Journal
AMERICAN
BANKRUPTCY
INSTITUTE
The Essential Resource for Today’s Busy Insolvency Professional
Equity Sponsors Beware: Delaware
Bankruptcy Court Issues a WARNing: Part I
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: This is part one of a twopart series.
S
ince the Great Recession in 2008,
many businesses have been
forced to close plants and offices
and otherwise reduce employees as a
means of cutting costs and driving productivity. In 1988, Congress enacted
the Worker Adjustment and Retraining
Notification Act (the WARN Act) 1 to
provide workers with time to seek
employment or retraining opportunities before termination. The WARN
Act requires a covered employer 2 to
provide at least 60 days’ written notice
to each affected employee prior to a
“plant closing” or “mass layoff” of 50
or more employees.
The WARN Act, as
implemented through
regulations promulgated by the U.S.
Department of Labor
(DOL), reflects a
congressional realization that for many
employees who have
Charles A. Dale III
been “dislocated due
to a layoff or plant
1 29 U.S.C. § 2101, et seq.
2 See Emp’t and Training Admin., U.S. Dep’t of Labor, Worker Adjustment
and Retraining Notification (WARN) Act, Worker’s Guide to Advance
Closing and Layoffs 2, available at www.doleta.gov/layoff/pdf/
WorkerWARN2003.pdf (last visited Sept. 5, 2011) (hereinafter Worker’s
Guide to Advance Closing and Layoffs) (providing definition of employers
covered by the WARN Act).
About the Authors
Charles Dale is a partner, and
Mackenzie Shea and Nicholas McGrath
are associates, in the Boston office of
K&L Gates.
closure, early intervention can play
an important role
in their successful
reemployment.”3
Any employer guilty
of violating the
WARN Act is liable
for the wages and
Mackenzie L. Shea
benefits that each
affected employee
would have received had the required
60-day advance notice of termination
been given.4
terminate employees without complying
with WARN’s 60-day notice requirement.
These two cases provide helpful guidance to equity sponsors confronted with
a financially troubled portfolio company.
WARN Act
In order to state a
prima facie claim
for employer liability under the WARN
Act, an employee
or its representative must demonstrate that (1) the
employer is covered
Nicholas M. McGrath
under the WARN
Act, (2) the site of
the layoffs constitutes a “single site of
employment,” (3) a sufficient number
of employees were affected to constitute a mass layoff or plant closing and
Feature
It is critical for private-equity and
venture-capital firms to understand that
liability under the WARN Act may not
be limited to the entity that employs
the affected individuals. Rather, DOL
regulations make it clear that the term
“employer” may include a parent company, equity sponsor or lender under the
so-called “single employer” theory of
liability. Two recent decisions by Hon.
Mary F. Walrath of the U.S. Bankruptcy
Court for the District of Delaware analyzed the conduct of the equity sponsors
for two failing portfolio companies and
arrive at vastly different results based on
a single aspect of the DOL regulations:
the extent to which the equity sponsor
or its agents controlled the decision to
3 Worker’s Guide to Advance Closing and Layoffs, supra n. 2.
4 D’Amico v. Tweeter Opco LLC (In re Tweeter Opco), 453 B.R. 534, 539
(Bankr. D. Del. 2011) (citing 29 U.S.C. § 2102(a)).
(4) the employer did not provide the
affected employees or their representative with the mandatory 60-day written
notice. When an employer violates the
WARN Act notification requirements,
the employer is “liable to each affected
employee for an amount equal to back
pay and benefits for the period of violation up to 60 days.”5
“Single Employer” Liability
under WARN Act: The DOL Test
Dislocated former employees asserting WARN Act claims against their
former employer may seek to establish
liability against the immediate employer
and other entities, including an equity
sponsor arguing that both constitute a
“single employer.” As adopted in the
5 Worker’s Guide to Advance Closing and Layoffs, supra n. 2.
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Third Circuit, the single-employer test is
“ultimately an inquiry into whether the
two nominally separate entities operated
at arm’s length.”6 Historically, “remoteownership equity sponsors have been
shielded from WARN Act liability due
to the significant obstacles common law
veil-piercing theories present for plaintiff
employees.”7 In recent years, a number of
court decisions have illustrated circumstances where courts will extend WARN
Act liability to equity sponsors of a failing
portfolio company.8 Such cases, particularly in the Third Circuit, make it unclear
when equity sponsors will be held liable
for WARN Act violations.9
The Third Circuit has adopted the
five-factor test contained in DOL regulations to determine whether “a lender
or parent is liable with its borrower/
subsidiary as a ’single employer.’” 10
Specifically, the DOL regulations consider five factors in determining “single
employer” status: (1) common ownership, (2) common directors and/or officers, (3) the de facto exercise of control,
(4) unity of personnel policies emanating from a common source and (5) the
dependence of operations between the
entities. 11 Although these factors are
“indicative of single employer status,”12
it is not an exhaustive list, and courts
will also consider any facts that “demonstrate a lack of arm’s length relationship between the companies.”13 Applying
the DOL’s five-factor test, Judge Walrath
recently explained that if certain factors
evidence an excessive degree of entanglement between the two entities, a court
may not hesitate to extend WARN Act
liability to an equity sponsor.
In re Tweeter Opco, LLC, et al.14
In Tweeter Opco, Judge Walrath
was confronted with a class-action lawsuit brought by former employees under
the WARN Act. The employees sought
to extend WARN Act liability to both
6 Pearson v. Component Tech. Corp., 247 F.3d 471, 495 (3d Cir. 2001).
7 See Nathaniel R. Hull and Nicholas M. McGrath, “Warnings about the
WARN Act: Catterton Partners Extension of Liability,” ABI Labor and
Employment Committee E-newsletter, September 2010, available
at www.abiworld.org/committees/newsletters/employeebenefits/vol5num4/catterton.html.
8 Tweeter Opco, 453 B.R. at 548; see also Blair v. Infineon Techs. AG,
720 F.Supp.2d 462, 474 (D. Del. 2010) (denying defendant’s motion to
dismiss because plaintiffs sufficiently alleged “single employer” liability
under DOL five-factor test).
9 Compare Tweeter Opco, 453 B.R. at 548, with Manning v. DHP Holdings
II Corp. (In re DHP Holdings II Corp.), 447 B.R. 418 (Bankr. D. Del. 2010).
While the Third and Fifth Circuits consistently apply the DOL five-factor
test, other circuits have “yet to speak definitively on the appropriate
test” for related entities, perhaps making such other venues more
attractive to equity sponsors. See Guippone v. BHS & B Holdings LLC,
No. 09-CV-1029, 2010 WL 2077189, at *3.
10 Tweeter Opco, 453 B.R. at 541 (citing Pearson, 247 F.3d at 494).
11 20 C.F.R. § 639.3(a)(2); see also Pearson, 247 F.3d at 478.
12 DHP Holdings II Corp., 447 B.R at 422 (citing Pearson, 247 F.3d at 478).
13 247 F.3d at 491; see also In re APA Transp. Corp., 541 F.3d 233, 245
(3d Cir. 2008).
14 D’Amico v. Tweeter Opco LLC (In re Tweeter Opco), 453 B.R. 534, 539
(Bankr. D. Del. 2011).
the debtor, Tweeter Opco LLC and
Tweeter’s equity sponsor, Schultze Asset
Management LLC (SAM), on a “single
employer” theory.15 As with her earlier
decision in DHP Holdings that will be
discussed in Part II of this article, Judge
Walrath evaluated each of the DOL factors to determine whether SAM and
Tweeter could be considered a “single
employer” for purposes of imposing
WARN Act liability.
The court first addressed the “common ownership” factor of the DOL test.16
Reciting the chain of equity ownership,
the court explained that “George Schultze
and his immediate family members [were]
100% owners of SAM. SAM [was] the
general partner of...Schultze Partners
LP, [which owned] approximately 37%
of Schultze Master Fund Ltd., which
own[ed] 100% of Schultze Holding Corp.,
which in turn own[ed] 82% of the Capital
Units of equity in Tweeter Newco LLC ...
which finally own[ed] 100% of the equity
in Tweeter.”17 Although SAM argued that
grandparent entities could not share common ownership with an indirect fourth
generation subsidiary, the court held that
further inquiry was necessary given the
circumstances.18 Delving further into the
relationship between SAM and Tweeter,
the court found that SAM exerted significant financial control over Tweeter
because an affiliate of SAM purchased the
senior-lien debt formerly held by Wells
Fargo, which allowed SAM to make
critical decisions for Tweeter.19 The court
explained that financial control alone is
sufficient to satisfy the common-ownership factor, and that SAM’s financial
control over Tweeter, coupled with the
indirect ownership interests in Tweeter,
was sufficient to satisfy the common ownership factor of the DOL test.20
The court next considered the “common directors and/or officers” factor of
the DOL test, which it explained requires
examination of whether “any of the same
individuals were a part of the formal management teams of each company.”21 The
plaintiffs asserted that for more than a
year, four of the five directors for Tweeter
were individuals that were in some way
connected to SAM.22 They further argued
15 Id.
16 Id. at 541-43.
17 Id. at 541-42.
18 Id. at 542 (citing Guippone, 2010 WL 2077189, at *4).
19 Id. at 542-43.
20 Id. DHP Holdings and Tweeter Opco illustrate that “common ownership” is a misnomer. Rather than analysis of “common ownership,”
courts assessing this first prong of the DOL test appear focused solely
on whether the equity sponsor owns, directly or indirectly, a controlling
stake in the immediate employer. This point is explored further in part II
of this article.
21 Id. at 543 (citing Pearson, 247 F.3d at 498).
22 Id.
that George Schultze was part of the
management teams at both Tweeter and
SAM. In response, SAM asserted that
George Schultze was, in fact, the only
SAM employee that held a position as a
director, and that the other three alleged
members connected to SAM were not formal, or even de facto, officers or directors
of SAM.23 The court agreed with SAM
that George Schultze was the only common director and/or officer of Tweeter
and SAM.24 The court then went one step
further, finding that Schultze and SAM
also controlled the other three directors
of Tweeter, either because they were
employees or on the advisory board of
SAM, which was sufficient to satisfy that
factor of the DOL test.25
Turning next to the “de facto exercise of control,” the court identified the
core inquiry as whether the parent or
lender specifically directed the allegedly
illegal employment practice. The court
focused heavily on the fact that a director
of Tweeter, who was a SAM employee,
told Tweeter’s CEO that George Schultze
wanted the CEO to terminate half of
Tweeter’s employees. 26 Additionally,
the court relied on a subsequent email
written by the same SAM employee to
Tweeter’s employees regarding the termination of Tweeter’s CEO, which stated
that “[SAM] felt [it] needed tighter control of Tweeter within [its] own organization.”27 This email, along with several
other facts, such as (1) repeated demands
by George Schultze for reductions in
payroll to increase profits, (3) a directive
by George Schultze to a SAM employee that she assist Tweeter management
with employee terminations and (3) the
involvement of SAM’s inside general
counsel in Tweeter’s affairs, were more
than enough for the court to find that
SAM exercised de facto control over
Tweeter under the DOL test.28 Indeed,
Judge Walrath found SAM’s control of
Tweeter “particularly egregious.”29
The court next addressed the “unity
of personnel policies” factor, which was
“targeted toward discerning whether the
nominally separate corporations actually
functioned as a single entity with respect
to [personnel] policies on a regular,
day-to-day basis.”30 The plaintiffs failed
to adequately address this prong of the
DOL test, and as a result, the court relied
23 Id.
24 Id.
25 Id.
26 Id. at 543-44.
27 Id. at 544.
28 Id. at 545.
29 Id.
30 Id. at 545 (alteration in the original) (citing Pearson, 247 F.3d at 490).
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on SAM’s evidence that Tweeter had its
own team overseeing payroll, personnel
policies and procedures, and employee
issues.31 Furthermore, SAM and Tweeter
did not share labor policies, hired and
fired employees separately, paid employees from separate payrolls and had separate labor contracts.32 Accordingly, the
court found no evidence that SAM and
Tweeter functioned as a single entity
with respect to personnel policies on a
day-to-day basis.33
Finally, with respect to “dependency of operations,” the plaintiffs argued
that the participation by one of the SAM
employees in the day-to-day operations of Tweeter during the two-day gap
between when the former CEO was fired
and when Tweeter hired a CRO supported the finding that there was a dependency of operations.34 The plaintiffs further
asserted that the participation by one of
SAM’s employees in Tweeter’s termination of its employees was an “interchange of employees.”35 SAM denied the
plaintiffs’ allegations, arguing that there
was no evidence that SAM and Tweeter
shared administrative services, equipment, employees or management.36 The
court concluded that the plaintiffs failed
to satisfy this prong of the DOL test, and
after looking at the “daily functioning of
the two companies, there [was] no evidence that they were dependent upon one
another to continue operations.”37
Summarizing its analysis, the court
stated that under the Third Circuit’s decision in Pearson, the de facto exercise-ofcontrol prong carries “special weight.”38
The court articulated that where the de
facto exercise of control is “particularly
egregious,” single-employer liability is
warranted.39 While the plaintiffs were
able to demonstrate three of the five factors (common ownership, common directors and officers, and the de facto exercise of control by SAM over Tweeter),
the court emphasized the particular relevance of the egregious nature of the de
facto exercise of control by SAM over
Tweeter.40 Accordingly, Judge Walrath
entered summary judgment against SAM
on the issue of single-employer liability.
Lessons to Be Learned
The outcome of Judge Walrath’s
decision in Tweeter Opco stands in
contrast to her earlier decision in DHP
Holdings. The reality is that only one
of five DOL factors—the de facto control prong—separated SAM from HIG
Capital LLC, the equity sponsor that
escaped liability in DHP Holdings.
Predictably, both sponsors satisfied the
common-ownership and common-officers-and-directors requirements. Those
factors will be satisfied in most situations
involving a sponsor with a controlling
equity stake. Likewise, 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 private-equity firms
to encroach on portfolio companies in
these areas. Thus, it was only the degree
of control that separated these two equity
sponsors in their liability (or lack thereof) under the WARN Act. Part II of this
article expands on this issue and offers
recommendations to equity sponsors
facing a reduction in workforce, but the
bottom line is this: Private-equity sponsors are extremely vulnerable to claims
of single-employer liability under the
WARN Act and 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. 9, November 2011.
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.
31 Id.
32 Id.
33 Id. at 545-46.
34 Id. at 546.
35 Id.
36 Id.
37 Id. at 546.
38 Id.
39 Id. (citing Pearson, 247 F.3d at 504).
40 Id. The court pointed out that the de facto exercise of control by SAM
over Tweeter was “particularly egregious” because SAM exercised
control over Tweeter’s hiring and firing decisions, particularly those
relevant to the litigation.
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