Journal
AMERICAN
BANKRUPTCY
INSTITUTE
The Essential Resource for Today’s Busy Insolvency Professional
Equity Sponsors Beware: Delaware
Bankruptcy Court Issues a WARNing: Part II
Written by:
Charles A. Dale III
K&L Gates LLP; Boston
chad.dale@klgates.com
Mackenzie L. Shea
K&L Gates LLP; Boston
mackenzie.shea@klgates.com
Contributing Editor:
Nicholas M. McGrath
K&L Gates LLP; Boston
nicholas.mcgrath@klgates.com
Editor’s Note: Part I appeared in the
November 2011 issue.
P
art I of this article focused on
Judge Mary Walrath’s recent
decision in Tweeter Opco, 1 in
which Tweeter Opco’s equity sponsor, Schultze Asset Management LLC
(SAM), was found liable under the
Worker Adjustment and Retraining
Notification Act (WARN Act) 2 on the
basis that it was a “single employer”
with Tweeter given its de facto degree of
control over the company. Part II of this
article compares the outcome of Tweeter
Opco with an earlier of Judge Walrath’s
decisions, DHP Holdings.3
In re DHP Holdings II Corp., et al.
In the earlier of her
two recent decisions on the subject, Judge Walrath
addressed the question of whether
HIG Capital LLC
was liable under
the WARN Act as
Charles A. Dale III
a single employer
with its portfolio
company DHP Holdings II Corp.4 DHP
and its affiliated debtors (collectively,
1 D’Amico v. Tweeter Opco LLC (In re Tweeter Opco), 453 B.R. 534
(Bankr. D. Del. 2011).
2 29 U.S.C. § 2101, et seq.
3 Manning v. DHP Holdings II Corp. (In re DHP Holdings II Corp.), 447 B.R.
418 (Bankr. D. Del. 2010).
4 Id. at 420-21.
About the Authors
Charles Dale is a partner, and Mackenzie
Shea and Nicholas McGrath are
associates, in K&L Gates’s Boston office.
the debtors) entered
into a credit agreement with a group of
senior lenders. HIG
was neither a party
to the loan agreement nor a guarantor of the debtors’
loan obligations. 5
Mackenzie L. Shea
After a series of
defaults, the senior
lenders urged the debtors to sell their
European division and use the proceeds to reduce their loan obligations.6
When DHP was unable to consummate
Addressing each
of the five U.S.
Department of Labor
(DOL) factors, the
court first analyzed
the question of “common ownership” and
“common directors
and/or officers.” 10
Nicholas M. McGrath
It was undisputed
between the parties that HIG owned 70 percent of DHP
Acquisition Corp., which owned 100 percent of DHP, which owned 100 percent of
debtor Desa LLC, the parent of all of the
other debtors.11 The court concluded that
this relationship satisfied the first prong
of the DOL test. With respect to the issue
of “common directors and/or officers,”
the court determined that the plaintiffs
satisfied this factor by demonstrating that
Feature
a sale, the senior lenders took matters
into their own hands, sweeping all of
the debtors’ cash and freezing their
bank accounts.7 In addition, the senior
lenders insisted that the debtors hire a
chief restructuring officer (CRO), who
subsequently conducted multiple rounds
of employee layoffs without providing
WARN notice.8 Soon after the plaintiffs
were laid off, the debtors sought chapter
11 protection. The plaintiffs then filed
a class-action complaint alleging that
HIG and the debtors constituted a “single employer” under the WARN Act
and that both were liable for 60 days of
back pay and benefits.9
5
6
7
8
9
Id. at 421.
Id.
Id. at 423.
Id. at 421.
Id.
HIG “associates” held a majority of the
director and officer positions of DHP and
the operating subsidiaries.12 HIG did not
contest either of these fact findings, but
argued that the establishment of these two
factors alone was insufficient to establish
WARN Act liability.13
Turning to the “de facto exercise of
control,” the court analyzed whether HIG
“was the decision-maker responsible for
the employment practice giving rise to
the litigation.” 14 HIG asserted that the
debtors’ CRO made the ultimate decision to lay off employees.15 The plaintiffs argued, however, that it was the
10 Id. at 422-23.
11 Id.
12 Id.
13 Id. at 423.
14 Id. at 423 (citing Pearson v. Component Tech. Corp., 247 F.3d 471, 504
(3d Cir. 2001)).
15 Id. at 423.
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HIG-controlled board of directors who
decided to close certain facilities, terminate employees and file for bankruptcy.16
The plaintiffs also asserted that prior to
the terminations, HIG directors made
decisions regarding cost-cutting, budget controls and a potential liquidation
analysis of the debtors.17 HIG responded
that when the senior lenders swept and
froze the debtors’ bank accounts, they
destroyed any chance of implementing
a feasible restructuring plan, effectively requiring HIG to leave the decision
regarding plant closings and employee
terminations in the hands of the CRO.18
Lacking any evidence “that any HIG
employee ever had any knowledge of
which employees were being terminated, when the terminations were to occur,
or the manner in which the employees
were informed of the terminations,” the
court sided with HIG, persuaded that the
only discussions that took place between
HIG directors and the CRO were phone
calls updating the lead HIG director on
the actions that the CRO was taking.19
The court also found that the CRO terminated the employees without seeking
prior authority from the debtors’ directors or any HIG employee.20 The court
concluded that the de facto control factor
of the DOL test had not been satisfied
because the CRO independently made
the decisions to close the facilities and
terminate the employees, and there was
no evidence that HIG played a significant role or controlled any of those decisions. 21 The Court found the fact that
both the CRO and HIG directors reached
the same conclusion about cost cuts and
facility closings was insufficient to support the conclusion that HIG directed the
termination of employees, in light of the
testimony to the contrary.
The court next addressed the “unityof-personnel-policies” element of the
DOL test. Judge Walrath explained that
this factor requires the plaintiffs to show
that “HIG and the Debtors ‘actually
functioned as a single entity with regard
to its relationship with employees.’” 22
When evaluating this aspect, courts
“must consider whether ‘the two companies in question engaged in centralized
hiring and firing, payment of wages and
personnel and benefits recordkeeping.’”23
16 Id.
17 Id. at 423.
18 Id.
19 Id. at 423.
20 Id.
21 Id. (stating that “the fact that the Debtors’ boards approved the bankruptcy filing or facility closings, is insufficient to establish that HIG
ordered the terminations”).
22 Id. at 424 (citing Pearson, 247 F.3d at 499).
23 Id. (citing In re APA Transp. Corp., 541 F.3d 233, 245 (3d Cir. 2008)).
HIG proffered evidence demonstrating that (1) the debtors negotiated their
own labor contracts, (2) the debtors had
their own human resource officer and no
common supervisor to whom employees
reported, (3) there was no evidence that
HIG had any control over the compensation structure of the debtors’ employees
and (4) HIG and the debtors had separate
tax identification numbers and filed separate tax returns.24 Accordingly, the court
determined that HIG and the debtors did
not “share a unified personnel policy
emanating from a common source” 25
and concluded that this factor weighed
in HIG’s favor.
The bottom line is that private-equity
sponsors are extremely vulnerable
to claims of single-employer liability
under the WARN Act.
Finally, the court addressed the
“dependency-of-operations” factor 26
and observed that in order to satisfy this
element of the DOL test, there must be
evidence of certain agreements between
HIG and the debtors, such as “sharing of
‘administrative or purchasing services,
interchange of employees or equipment, and commingled finances.’”27 The
court found that HIG was an investment
company that solely managed its investments, and that despite the debtors’
bankruptcy filing and subsequent cessation, HIG continued to run its business,
clearly demonstrating a lack of dependency of operations.28
Ultimately, Judge Walrath concluded that satisfaction of two of the five
factors was insufficient to find “single
employer” status and extend WARN Act
liability to HIG as the equity sponsor.29
Accordingly, summary judgment was
entered in HIG’s favor.30
Lessons to Be Learned
Although Judge Walrath attempts
to differentiate between situations
where single-employer liability will be
extended to an equity sponsor and situations where equity sponsors will escape
such liability, the reality is that only
one of five DOL factors separated HIG
24 Id. at 424.
25 Id.
26 Id. at 425.
27 Id. (citing Pearson, 247 F.3d at 500).
28 Id. at 425.
29 Id.
30 Id. (citing Pearson, 247 F.3d at 494; Coppola v. Bear Stearns & Co. Inc.,
499 F.3d 144, 150 (2d Cir. 2007)).
from SAM: the de facto control prong.
Predictably, both sponsors satisfied the
common-ownership and common officers and directors requirements, and
those factors will be satisfied in most
situations involving a sponsor with a
controlling equity stake. Neither HIG nor
SAM was found to offend the fourth or
fifth DOL factors (i.e., unity of personnel policies emanating from a common
source or dependency of operations).
It is unusual for a private-equity firm
to encroach on a portfolio company in
these areas. Considering the fact that
the DOL regulations were drafted with
subsidiaries—not parent companies or
their shareholders—in mind, one would
not expect these factors to be satisfied or
even applicable to most private-equity
investments. Instead, these cases appear
to turn on a single issue: the degree of
involvement that the sponsor has with
the portfolio company’s decision to
lay off employees in violation of the
WARN Act—a razor-thin line in many
(if not most) cases. As any experienced
turnaround professional can attest, only
a modest tweak to the facts of the DHP
Holdings case would have put HIG in
virtually the same situation in which
SAM found itself in Tweeter. For example, if the directors of DHP Holdings had
rejected the senior lenders’ demand that
a CRO be hired following the lenders’
decision to sweep DHP’s cash deposit
accounts, then the HIG-controlled board
of directors, not the CRO, would have
been left with the unenviable task of conducting the same layoffs that the CRO
implemented. While Judge Walrath did
not elaborate on this point, her decisions
leave open the question of whether HIG
or SAM would have been liable as a single employer if their involvement in the
decision to lay off employees without the
required notice was limited to attending a
board meeting and authorizing the reduction in workforce.
Further guidance may be gleaned
from analysis of other decisions in this
area, including the often-cited decision in Pearson. 31 In Pearson, the
Third Circuit addressed the question of
whether General Electric Capital Corp.
(GECC) was liable for WARN Act violations with Component Technology
Corp. (CTC).32 In 1989, GECC loaned
CTC and several affiliates $25 million
to finance an expansion that was necessitated by a new business arrangement
between CTC and the Eastman Kodak
31 Pearson, 247 F.3d 471.
32 Id. at 477.
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Co. 33 When Kodak canceled the contract, GECC and CTC negotiated an
elaborate restructuring whereby a substantial portion of GECC’s loan was
converted to preferred equity and GECC
appointed a new board of directors, who
then replaced the company’s seniormanagement team with new officers.34
After overseeing a three-year turnaround
effort at CTC, GECC ran out of patience,
refused to provide further financing and
forced a liquidation of CTC.35 Former
employees then sued GECC, seeking to
impose single-employer liability under
the WARN Act.36 Ultimately, the court
found in GECC’s favor, notwithstanding
this degree of control.37
Prior to Pearson, there was no single legal standard to determine when
affiliated corporations could be liable
to former employees of one of the affiliates under the WARN Act. Although
the DOL regulations and definition of
“employer” were issued shortly after the
WARN Act was enacted, the regulations
did not contemplate extending liability to
lenders or equity sponsors.38 Rather, the
DOL regulations are expressly written
to address situations in which affiliated
“subsidiaries” or independent contractors of a common parent are so closely
intertwined that they can rationally be
viewed as one employer.39 Nevertheless,
after chronicling the three different tests
(and differing formulations of each)
used by courts to resolve the issue, the
Third Circuit adopted the five-factor test
contained in the DOL regulations that
defines the term “employer.”40 The Third
Circuit concluded its analysis as follows:
Affiliated corporate liability
under the WARN Act is ultimately an inquiry into whether
the two nominally separate entities operated at arm’s length.
To that end, the [DOL] has specifically mandated consideration
of: (1) common ownership, (2)
common directors and/or officers, (3) de facto exercise of control, (4) unity of personnel policies emanating from a common
source and (5) the dependency of
operations. We acknowledge that
although these factors do not cor33 Id. at 478.
34 Id. at 479.
35 Id. at 479-81.
36 Id. at 481-82.
37 Id. at 482.
38 Id. at 483-84. The Third Circuit pointed out that an arrangement
between a secured lender and a borrower was a situation that was
“unaddressed by either the [WARN] Act or the regulations,” unlike the
traditional parent/subsidiary relationship that the “standard” WARN Act
test was created to address.
39 Id.
40 Id. at 478.
respond precisely to established
tests for liability, reliance on
analogous precedent may often
be useful in the interpretation and
application of those factors.
We believe that the DOL’s caveat that the factors are a nonexhaustive list is intended to allow
the factfinder to consider other
evidence, if any, of a functional
integration between the two nominally separate entities—with, as
always, an eye to the sorts of
circumstances that courts have
considered relevant to “veilpiercing” inquiries in the past.
So, although ordinarily such hallmarks of integration as “nonfunctioning of officers and directors”
and “nonpayment of dividends”
are not of great importance in
the labor context, certainly the
factfinder would be permitted to take such arrangements
into account when determining
WARN Act liability, as well as
any other arrangements that bear
on the question whether the two
companies failed to maintain an
arm’s-length relationship.
Further the “de facto exercise of
control” factor allows the factfinder to consider, as has been
done in the “integrated enterprise” context, whether a parent
corporation was the final decisionmaker for the challenged
practice. If the evidence of the
parent’s control with respect to
the practice is particularly egregious—for instance, if the parent
corporation has “disregard[ed]
the separate legal personality of
its subsidiary” in directing the
subsidiary to act...such evidence
alone might be strong enough to
warrant liability.41
a reduction in workforce, extreme care
must be taken by equity sponsors and
their board designees to ensure that an
appropriate WARN analysis is conducted
and the requisite notice is provided, if
required. If a lack of time or money render a covered portfolio company unable
to comply with the WARN Act, equity
sponsors must exercise extraordinary
care in respecting corporate formalities
and the separateness of entities when
evaluating and implementing plant closures and layoffs. n
Reprinted with permission from the ABI
Journal, Vol. XXX, No. 10, December/
January 2012
The American Bankruptcy Institute is a
multi-disciplinary, nonpartisan organization
devoted to bankruptcy issues. ABI has
more than 13,000 members, representing
all facets of the insolvency field. For more
information, visit ABI World at www.
abiworld.org.
Conclusion
Applying the DOL regulations to
determine whether an equity sponsor is
liable under the WARN Act as a single
employer offends common notions of
veil-piercing and substantially erodes
the protections normally afforded to corporate shareholders and limited liability
company members. In this respect, the
rule of law is fraught with uncertainty.
The bottom line is that private-equity
sponsors are extremely vulnerable to
claims of single-employer liability
under the WARN Act. When evaluating
41 247 F.3d at 496-97 (internal citations omitted).
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