its sale of Honda and Suzuki motorcycles. Plaintiff understood it was possible she might lose some or all of her investment, and that even if the business were successful, it would take some time before it would start showing a profit. Plaintiff further understood that although the shares of stock were split 51 percent/49 percent between the Wilsons and the Hesses, everything else—including profits—would be divided equally (i.e., 50/50 between the Wilsons and the Hesses). According to Plaintiff, the business never made a profit.

Plaintiff testified it was her responsibility to pay bills and that she had authority to pay certain expenses, such as rent and dealership insurance, without consulting the other officers. Plaintiff was authorized to issue payroll checks to herself and others if the company had sufficient funds, and it appears Plaintiff issued a check to herself at least once during her tenure as CFO. At his deposition, Wilson testified he and Plaintiff interviewed prospective employees together and that Plaintiff “had a say in everybody [the company] hired.” Wilson further testified Plaintiff handled employee disciplinary matters “95 percent of the time” and that she was not required to consult with him before terminating an employee. It also appears Plaintiff was afforded special benefits. Plaintiff testified “if [she or Wilson] took days off, since [they] were on salary, [they] would be paid the days.” Other employees also had paid vacation, but only for a limited number of days. The company paid for vehicles and fuel for the Wilsons and the Hesses, whereas other employees did not have a vehicle allowance. Per Wilson, the company paid the cost of health insurance for shareholders, including Plaintiff, whereas it covered only part of the premiums for employees, who had to contribute the rest. All of this evidence, Defendants contend, shows Plaintiff was a co-owner, not an employee.

In light of the above undisputed facts, the defendant argued “that Plaintiff [could not] be considered an employee because Plaintiff assumed significant business risk, had involvement and discretion in the corporate decision-making process and was entitled to benefits not available to Madera Honda Suzuki’s other employees, none of which was consistent with employee status.” However, the court disagreed.

The court distinguished case law that has held that partners of a partnership cannot simultaneously be FLSA employees, in part discussing a case previously discussed here, from the situation before it where the alleged employee had a part-ownership interest in an s-corp. The court explained:

Defendants have provided no authority—and the Court’s research reveals no authority—stating categorically that a co-owner and shareholder of a closely held corporation who works for the corporation in another capacity, as was apparently the case here, cannot also be the corporation’s employee for the purpose of the FLSA. Indeed, case law seems to suggest otherwise. See Goldberg v. Whitaker House Co-op, Inc., 366 U.S. 28, 32, 81 S.Ct. 933, 6 L.Ed.2d 100 (1961) (“There is nothing inherently inconsistent between the coexistence of a proprietary and an employment relationship. If members of a trade union bought stock in their corporate employer, they would not cease to be employees within the conception of [the FLSA]. For the corporation would ‘suffer or permit’ them to work whether or not they owned one share of stock or none or many”).

While the court noted similarities between the structures of a partnership and the closely-held s-corp. at issue here, ultimately it reasoned that the differences permitted a co-owner who lacked the ability to use the corporate assets as her own and lacked the ability to use the corporate assets as she thought fit. Further, contrary to the relationship partners have in a partnership where they are primarily investors, the court noted that shareholders such a plaintiff remain economically dependent on the s-corporation and their primary source of income is typically wages earned from the s-corporation:

The fact the company is a closely held corporation is key because shareholders view closely held corporations precisely as a means of acquiring corporate assets through employment: “Unlike the typical shareholder in a publicly held corporation, who may be simply an investor or a speculator and does not desire to assume the responsibilities of management, the shareholder in a close corporation considers himself or herself as a co-owner of the business and wants the privileges and powers that go with ownership. Employment by the corporation is often the shareholder’s principal or sole source of income. Providing employment may have been the principal reason why the shareholder participated in organizing the corporation. Even if shareholders in a close corporation anticipate an ultimate profit from the sale of shares, they usually expect (or perhaps should expect) to receive an immediate return in the form of salaries as officers or employees of the corporation, rather than in the form of dividends on their stock. Earnings of a close corporation are distributed in major part in salaries, bonuses and retirement benefits[.]” Hollis v. Hill, 232 F.3d 460, 467 (5th Cir.2000).

Having determined that part-ownership of an s-corporation does not preclude a finding of an employer-employee relationship under the FLSA, the court held that—taking the facts most favorably for plaintiff, the non-movant—plaintiff could meet the economic reality test and demonstrate that she was an employee subject to FLSA coverage. Thus, the court denied defendant’s motion for summary judgment on this ground.

Click Hess v. Madera Honda Suzuki to read the entire Order re: Motion for Summary Judgment or Summary Adjudication.

S.D.N.Y.: Members Of Restaurant Co-op Are Akin To Partners And Not Employees Within Meaning Of FLSA

Godoy v. Restaurant Opportunity Center of New York, Inc.

Plaintiffs, brought suit against Defendants Restaurant Opportunity Center of New York, Inc. (“ROC-NY”), 417 Restaurant LLC a/k/a ROC N.Y. Restaurant LLC d/b/a Colors, ROC-NY Worker Owner Restaurant, LLC a/k/a RWOR, Saru Jayaraman, and Grace Gilbert, as President of ROC-NY (“Defendants”), alleging breach of contract, fraud, and violations of the federal Fair Labor Standards Act (“FLSA”), 28 U.S.C. § 216(b), and New York State Labor Law. Plaintiffs, former restaurant workers and members of Defendant not-for-profit corporation ROC-NY, alleged that Defendants broke their agreement with Plaintiffs that Plaintiffs would gain equity in and employment at the “worker-owned” restaurant they helped ROC-NY to create in exchange for the hundreds of hours that Plaintiffs contributed to that effort. Plaintiffs sought through this action damages and injunctive relief in the form of their promised shareholder status in and employment at the restaurant, now known as “Colors,” back pay for the work they performed on behalf of ROC-NY during the period of 2002-2005 and the wages they did not earn because they were not employed at the restaurant once it opened, and costs and attorneys’ fees in prosecuting this action. Defendants moved to dismiss Plaintiffs’ First Amended Complaint in its entirety, pursuant to Fed.R.Civ.P. 12(b)(6). In granting Defendants’ Motion, the Court discussed the unique situation under which the Plaintiffs worked for and with the co-op, applying the various economic reality tests to determine that they were not “employed” by Defendants, and therefore dismissing the Complaint.

Several Plaintiffs became members of Defendant ROC-NY in August 2002. Several months later, ROC-NY began seeking grants to launch what was described as a “cooperatively owned restaurant” which would be run by-workers displaced after the September 11 terrorist attacks, and a “Cooperative Committee” of ROC-NY was created to direct that effort. Several Plaintiffs were initial members of the Cooperative Committee. Other Plaintiffs joined ROC-NY and the Cooperative Committee in around 2003, and one Plaintiff joined in around 2004. All of the Plaintiffs joined the Cooperative Committee when they joined ROC-NY, and many served on the Committee’s Board of Directors at various times.

Significantly, the Court noted, “[ha]ving surveyed the various economic reality tests and factors applied by the courts, this Court finds lacking any standard applicable to the question presented by the particular facts of this case-that is, whether workers laboring for and together with a not-for-profit corporation to develop a business that they would co-own are employees of that corporation for purposes of the FLSA. Instead, the Court finds company with the Tenth Circuit in its decision in Wheeler v. Hurdman, 825 F.2d 257 (10th Cir.1987). In that case, the Circuit considered whether a general partner of an accounting firm was an “employee” of that firm for purposes of a FLSA action. After reviewing the traditional “economic reality” factors employed by the courts, the Court noted the “absence … of any coherent standard of ‘economic reality’ for supposed application to partners” in a business, and concluded that “the specific independent contractor/employee factors … are largely useless in a general partnership context.” Id. at 271-72. The Court explained that while “[t]he focal point in deciding whether an individual is an employee” under the “economic realities” jurisprudence, “is whether the individual is economically dependent on the business to which he renders service … or is, as a matter of economic fact, in business for himself,”

Consideration of the factors used by the Tenth Circuit in Wheeler to assess the economic reality presented by a partnership supports the absence of an employer-employee relationship in this instance. See Wheeler, 825 F.2d at 274-75. Like partners at a firm. Plaintiffs, as putative co-owners of the business they were working to create, “assume[d] the risks of loss and liabilities” of the venture, and had a real opportunity to share in its profits upon success. Plaintiffs’ hours of “sweat-equity” represented their “capital” contribution to the business, and one that “would earn [Plaintiffs] equity in the RWOR” as “sweat equity converted to cash equivalent in stock.” While Plaintiffs’ “right to share in management” once the restaurant opened is not specifically alleged in the Complaint, the Court notes that Plaintiffs were members of the Board of Directors of the Cooperative Committee tasked with the management of the restaurant’s planning and development phase. Taken together, the balance of these “economic realities” weighs against the existence of an employment relationship in this case. As Plaintiffs and Defendants were at all relevant times putative co-owners of the restaurant they were working to create, the Court finds that Plaintiffs were not, as a matter of economic reality, the employees of Defendants. As such. Plaintiffs have no claims under the FLSA, see Alamo, 471 U.S. at 296-97, and Defendants’ Motion to Dismiss these claims is GRANTED.”

This unfortunate result, seems unavoidable given the fact that the Plaintiffs were technically “owners” of the business for which they worked, and it is likely that the decision will have limited application in future cases.