In Czyzewski v. Sun Capital Partners, Inc.1, the United States District Court for the District of Delaware affirmed a Bankruptcy Court determination that a private equity firm was not liable for its subsidiary portfolio company’s failure to provide adequate notice of a plant closing under the federal Worker Adjustment and Retraining Notification Act (WARN Act). In reaching its conclusion, the Court applied the so-called “single employer” test set forth by the United States Department of Labor in its regulations promulgated under the WARN Act. The Court held that, despite Sun Capital’s status as a parent corporation, the presence of two of its officers on the subsidiary’s board, its involvement in developing a financial restructuring plan, and its decision to cease investment in its troubled subsidiary, Sun Capital and its subsidiary did not constitute a “single employer” under the WARN Act. Accordingly, Sun Capital was not vicariously liable for its subsidiary’s failure to provide adequate notice under the WARN Act.

“Single Employer” Liability in WARN Act Cases

The WARN Act is intended to protect workers and their families by requiring employers to provide advance notification of plant closings and mass layoffs.In theory, this advance notice gives workers time to adjust to the possibility of unemployment, enter the job market for new opportunities, or enter skills training to begin the transition to a new field. To that end, the Act requires employers of a certain size to serve written notice of a planned plant closure or mass layoff 60 days before the action takes place. Employers who fail to provide a timely WARN Act notice may be liable for up to 60 days’ back pay and benefits. More than 20 states, including New York, New Jersey and California, have enacted their own “mini” WARN Acts that provide similar or greater employee rights than those provided under the federal statute.

Plant closures and mass layoffs often occur in troubled companies. Indeed, such actions often precede the filing of a bankruptcy petition or corporate liquidation. That was the case with Sun Capital’s subsidiary, Jevic. Under such circumstances, aggrieved employees who fail to receive adequate notice under the WARN Act often will seek a remedy from a financially sound parent or affiliate. That is precisely what the employees of Sun Capital’s subsidiary sought to do.

The United States Department of Labor’s regulations under the WARN Act establish the circumstances under which affiliated entities will be deemed a “single employer,” and thus, vicariously liable for violations of the WARN Act. The five factors identified by the Department of Labor are: (i) common ownership,(ii) common directors and/or officers, (iii) de facto exercise of control, (iv) unity of personnel policies emanating from a common source, and (v) the dependency of operations.2

Applying the Test to Sun Capital

Sun Capital acquired Jevic in a leveraged buyout. The transaction included a third-party financing agreement that furnished Jevic with a revolving credit facility so long as it maintained a minimum amount of assets and collateral. Sun Capital and Jevic entered into a management services agreement under which Sun Capital provided certain consulting services to Jevic and received compensation for such services. Within a few months, Jevic defaulted on the third- party financing covenant, and required several forbearance agreements that were negotiated and financially supported by Sun Capital. An out-of-court restructuring plan failed to improve Jevic’s financial performance. Jevic terminated its employees and filed for bankruptcy. The employees filed a complaint alleging violations of the WARN Act and an analogous state statute because the WARN Act notice delivered by Jevic was not provided 60 days in advance of their employment loss. Following discovery, both Sun Capital and the former employees of Jevic filed cross-motions for summary judgment on the issue of whether Sun Capital could be held liable for Jevic’s WARN Act violations as a “single employer”.

Sun Capital conceded the first two of the five factors utilized by the Department of Labor – common ownership and common directors and/or officers. However, as noted by the court, the first two factors alone are not sufficient to warrant a “single employer” finding. The court then considered the remaining three factors: de facto exercise of control, unity of personnel policies emanating from a common source, and dependency of operations.

The court reasoned that “de facto exercise of control” in this framework requires that the parent company specifically direct or decide on the employment action that gives rise to the litigation. Even though Sun Capital made the decision to cease funding Jevic, which eventually led to the bankruptcy and the employment action at issue, the Court found that Jevic retained ultimate control over the decision to terminate the employees and file for bankruptcy. Similarly, the court found that Sun Capital and Jevic lacked unified personnel policies. The companies shared a healthcare initiative, business insurance, and incentive programs for management, but the court relied on the facts that Sun Capital did not directly hire or fire any Jevic employees, pay their salaries, or share a recordkeeping system in reaching its conclusion that the companies did not have a unified personnel policy.

Finally, the court applied the dependency of operations factor. The court found persuasive the facts that the companies maintained separate business records, had their own bank accounts, and did not share administrative services, facilities, or equipment. The existence of the management services agreement between the two entities did not negate these facts, because the terms of the agreement specified that Jevic retained control over the day-to-day operations of its business.

Lessons for Corporate Parents and Private Equity Firms

The Department of Labor’s single employer test has been increasingly adopted by courts across the country. The Third3, Fifth4, and Ninth5 Circuit Courts of Appeal have each adopted the Department of Labor’s test, as have district courts in the Second6 and Seventh Circuits7. Corporate parents and other affiliated corporate entities should therefore look to this test when structuring their relationships with their affiliates.

Whenever practicable, firms should:

  • permit subsidiaries and affiliates to retain direct control over hiring and firing of employees and other day-to-day personnel matters;
  • avoid or minimize overlap of directors and/or officers of subsidiary and affiliate corporations;
  • maintain separate payroll and record-keeping systems;
  • refrain from sharing administrative resources, facilities, and personnel;
  • maintain separate benefit plans;
  • require that any decision to close a facility or engage in a mass layoff be made by the subsidiary or affiliate corporation; and
  • include a provision in any consulting or services agreement between parent and subsidiary entities that the subsidiary retains control over its day-to- day operations.

Of course, the best way of avoiding liability under the WARN Act, as a single employer or otherwise, is to ensure that the employer provides the required advance written notice of a plant closing or mass layoff. Understanding that exigent circumstances will not always permit strict compliance with the WARN Act, the guidance set forth above will help minimize the risk that vicarious liability will be imposed on parent and affiliate corporations.