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WARN Act Obligations In Chapter 11 Bankruptcies

The Worker Adjustment and Retraining Notification Act (“WARN Act” or the “Act”),1 29 U.S.C. §§ 2101-2109, requires covered employers to give 60 days’ advance written notice to affected employees in the case of either a permanent or extended temporary plant closing or mass layoff.2  Last year, two cases were decided that helped to clarify the effect of a chapter 11 filing on an employer’s notice obligations under the WARN Act.  In each of these cases, the pivotal issue facing the court was whether an employer that was a debtor-in-possession in a chapter 11 case was a “liquidating fiduciary” and whether that status relieved the employer from the obligation of giving its employees 60 days’ notice in accordance with the WARN Act.

In In re United Healthcare System, Inc., 200 F.3d 170 (3rd Cir. 1999), the Third Circuit found that a debtor-hospital which had filed a chapter 11 petition in the Bankruptcy Court sixteen days earlier was a “liquidating fiduciary” at the time it laid off 1,200 of its 1,300 employees.  Accordingly, the court found that the debtor-hospital was not a “business enterprise” under the WARN Act at the time of the layoff.  Because the WARN Act applies only to “employers” that are “ business enterprises,” the court held that the debtor-hospital was not liable for back pay to employees under the WARN Act for having failed to give its employees 60 days’ notice.

The court in In re Jamesway Corporation, 235 B.R. 329 (Bankr. S.D.N.Y. 1999), likewise recognized that the status of “liquidating fiduciary” could relieve a debtor-in-possession from WARN Act liability, but nevertheless found the retailer liable under the WARN Act because, six days prior to filing its chapter 11 petition in the Bankruptcy Court, it had 1) decided to liquidate, 2) identified all of the employees who would lose their jobs in the layoff, 3) determined the schedule of terminations in the layoff, and 4) commenced terminating employees as part of the layoff.  Based on these facts, the Court found that the employer was liable under the WARN Act prior to the chapter 11 filing because the employees became entitled to notice of the termination of their employment at the time of these events.  

United Healthcare System and Jamesway are important decisions not only with respect to the outcome of WARN Act claims against debtors-in-possession, but also with respect to the possible ramification these cases may have on the timing of layoffs or plant closings by employers considering a chapter 11 filing.  Under the Bankruptcy Code, courts that have considered the issue generally have held that WARN Act back pay damages are deemed wages earned at the date of the employee’s termination of employment.3  Thus, if the termination of employment occurs prior to the chapter 11 filing, courts generally have held that the employee’s recovery against the employer under the WARN Act will be paid on a third priority basis, only up to $4,300.4  In that case, under the Bankruptcy Code, the remainder of the claim is treated as a general unsecured claim, entitled to no priority, which often is paid at a fraction of its full value.5  By contrast, if the termination of employment occurs after the chapter 11 filing, courts generally have held that the employee’s recovery against the employer under the WARN Act will be paid as a first priority “administrative expense” and thus entitled to full satisfaction prior to payment being made to any pre-petition unsecured creditors.6

Following United Healthcare System and Jamesway, employers who previously may have undertaken layoffs prior to filing chapter 11 petitions to take advantage of the limited priority accorded to pre-petition wage claims, may now be incentivized, under certain circumstances, to defer some or all layoffs or plant closings even after the chapter 11 petition is filed.  This is because employers who believe they may become “liquidating fiduciaries” of a chapter 11 debtor’s estate may avoid WARN Act liability entirely.

The best way for an employer to avoid WARN Act liability is still to provide employees the full 60-days’ notice prior to the plant closing or mass layoff.  However, for an employer experiencing extreme financial difficulties and contemplating a chapter 11 filing, the uncertainties of business and financial considerations often make it impossible to give employees the full 60 days’ notice.  
Accordingly, the defense accorded by United Healthcare System and Jamesway may be an important factor for consideration prior to a chapter 11 filing.

In this month’s article, we analyze United Healthcare Systems and Jamesway.

Background
The WARN Act applies to any business enterprise that employs either (i) 100 or more employees, excluding part-time employees, or (ii) 100 or more employees who, in the aggregate, work at least 4,000 hours per week, including part-time employees, but excluding overtime hours.7  Pursuant to the Act, a plant closing is defined as a permanent or temporary shutdown of a single site of employment, or one or more facilities or operating units within a single site of employment, if the shutdown results in an employment loss at that site during any 30-day period of 50 or more full-time employees.8  A mass layoff is defined as a reduction in force, which is not a plant closing, and results in employment loss at the single site of employment during any 30-day period comprising (i) at least 33% of the full-time employees at such site (provided there are at least 50 such employees), or (ii) 500 or more full-time employees (without regard to the percentage of employees at the site affected).9

While Congress provided certain express exceptions to the WARN Act’s 60-day notice requirement, the statute is silent as to the effect of a chapter 11 filing with the Bankruptcy Court on an employer’s notice obligations.  The Act provides for certain exceptions which either relieve an employer from providing notice or reduce the amount of notice an employer is required to give.  

Thus, for example, in the case of a sale of all or part of the assets of a business, the Act provides that the seller shall be responsible for providing notice up to and including the date of the sale.  After that date, the purchaser is responsible for providing notice.  However, to the extent that the buyer hires an employee of the seller, that person shall be considered an employee of the purchaser immediately after the effective date of the sale.  Thus, the event of the sale and the technical “loss of employment” does not trigger notice obligations under the Act.10  

Moreover, the Act does not apply if the plant closing or mass layoff is a result of (1) a closing of a temporary facility or after the completion of a particular project or undertaking, and the affected employees were hired with the understanding that their employment was limited to the duration of the facility or project or undertaking, or (2) the closing or layoff constitutes a strike or constitutes a lockout not intended to evade the requirements of the Act.11  Additionally, the notification period under the Act may be reduced by (1) the faltering company exception in the WARN Act, which applies only to plant closings, (2) the unforeseen business circumstances exception, or (3) the natural disaster exception.12

The failure to comply with the Act gives rise to potential civil actions by employees for damages in the form of back pay for each day of violation and benefits under any employee benefit plan which would have been covered under an employee benefit plan if the employment loss had not occurred.13  Thus, for example, if an employer terminates its employees without giving the requisite WARN notice, the employer will be liable for 60 days of back pay.  If, however, an employer gives the requisite WARN notice but then terminates its employees 15 days after giving the notice, then the employer will be liable for 45 days of back pay.14  Additionally, a court can impose a civil penalty of not more than $500 for each day of violation.15
DOL Position
In 1989, the United States Department of Labor (“DOL”) published a commentary to accompany its final regulations under the WARN Act.  In that commentary, the DOL expressed its position regarding the application of the WARN Act in the context of a liquidating fiduciary in bankruptcy as follows:  

    Another commentor [sic] suggested that ‘fiduciaries’ in bankruptcy proceedings should be excluded from the definition of employer.  Since adequate protections for fiduciaries are available through the bankruptcy courts, the Department does not think it appropriate to change the regulations to address this situation.  Further, DOL agrees that a fiduciary whose sole function in the bankruptcy process is to liquidate a failed business for the benefit of creditors does not succeed to the notice obligations of the former employer because the fiduciary is not operating a ‘business enterprise’ in the normal commercial sense.  In other situations, where the fiduciary may continue to operate the business for the benefit of creditors, the fiduciary would succeed to the WARN obligations of the employer precisely because the fiduciary continues the business in operation.16

Both the United Healthcare System and Jamesway courts quoted and cited with approval the DOL’s position in the commentary.

United Healthcare System
United Healthcare System, Inc. (“United Healthcare System”) was a New Jersey not-for-profit corporation that provided hospital and healthcare services in the Newark area.  The company began to experience financial difficulties in 1993, but these problems did not become acute until 1996, when it suffered substantial financial losses and encountered trouble maintaining supplies.17
After its secured creditor issued a notice of default terminating all financing, United Healthcare System voted to accept the offer of another healthcare provider to purchase all of its assets and close its hospital.  Shortly thereafter, United Healthcare System advised the New Jersey Department of Health that it would close and surrendered its certificates of need.  Additionally, on the same day, United Healthcare System filed a voluntary chapter 11 petition and provided its approximately 1,300 employees with 60 days’ notice of termination of employment pursuant to the WARN Act.18

Less than three weeks after United Healthcare System filed its chapter 11 petition, the Official Committee of Unsecured Creditors of United Healthcare System (the “Committee”) filed a motion asking the Bankruptcy Court to order United Healthcare System to terminate all employees immediately.  Before the Bankruptcy Court ruled on the Committee’s motion, United Healthcare System informed 1,200 of its 1,300 employees that they were no longer to report to work.  The remaining 100 employees were retained to secure the plant facility and to maintain necessary equipment.19

United Healthcare System and the Committee stipulated before the Bankruptcy Court that United Healthcare System’s February 19 WARN Act notice created a $7.3 million payroll obligation.  Although the parties agreed that United Healthcare System’s 1,200 furloughed employees were entitled to be paid for the sixteen days they actually worked, the parties could not agree whether the employees were entitled to WARN Act back pay for the remaining forty-four days.  United Healthcare System asserted that the employees were entitled to WARN Act back pay for those forty-four days and were also entitled to first priority administrative claim status under the Bankruptcy Code.  The Committee responded that the employees were not entitled to WARN Act back pay because United Healthcare System ceased to be an employer subject to the WARN Act once it surrendered its certificate of need.  In the alternative, it also contended that United Healthcare System was excused from providing notice under the WARN Act’s “faltering company” and “unforeseeable business circumstances” exceptions.20

The Bankruptcy Court rejected all of the Committee’s arguments, holding that United Healthcare System’s employees were entitled to WARN Act back pay and that their claims should be granted first priority administrative claim status.  The Bankruptcy Court found that United Healthcare System remained an employer subject to the Act after it filed its chapter 11 petition because it continued to employ its 1,300 person workforce for sixteen days after the chapter 11 petition was filed.21  The District Court affirmed.

On appeal, the Third Circuit held that United Healthcare System was no longer an “employer” within the meaning of the WARN Act when it terminated its employees and therefore was not liable for the back pay.  The court stated that whether a chapter 11 debtor is an “employer” under the WARN Act depends on the nature and extent of its business and commercial activities while in chapter 11, and not merely on whether the entity’s employees continue to work “on a daily basis.”22  The court stated that the more closely the debtor’s activities resemble those of a business operating as a going concern, the more likely it is that the debtor is an “employer.”  The more closely the activities resemble those of a business winding up its affairs, the more likely it is that the debtor is not subject to the WARN Act.23

In finding that United Healthcare System was not operating as a going concern but rather as a business liquidating its affairs when it terminated its employees, the court relied on the following facts which existed prior to United Healthcare System terminating its employees:  (1) United Healthcare System surrendered its certificate of need and therefore, pursuant to New Jersey State law, it could no longer operate its health care facility,24 (2) it discharged or transferred all of its patients and was no longer admitting new patients, and (3) its employees were no longer engaged in their regular duties but instead were performing tasks solely designed to prepare it for liquidation.25

The court stated that although it found WARN Act liability did not attach under those facts and circumstances, it did not foreclose the possibility that WARN Act liability may apply in other situations where an employer commences a chapter 11 case and then terminates its employees.26  The court stated that an employer as a debtor-in-possession will succeed to its WARN Act obligations if an examination of the debtor’s economic activities leading up to and during the chapter 11 reveals that the employer as debtor-in-possession has continued in an “employer” capacity, operating the business as an ongoing concern.27  

Jamesway Corporation
Although the United Healthcare System decision provides debtors-in-possession an important defense to WARN Act claims by employees, employers seeking to take advantage of this defense should be extremely careful in seeking to establish their status as “liquidating fiduciaries.”  As demonstrated by Jamesway, the defense may not be available where the employer had 1) decided to liquidate, 2) identified all of the employees who would lose their jobs in the layoff, 3) determined the schedule of terminations in the layoff, and 4) commenced terminating employees as part of the layoff.

Prior to commencing its chapter 11 case, Jamesway Corporation (“Jamesway”) operated discount department stores located throughout New York, Pennsylvania, New Jersey, Virginia, Maryland, Delaware and West Virginia.28  Beginning on October 12, 1995 and continuing through November 11, 1995, Jamesway fired a total of approximately 549 employees from its various locations.  In order to control and effectuate its liquidation through the bankruptcy process, Jamesway filed its chapter 11 petition on October 18, 1995.29  

A group of terminated employees and a labor union representing certain Jamesway employees brought an action against Jamesway under the WARN Act claiming that Jamesway fired them without giving them 60 days’ advance notice of their terminations pursuant tothe Act.   The plaintiffs contended that the employees were entitled to 60 days of back pay and that their claims were entitled to administrative priority status under the Bankruptcy Code.30

Jamesway first argued that it was not liable to the plaintiffs under the Act on two separate bases.  Jamesway contended that because it ceased operating due to “not reasonably foreseeable business circumstances” and/or because it was a “faltering company” it did not have to give WARN notice to the plaintiffs.31  The court found these exceptions inapplicable, however, because Jamesway failed to give any of written notice prior to terminating the plaintiffs, which the court determined was required under the Act.32  

Jamesway also argued that because it was a liquidating fiduciary in bankruptcy, it was not subject to the WARN Act.33  Jamesway contended that immediately subsequent to its liquidation and shutdown, and the resultant termination of its employees, its efforts were geared towards finalizing the planning, documentation and other advance activities necessary to commence its liquidating chapter 11 case so that its liquidation could proceed in an orderly manner.  Citing the DOL’s commentary to the final regulations under the WARN Act, Jamesway contended “that once it began its liquidating chapter 11 case, it was a fiduciary liquidating its failed business and did not succeed to the notice obligations of the pre-bankruptcy entity.”34

Although the plaintiffs disputed that Jamesway was a liquidating fiduciary, the court noted that it did not need to resolve that dispute because, as the court stated, assuming arguendo that Jamesway was a liquidating fiduciary when it filed the chapter 11 case on October 18, 1995, it nevertheless was liable under the Act because, as of October 12, 1995, it was an employer obligated to give notice under the Act.35  The court based its conclusion on the fact that on October 12, 1995, Jamesway’s directors voted to liquidate the company and authorized Jamesway to file a liquidating chapter 11 case and that Jamesway had already identified all the plaintiffs as employees that would lose their jobs in the ensuing liquidation, and formulated a schedule for firing them.36  The court found that when Jamesway failed to serve the affected employees with notice, it became liable to them under the Act.  Additionally, the court stated that the subsequent filing of the chapter 11 petition did not divest Jamesway of its obligations under the Act to those terminated employees.37  With respect to the status of the claims, the court also found that they were not entitled to administrative expense priority status because Jamesway’s obligation under the WARN Act arose prior to its chapter 11 filing.38

Conclusion
It goes without saying that, regardless of when the employer chooses to terminate its employees, the employer should make every effort to provide the required notice.  However, in situations where the 60 days advance notice simply is not practicable, employers should strongly consider the financial ramifications of terminating its employees pre-petition versus post-petition.  Now, part of that calculus should include the results in United Healthcare System and Jamesway.
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1.  29 U.S.C. §§ 2101, et seq.
2.  29 U.S.C. § 2102(a).
3.  See In re Hanlin Group, Inc., 176 B.R. 329, 333-34 (Bankr. D.N.J. 1995) (“The [WARN Act back pay] wages are ‘earned’ at the time of the termination of employment.”); In re Cargo, Inc., 138 B.R. 923, 927 (Bankr. N.D. Iowa 1992) (“WARN damages are more similar to the first type - pay at termination in lieu of notice.  It is earned, not over a period of employment, but upon termination.”).  But see In re Jamesway Corp., 235 B.R. 329 (Bankr. S.D.N.Y. 1999) (finding employees that were terminated post-petition were not entitled to post-petition administrative expense priority status because employer’s “obligation” to give WARN Act notice arose pre-petition).
4.  See, e.g., In re Cargo, Inc., 138 B.R. 923 (Bankr. N.D. Iowa 1992) (finding employees’ WARN Act claims, when employees were terminated prior to the filing of the bankruptcy petition, were claims for “wages” entitled to Section 507(a)(3) of the Bankruptcy Code priority status);
In re Riker Industries, Inc., 151 B.R. 823 (Bankr. N.D. Ohio 1993) (same).  Section 507(a)(3) of the Bankruptcy Code provides, in pertinent part, that claims earned within “90 days before the date of the filing of the petition or the date of cessation of the debtor’s business, whichever occurs first, for (A) wages, salaries, or commissions . . . “ are entitled to third priority status among the unsecured creditors claims.  See 11 U.S.C. § 507(a)(3).  Pursuant to Section 507(a)(3), these claims are entitled to a maximum of $4,300 per claim.  Id.
5.  See In re Chicago Lutheran Hosp. Assoc., 75 B.R. 854, 856 (Bankr. N.D. Ill. 1987).
6.  See, e.g., In re Hanlin Group, Inc., 176 B.R. 329 (Bankr. D.N.J. 1995) (finding employees’ WARN Act claims, when employees were terminated after the filing of the bankruptcy petition, entitled to Section 503(b)(1) and Section 507(a)(1) of the Bankruptcy Code priority status); In re Beverage Enterprises, Inc., 225 B.R. 111 (Bankr. E.D. Pa. 1998) (same).  But see In re Jamesway Corp., 235 B.R. 329 (Bankr. S.D.N.Y. 1999) (finding employees that were terminated post-petition were not entitled to post-petition administrative expense priority status because employer’s “obligation” to give WARN Act notice arose pre-petition).  Section 503(b)(1) of the Bankruptcy Code provides, in pertinent part, that there shall be allowed administrative expenses including “the actual, necessary costs and expenses of preserving the estate, including wages, salaries or commissions for services rendered after commencement of the case.”  See 11 U.S.C. § 503(b)(1).  Pursuant to Section 507(a)(1), these claims are entitled to first p
riority status.  Id.
7.  29 U.S.C. § 2101(a)(1).
8.  29 U.S.C. § 2101(a)(2).
9.  29 U.S.C. § 2101(a)(3).
10.  29 U.S.C. § 2101(b)(1).  See also 54 Fed. Reg. 16,042, 16,052.
11.  29 U.S.C. § 2103.
12.  29 U.S.C. § 2102(b)(1) & (b)(2)(A).
13.  29 U.S.C. § 2104(a)(1).
14.  The Act provides that such liability shall be calculated for the period of the violation, up to a maximum of 60 days, but in no event for more than one-half the number of days the employee was employed by the employer.  Id.  Most Courts of Appeal that have considered the issue uniformly have adopted a “work day” approach in calculating damages, that is, using the number of work days within the violation period as opposed to actual “calendar days.”  See, e.g., Burns v. Stone Forest Indus., Inc., 147 F.3d 1182 (9th Cir. 1998); Breedlove v. Earthgrains Baking Companies, Inc., 140 F.3d 797 (8th Cir. 1998); Saxion v. Titan-C-Manufacturing, Inc., 86 F.3d 553 (6th Cir. 1996); Frymire v. Ampex Corp., 61 F.3d 757 (10th Cir. 1995); Carpenters Dist. Council v. Dillard Dep’t Stores, 15 F.3d 1275 (5th Cir. 1994).  But see United Steelworkers v. North Star Steel Co., Inc., 5 F.3d 39, 43 (3d Cir. 1993) (adopting a calendar approach in calculating back pay damages).
15.  29 U.S.C. § 2104(a)(3).  This penalty does not apply if the employer pays to each affected employee the amount for which the employer is liable to that employee within three weeks from the date the employer orders the closing or layoff.  Id.  Additionally, a court can lower the civil liabilities and penalties imposed under the Act if the employer proves to the satisfaction of the court that the employer acted in good faith and had reasonable grounds for believing the act or omission was not in violation of the Act.  See 29 U.S.C. § 2105(a)(4).
16.  54 Fed. Reg. 16042, 16045 (1989).
17.  Id. at 172.
18.  Id. at 172-73.  The notice explained that their employment would end on April 20, 1997, or within fourteen days of that date.  The notice also stated that they should continue to report to work until United Healthcare System closed.  Because all of United Healthcare System’s patients had been transferred to another hospital affiliate or sent homeby February 21, within 48 hours after United Healthcare System issued the WARN notice, its employees were unable to perform their regular duties but instead cleaned, took inventory and prepared the company’s assets for sale.  Id. at 173.
19.  Id.
20.  Id. at 174.
21.  Id. The Bankruptcy Court also concluded that the faltering company and unforeseeable business circumstance exceptions did not apply.  Id.  The Third Circuit did not address those issues on appeal.
22.  Id. at 178.
23.  Id.
24.  Id. at 173 n.1.
25.  Id. at 178.
26.  Id. at 179.
27.  Id. This statement by the Third Circuit is consistent with other district courts that have found liability for post-petition terminations in the chapter 11 reorganization context.  See, e.g., Hotel Employees Restaurant Employees Int’l Union Local 54 v. Elsinore Shore Assocs., 724 F. Supp. 333 (D.N.J. 1989) (finding chapter 11 debtor defendant employer, and not the conservator appointed by the State, retained the WARN Act liability because the defendant employer continued the day-to-day operations of the business while the conservator simply monitored and assessed the business in consultation with the State Gaming Commission).  See also
In re Hanlin Group, Inc., 176 B.R. 329 (D.N.J. 1995) (finding debtor employer liable under the Act where it kept the plant in operation for at least one month after the chapter 11 petition was filed and continued to operate the business as a whole for the benefit of all parties in interest).  Accord Chauffeurs, Sales Drivers, Warehousemen & Helpers Union Local 572 v. Weslock Corp., 66 F.3d 241 (9th Cir. 1995) (secured lender, whose interaction with delinquent debtor primarily was limited to financial controls and no functional involvement in the operations of the facility, was not liable for WARN Act violations).
28.  See In re Jamesway Corp., 1997 WL 327105 (Bankr. S.D.N.Y. 1997).
29.  In re Jamesway, 235 B.R. at 335.
30.  Id.
31.  Id. at 337.
32.  Id. at 342-43.
33.  Id. at 337.
34.  Id. at 343.
35.  Id.
36.  Id.
37.  Id. at 343-44.
38.  Id. at 348.

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