Warning: Watch out for WARN –

If following the regimen of Sarbanes-Oxley wasn’t enough, VCs and their lawyers may want to take notice of another federal law – the Worker Adjustment and Retraining Notification (WARN) Act. The Act has been around for 15 years and has the potential to cause plenty of headaches for investors.

The Act requires businesses to announce major layoffs or business site closings at least 60 days in advance. Investors have never had much reason to be concerned about WARN.

But VCs may increasingly find themselves faced with employment lawsuits under the Act, warns John Fox, a partner with the Palo Alto, Calif.-based law firm Fenwick & West. Fox has been warning VCs about the so-called “single-enterprise” theory that allows employees to sue the investment firms of their employer by maintaining that it’s the VCs who control the company and are thus liable for employment law violations, such as termination notices of less than 60 days.

Last month, Fox said he was mediating this very issue of who the employer is while representing a firm’s client, Genstar Capital, a private equity investor in San Francisco, which found itself named in a lawsuit.

Fox said a former CEO from one of Genstar’s portfolio companies named Genstar in a suit following the executive’s termination, claiming Genstar’s partners ran everything at the company and were therefore liable for his unlawful termination.

Commenting on WARN, in general, Fox said that there are a few points VCs should be aware of.

Whether a VC will be liable as an “employer” depends on how involved the investor is with the portfolio company. For instance, if the VC makes the employment decisions of the portfolio company – instead of letting either the company management or board make the choices – the VC investor runs the risk of being identified, too, as the employer. This means the investor will be held responsible for any challenged employment decisions, such as terminations.

Also, assuming the VC leaves day-to-day control of the portfolio company to management or the company board, the next question involves the VC’s actions while sitting on the board. Did the VC act as a member of the board or as an investor?

To avoid confusion about simultaneously roles, Fox says that VC investors should make it clear, in oral and written statements, what role they are playing when making decisions affecting the company.

“This issue is not going to go away. This is on the horizon getting ready to bite many of our VC clients,” Fox says.