The United States Court of Appeals for the Second Circuit on Aug. 30, 2007, affirmed the dismissal of a lender liability class action brought by employees of a defunct originator and seller of mortgages and home equity loans. 2007 U.S. App. LEXIS 20791 (2d Cir. August 30, 2007). Agreeing with the district court, the Second Circuit held that the lender was not an "employer" within the meaning of the Worker Adjustment & Retraining Notification Act ("WARN Act"), and thus was not liable to the employees for the sudden loss of their jobs. Id., at *2.

The Court of Appeals went further: "The control exerted by [the lender] was indeed substantial but no more than was needed for a lender who had been defrauded of $5.6 million by [the borrower's] management and who was attempting to salvage a company bereft of cash." Id., at *19-20. Unlike other cases "in which lender liability has been found," the lender here "took no long-term interest in the operation of [its borrower] as a business. Rather, … [the lender's] conduct was prompted solely by a short-term interest in facilitating the sale of [the borrower] as a means of salvaging some of the debt it had extended." Id., at *20.

Fact Summary

The borrower had a long-term "warehouse" credit line with the lender. When, in early 1999, it had difficulty funding its continued operations, it falsified the weekly loan schedules it submitted to the lender so as to obtain working capital. The borrower later disclosed its misappropriations to the lender, placing it in default under the terms of its loan agreement and entitling the lender to seize its assets to pay off the credit line.

Instead of exercising its remedies, however, the lender "pursued a workout strategy that would allow [the borrower] to remain in business for a time in the hope of selling [the borrower] and using the proceeds to repay [the lender]," but refused "to do business with the individuals responsible for the fraud." Id., at *4.

The borrower then installed new management and bolstered its relationship with the lender. The lender obtained, among other things, a stock pledge of approximately 96% of the borrower's stock, entitling the lender to exercise its rights at any time after giving notice to the stock pledgors, but the lender never voted or took any action with respect to the stock. Id.

When the debtor was unable to meet its payroll in December 1999, and the lender refused to loan it any money for that purpose, the borrower shut down its operations and "close[d] its doors." On Dec. 21, 1999, the lender issued a notice of default, stating that the borrower had advised it that it was "ceasing operations." Management then told employees of the closure. Id., at *8-9.

The WARN Act

The WARN Act "requires employers to give sixty days' advance written notice before a plant closing or mass

layoff." Id., at *9, citing 29 U.S.C. § 2102. Moreover, an "employer who orders a plant closing or mass layoff in violation of [the notice requirements of] section 2102" is liable to affected employees for back pay and benefits. 29 U.S.C. § 2104(a). The "dispositive" question, therefore, was whether the lender was an "employer" under the WARN Act. Id.

Limited Liability of a Creditor Under the WARN Act for Borrower's Plant Closing or Mass Layoff

Following the Eighth and Ninth Circuits, the Second Circuit held that liability would be imposed only when the lender's conduct "amounts to the operation of the debtor as an ongoing business." Id., at *16, citing Chauffeurs, Sales Drivers, Warehousemen & Helpers Union Local 572, Int.'l Bhd. of Teamsters, AFL-CIO v. Weslock Corp., 66 F.3d 241, 244 (9th Cir. 1995) ("Test is whether, at time of plant closing, creditor was in fact "responsible for operating the business as a going concern," rather than acting only to "protect [its] security interest" and "preserve the business asset for liquidation or sale."); Adams v. Erwin Weller Co., 87 F.3d 269, 272 (8th Cir. 1996) ("Only when a lender becomes so entangled with its borrower that it has assumed responsibility for the overall management of the borrower's business will the degree of control necessary to support employer responsibility under WARN be achieved.").

Asserted Control of Borrower's Business

The plaintiff employees argued that the lender had unilaterally taken over and become responsible for its borrower's continued operations. Id., at *18. For example, they asserted, the lender had purportedly installed a "caretaker/manager" at the borrower's headquarters. Significantly, however, the plaintiffs acknowledged that the lender's purpose was "to facilitate [the lender's] recovery of $5.6 million" under its loan agreement. Id., at *18-19.

Lender Never Operated Borrower's Business

Analyzing the evidence, the court affirmed the dismissal of the complaint because of the lender's limited role, reasoning as follows:

"[The lender] exerted the control necessary for it to attempt a work-out possibly resulting in the salvage of [the borrower]. '[S]uch a power is inherent in any creditor-debtor relationship and … the existence and exercise of such a power, alone, does not constitute control for the purposes of WARN, just as it does not constitute control in the ordinary alter-ego context.'"

Id., at *19, quoting Krivo Indus. Supply Co. v. Nat'l Distillers & Chem. Corp., 483 F.2d 1098, 1114 (5th Cir. 1973).

In short, the lender only took control of the borrower's business to the extent of protecting its collateral for repayment. Indeed, whatever control the lender exerted may have been substantial, but no more than was necessary for a defrauded lender to salvage a recovery from its collateral. Id.


Joining the Eighth and Ninth Circuits, the court also rejected the Third Circuit's approach to the same problem in Pearson v. Component Tech. Corp., 247 F.3d 471, 493 (3d Cir. 2001), where the court relied on Department of Labor ("DOL") criteria as relevant to whether, for the purposes of imposing WARN Act liability, "independent contractors and subsidiaries are treated as separate employers or as part of the parent or contracting company." Id., at *13.

Under that approach, courts look at "(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." Id., at *13-14, quoting 20 C.F.R. § 639.3(a)(2). See also Vogt v. Greenmarine Holding LLC, 2004 W.L. 187153 (S.D.N.Y. 2004) (held, when adopting Third Circuit's reasoning in Pierce, "the Second Circuit has not addressed this issue …."); Administaff Co. v. UNITE, 337 F.3d 454, 458 (5th Cir. 2003) (following Pearson and applying DOL test for intercorporate WARN Act liability).

Rejecting this approach, however, the Second Circuit found it to be relevant only when disregarding the corporate form of two related firms, but had "little direct bearing on paradigmatic relationships between lenders and borrowers." Id., at *15 (emphasis added).