The U.S. District Court for the District of Delaware recently cleared the way for a private equity firm to avoid liability under the Worker Adjustment and Retraining Notification Act (the “WARN Act”) for layoffs in connection with the closure of one of its portfolio companies.  The court also provided a road map for proactive private equity firms to follow in order to fend off any WARN Act claims or, better yet, to prevent any WARN Act claims from being brought in the first place.

The facts in the case, Czyzewski v. Sun Capital Partners, Inc. (In re Jevic Holding Corp.), 2014 U.S. Dist. LEXIS 137071 (D. Del. Sept. 29, 2014), are relatively straightforward.  Sun Transportation, LLC, a wholly owned subsidiary of Sun Capital Partners, Inc. (“Sun Capital”), acquired Jevic Transportation, Inc. (“Jevic”) in a leveraged buyout.  As part of the transaction, Sun Capital and Jevic entered into a Management Services Agreement (the “MSA”), which provided for consulting services to be provided by Sun Capital and for Sun Capital to be compensated for such services.  Jevic subsequently defaulted under the financial covenants with its secured lender, CIT Group/Business Credit, Inc. (“CIT”).  As part of a forbearance agreement entered into by Jevic and CIT, Sun Capital provided a $2 million guarantee in favor of CIT.  CIT ultimately presented Sun Capital with two options: (1) Sun Capital could invest additional funds in Jevic in exchange for a long-term forbearance agreement; or (2) Sun Capital could receive a 45-day forbearance in exchange for beginning an active sale process.  Sun Capital chose not to invest more money in Jevic and Jevic began making plans for either an active sale process or a reorganization.  However, Jevic found itself again in default of its financial covenants with CIT.  The Jevic board formally authorized the bankruptcy filing on May 16, 2008, and Jevic thereafter sent its employee termination notices in accordance with the WARN Act.  These notices were received by employees on May 19, 2008, and Jevic filed its Chapter 11 petition one day later, on May 20, 2008.

Immediately after the bankruptcy filing, former Jevic employees filed an adversary complaint in the Bankruptcy Court alleging that Jevic and Sun Capital violated the WARN Act and the New Jersey equivalent of the WARN Act by failing to provide employees with the required 60-day notice before a plant closing or mass layoff.  The Bankruptcy Court subsequently certified the WARN Act class.

The primary hurdle facing the class plaintiffs was the fact that Sun Capital was not their employer and that it was Jevic, and not Sun Capital, that had closed its doors.  The plaintiffs sought to avoid this hurdle by alleging that Sun Capital was liable for WARN Act violations because it and Jevic operated as a “single employer.”  The Bankruptcy Court rejected these claims, and the District Court affirmed the Bankruptcy Court’s ruling on appeal.

The District Court held that the standard for inter-corporate liability under the WARN Act rests on whether the companies in question had become “so entangled with [one another’s] affairs” that the separate companies “are not what they appear to be, [and] in truth they are but divisions or departments of a single enterprise.”  The District Court cited to five factors promulgated by the U.S. Department of Labor for courts to use when considering whether to impose derivative liability under the WARN Act on an affiliated corporation:  (1) common ownership; (2) common directors and/or officers; (3) de facto exercise of control; (4) unity of personnel policies; and (5) dependency of operations.  20 C.F.R. § 639.3(a)(2).

Most importantly from a private equity perspective, the District Court held that these five factors are not balanced equally.  Citing the Third Circuit’s opinion in In re APA Transport Corp. Cansol. Litig., 541 F.3d 233, 243 (3d Cir. 2008), the District Court held that the first and second factors, common ownership and common directors and/or officers, “are not sufficient to establish that the two entities are a single employer.”  As discussed below, this portion of the Sun Capital decision will be extremely useful to private equity firms which normally have common ownership of, and typically share directors and/or officers with, their portfolio companies.

In what should be seen as another boon to private equity, the District Court set a very high bar for “de facto control.”  The court held that de facto control is not present where the parent corporation exercises control pursuant to the ordinary instances of stock ownership, but exists only where “the parent has specifically directed the allegedly illegal employment practice that forms the basis for the litigation.”  In other words, the parent corporation must be the decision maker responsible for the employment practice at issue and must have ultimate responsibility for keeping the company alive.  Accordingly, Sun Capital, which did not direct Jevic to shut down, did not have de facto control even though its decision to withhold funding directly caused the closure.

The District Court also set a high bar for finding unity of personnel policies and dependency of operations.  With respect to the former, the court characterized the issue as “whether the two companies in question engaged in centralized hiring and firing, payment of wages, and personnel and benefits recordkeeping.”  There must be evidence that the parent “directly” hired or fired the other company’s employees, paid the salaries of the employees or shared a personnel or benefits recordkeeping system with the other company.  The District Court found there was no dependency of operations because the two companies maintained separate books and records, had their own bank accounts and prepared their own financial statements.  Importantly, the District Court rejected the argument that the MSA, under which Sun Capital provided management consulting services (including restructuring advice) in exchange for compensation, was sufficient to establish “dependency of operations.”

The Sun Capital decision by the respected District Court for the District of Delaware should provide much comfort to private equity firms.  Private equity firms typically meet the first two Department of Labor factors of common ownership and common directors and/or officers.  However, the District Court held that these two factors are not sufficient in and of themselves to establish single employer status.  Private equity firms many times enter into management services agreement with their portfolio companies.  However, the Sun Capital court specifically rejected the argument that a management services agreement, negotiated at arm’s length, is indicia of a single employer.  Moreover, the Sun Capital decision provides additional protection to private equity firms by requiring the parent corporation to be the decision maker responsible for the employment practice giving rise to the litigation and to have ultimate responsibility for keeping the company alive.  Private equity firm would be well advised to review their relationships with their portfolio companies in order to ensure that they are following the “Sun Capital road map” for avoiding WARN Act liability.