A recent Delaware court ruling was an eye-opener for private equity firms and other entities owning controlling stakes in faltering businesses.  Breaking from the norm, the Delaware District Court inWoolery v. Matlin Patterson Global Advisers, LLC refused to dismiss private equity firm MatlinPatterson Global Advisers, LLC (MatlinPatterson) and affiliated entities from a class action lawsuit brought under the WARN Act alleging that the 400-plus employees of Premium Protein Products, LLC (Premium), a Nebraska-based meat processer and MatlinPatterson portfolio company, had not received the statutorily mandated 60 days advance notice of layoffs.

According to the plaintiffs, when Premium’s performance began to decline in 2008, the defendants became more involved in Premium’s day-to-day operations. The defendants made key business strategy decisions (e.g., the decision to enter the kosher food market) and terminated Premium’s existing President and installed a new President.  In June 2009, the defendants decided to “furlough” all of Premium’s employees virtually without notice and close the plant.  In November 2009, the defendants converted the furlough to layoffs, and Premium filed for bankruptcy.  According to the plaintiffs, Premium’s head of human resources raised WARN Act concerns in June, when the defendants decided to close the plant and furlough the employees, but the defendants ignored the issue. 

With Premium in bankruptcy, the plaintiffs named MatlinPatterson and the other defendants as the targets of their WARN Act claim, asserting that they and Premium were a “single employer.”  The Court applied the Department of Labor’s five-factor balancing test to determine whether the defendants and Premium constituted a single employer, namely: (1) whether the entities share common ownership; (2) whether the entities share common directors or officers; (3) the existence of de facto exercise of control by the parent over the subsidiary; (4) the existence of a unity of personnel policies emanating from a common source; and (5) the dependency of operations between the two entities.  This test often favors private equity firms and, on balance, it appeared to favor the defendants in this case.  The Court found that the plaintiffs had made no showing as to three of the five factors.  Nevertheless, the Court decided not to grant the defendants’ motion to dismiss.  The Court held that the complaint alleged that the defendants had exercised de facto control over Premium and it gave that factor determinative weight in rendering its decision.

In determining whether to grant a motion to dismiss, a court must accept all plaintiff allegations as true. Given the severity of the plaintiffs’ allegations in Woolery, the Court’s decision did not come as a total surprise.  The allegations presented an ugly picture of a private equity firm making some of the most critical decisions on behalf of the company (to close the plant and lay off employees) without regard for the WARN Act’s notice requirements.  The Court’s application of the five-factor balancing test is nevertheless a cautionary tale for private equity firms facing similar predicaments and presents a potential conundrum: do nothing and watch your investment sink or become actively involved and risk WARN Act liability.

So what is a private equity firm, lender or majority investor to do?  Obviously, the best scenario is to build in the required 60-day notice period or, if applicable, utilize WARN Act exceptions, including the “faltering company” and “unforeseen business circumstances” exceptions.  Even where that is not possible, private equity firms and other controlling investors need not take a completely hands-off approach.  They would, however, be best-served (at least for WARN Act purposes) to do the following:

• Provide only customary board-level oversight and allow the employer’s officers and management team to run the employer’s day-to-day operations;

• Although Board oversight and input can occur, continue to work through the management team on major decisions, including layoffs and potential facility closures;

• Avoid placing private equity firm or lender employees or representatives on the employer’s management team;

• Have the employer’s management team and retained advisors execute contracts with the employer, not the private equity firm or lender, and have the contracts, for the most part, create obligations only to the employer; and

• Allow the employer to maintain its own personnel policies and practices, as well as Human Resources oversight and function

In these cases, the courts are primarily concerned with (a) a high degree of integration between the private equity firm or lender and the actual employer, particularly with respect to day-to-day operations, and (b) who the decision-maker was with regard to the employment practice giving rise to the litigation (typically the layoff or plant closure decision).  Private equity firms and lenders that have refrained from this level of integration have had success in avoiding WARN Act liability and returning the focus of the WARN Act discussion to the actual employer.  Indeed, just two weeks after the Woolery case, the District of Delaware Bankruptcy Court, in In Re Jevic Holding Corp.,granted summary judgment for Sun Capital Partners, Inc. and its affiliates, even though Sun Capital was providing some level of oversight over the employer and Sun Capital’s refusal to provide an additional investment arguably triggered the bankruptcy filing and layoffs at issue.  The Court so ruled because, overall, Sun Capital was not exercising de facto control over the employer and, most critically, was not involved in the decisions to terminate employees or shut down facilities.  We expect that this trend will continue and that Woolery, although an important cautionary tale, should not create an issue for the prepared lender or equity firm.