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Third Circuit Bankruptcy Decisions Offer WARN Act Guidance for Financially Distressed Companies

December 12, 2008
Marc S. Casarino

Reductions in force are a reality for many financially distressed companies. A significant consideration for any company faced with potential closures and layoffs is the Worker Adjustment and Retraining Notification (WARN) Act.  The WARN Act requires that companies provide 60 days notice to employees before ordering a plant closing or mass layoff if they have 100 or more employees, exclusive of part-time employees, or 100 or more employees who in the aggregate work at least 4,000 hours, excluding overtime..  Employers must also notify the state and the unit of local government in which the layoff or closing is to occur.

Unexcused failure to comply with the WARN Act notice requirements may render the employer liable for any affected employee’s wages and benefits for each day of the violation, up to 60 days.  Even though part-time employees are not counted in determining whether a mass layoff or plant closing occurred under the Act, part-time employees are still eligible for damages under the Act.  The employer may also be liable to the unit of local government for an amount not more than $500 for each day of the violation, up to 60 days.  Violations of the Act can be costly for companies with a large number of employees.

The “Faltering Company” Exception

There are several defenses provided by the Act for financially distressed companies.  Section 2102(b)(1) of the Act, commonly referred to as the “faltering company” exception, provides that an employer acting in good faith to obtain capital that would have prevented the plant closure or mass layoff and reasonably believes giving notice pursuant to the Act would have precluded the employer from obtaining the capital is not liable for ordering a closing before the 60-day period concludes.  Similarly, the notice requirement is excused if, at the time notice should have been given under the Act, the cause of the closing or layoff was not reasonably foreseeable or was the result of a natural disaster.

What Constitutes “Actively Seeking” Financing?

The Third Circuit Court of Appeals recently rejected a financially distressed employer’s attempt to use the “faltering company” defense to WARN Act violation claims in In re APA Transport Corp. Consol. Litigation because the employer was not making a good-faith effort to actively seek financing.  In the APA Transport Corp. (APA) case, the company gave only six days notice before closing its operations and terminating all of its employees.  Prior to its shutdown, APA had maintained a revolving credit facility with Transamerica Business Credit Corp.  Before the notice period, APA made only informal efforts to obtain additional funding or to extend its existing loan with Transamerica.  After the notice period, APA sent formal requests to Transamerica for additional financing.  Significantly, APA never sought financing from any other sources.

The court held that the single, informal exchange between APA and Transamerica did not constitute the active pursuit of financing.  The court emphasized that  APA made no effort to pursue financing beyond Transamerica.  The court characterized APA’s efforts as “waiting for Transamerica to offer additional financing” rather than “actively seeking” financing.  Accordingly, APA was not protected by the “faltering company” exception and was found to have violated the notice requirements of the Act.

Employers should take heed that informal discussions, even with an existing lender, will likely be insufficient to qualify for the “faltering company” exception.  At a minimum, an employer who is considering to raise the “faltering company” defense must approach new lenders while working on restructuring efforts with existing lenders..  In each case, the employer should consistently document a systemic effort to obtain financing.

Treatment of WARN Act Damage Claims in Bankruptcy

In Henderson v. Powermate Holding Corp. (In re Powermate Holding Corp.)[1], the Delaware Bankruptcy Court determined, as a matter of first impression in the Third Circuit, WARN Act damage claims under the 2005 amendments to the Bankruptcy Code.  In Powermate, a group of employees sought second priority payment status of their damages as administrative expenses pursuant to the 2005 amendment of section 503(b)(1)(A)(ii) of the Bankruptcy Code.  From the treatment historically given wage claims, the employees sought to improve their position in the bankruptcy distribution hierarchy.

According to the court, WARN Act damages vest entirely upon termination of the employee without the required notice.  WARN Act damage claims are afforded administrative priority under section 503(b)(1)(A)(ii) only if they are attributed to a post-petition period of time.  If the employee is terminated pre-petition, then the WARN Act damages vest pre-petition and are not administrative claims under section 503(b)(1)(A)(ii).  Instead, such claims are governed by sections 507(a)(4)-(5) of the Bankruptcy Code, providing fourth priority status to unsecured claims for wages, salaries and commissions, vacation pay, and severance pay.  Section 507(a)(5) provides fifth priority status to unsecured claims for contributions to an employee benefit plan.  Claims allowable to each individual under sections 507(a)(4)-(5) are limited to $10,950, with any amount over that statutory cap being treated as a general unsecured claim.  Proper timing can therefore significantly reduce a bankruptcy estate’s administrative expense liability for WARN Act violation damages.

Conclusion

The APA Transport and Powermate decisions must be considered in pre-bankruptcy planning for certain financially distressed companies who may close their plants or layoff substantial numbers of employees.  If good faith efforts to obtain financing with existing and prospective lenders are actively made and properly documented, APA Transport suggests that financially distressed companies will be in a stronger position to avoid WARN Act liability pursuant to the “faltering company” defense.  When closures are likely to occur, a financially distressed company must carefully consider how and when to terminate employees under the WARN Act.  If not done properly, the company and the bankruptcy estate may be faced with a significant administrative expense liability.  These potential pitfalls require careful planning and consultation with qualified legal counsel.

[1] Subject to pending appeal.

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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