Governance structures utilized by private equity funds continue to be examined by the courts when the investment fails and the acquired company files for bankruptcy. We previously reported how a court analyzed PE fund structures in the context of federal statutory pension withdrawal liability. Today we turn to Guippone v. BH S&B Holdings LLC, No. 12-183-cv (Dec. 10, 2013), where the U.S. Court of Appeals for the Second Circuit held that the parent holding company established by investment funds can be held liable under the Worker Adjustment and Retraining Notification Act (WARN Act) if it directs the employment practice that forms the basis for liability of its subsidiary.

Steve & Barry’s Owner and Its Owner’s Owner

According to the opinion, the plaintiffs, Michael Guippone, individually and on behalf of all other similarly situated employees, were employed by Steve & Barry’s, a chain of retail apparel stores (S&B). The stores and inventory were purchased in bankruptcy in August 2008 by two investment firms, Bay Harbour Management LC and York Capital Management LP, and certain of their respective affiliates. According to the opinion, Bay Harbour and York created a series of interrelated entities to purchase and manage S&B, including BH S&B Holdings LLC, the owner of the Steve & Barry’s stores and other purchased assets, and BHY S&B HoldCo LLC, Holdings’ sole managing member. The opinion states the asset purchase was accomplished using $70 million from Bay Harbour and York, plus an additional $125 million loan from Ableco Finance LLC.

S&B’s life outside of bankruptcy was short-lived. In mid-October 2008, S&B defaulted under the Ableco loan, and Ableco swept roughly $30 million from Holdings’ account. By the end of October, HoldCo board members and members of Bay Harbour and York were formulating a liquidation plan. In early November, RAS Management Advisors replaced certain of Holdings’ senior officers to manage a wind-down. Holdings filed for bankruptcy Nov. 19, 2008.

The opinion notes that Holdings did not have a board of directors of its own, and HoldCo decided to remove certain of Holdings’ senior managers and install RAS Management as chief restructuring officer. The HoldCo board hired a member of an accounting firm to act as Holdings’ chief financial officer. A HoldCo board member (and member of Bay Harbour) served as Holdings’ assistant secretary, and the HoldCo board discussed Holdings’ retention of bankruptcy counsel, worker layoffs, and delivery of notices under the WARN Act. On Nov. 10, 2008, at the request of RAS Management, the HoldCo board passed a resolution “authorizing” Holdings to effectuate a reduction in force. Holdings began issuing WARN Act notices Nov. 17, two days before its bankruptcy filing.

Single-Employer Liability Under the WARN Act

Under the WARN Act, liability is imposed upon “any employer who orders a plant closing or mass layoff in violation of Section 2102 of this title.” Section 2102 requires employers to give employees 60 calendar days’ notice in advance of plant closings and mass layoffs. Employers who fail to comply with the WARN Act’s notice provisions are liable to affected employees for up to 60 days of pay and benefits unless excused under the statute.

Holdings owned the S&B stores and was the plaintiffs’ employer. However, the plaintiffs also named HoldCo and the Bay Harbour and York entities as defendants. Department of Labor regulations permit a court to treat a parent company and its partially or wholly owned subsidiary as a single employer depending on the subsidiary’s degree of independence from the parent. The factors considered in making that determination are (1) common ownership, (2) common directors and/or officers, (3) de facto exercise of control, (4) unity of personnel policies emanating from a common source, and (5) the dependence of operations.

The District Court Dismissed the Defendants

The defendants filed two motions to dismiss the complaint, one for Bay Harbour and York and the other for HoldCo. The district court granted Bay Harbour and York’s motion to dismiss, but denied HoldCo’s. After discovery, HoldCo and the plaintiffs each filed motions for summary judgment.

The district court applied the Department of Labor factors, and held HoldCo and Holdings were not a “single employer” for purposes of WARN Act liability. The district court found that while the two entities shared common ownership and directors/officers, those factors should carry less weight. The district court reasoned that “control” in the context of WARN Act liability is only appropriate when “a parent disregards corporate form and actually makes a decision giving rise to a WARN claim at issue.” Here, according to the district court, the reduction-in-force decision was made by RAS Management and Holdings, not HoldCo, and HoldCo merely authorized the layoffs. With respect to the fourth and fifth factors, the district court concluded that HoldCo and Holdings did not share a unity of personnel policies or interdependence of operations, and ruled HoldCo was merely the owner and member of Holdings, and did not direct the termination of Holdings’ employees. The district court denied the plaintiffs’ motion for summary judgment and granted HoldCo’s motion. The plaintiffs appealed.

Second Circuit Reversed with Respect to HoldCo

After reviewing the factual record and provisions of the WARN Act, the court discussed the appropriate test to measure “single employer” status. The opinion notes the test of whether a parent or affiliated entity can be considered a single employer under the WARN Act had not been addressed by the Second Circuit. The court rejected use of the test applied to creditors that examines whether the creditor was responsible for operating the business rather than protecting its security interest and preserving the value of the business for liquidation or sale, and limited the applicability of that test to creditors. Instead, the court adopted the “non-exclusive” Department of Labor five-factor test used by the district court. The court observed no single factor should control, and all five factors need not be established for liability.

Applying the Department of Labor test, the court affirmed the district court’s decision with respect to Bay Harbour and York for the reasons set forth by the district court. As to HoldCo, the court found the record raised a question as to whether HoldCo exercised de facto control over Holdings. Quoting from the Third Circuit’s decision in Pearson v. Component Technology, 247 F.3d 471 (2001), the court wrote: “The de facto control factor ‘is not intended to support liability based on a parent’s exercise of control pursuant to the ordinary incidents of stock ownership. … The factor is appropriately utilized, however, if the parent … was the decision-maker responsible for the employment practice giving rise to the litigation. … Thus, the “de facto exercise of control” prong allows the fact-finder to consider whether the parent has specifically directed the allegedly illegal employment practice that forms the basis for the litigation.’”

The court noted that in this case, the plaintiffs presented evidence that Holdings’ assistant secretary did not know the difference between HoldCo and Holdings, Holdings lacked its own board, and HoldCo’s board chose Holdings’ management and negotiated Holdings’ financing. The court concluded the evidence raised a question of fact as to whether HoldCo in fact “made the decisions leading to the alleged illegal employment practice.”

The court also held the district court wrongly concluded as a matter of law that HoldCo did not make the termination decision because it was acting on the recommendation of RAS Management, but merely had occurred after a presentation by RAS Management. The opinion states, “Authorizing layoffs is not just a prerogative of ownership—it’s a function of being an employer, especially where, as here, HoldCo was the sole member and manager of Holdings, and the HoldCo board operated as Holdings’ board.”

Private Equity Beware

In a prior column, we reviewed Sun Capital Partners III LP v. New England Teamsters and Trucking Industry Pension Fund, No. 12-2312 (1st Cir. 2013), where the First Circuit found private equity funds could be subject to pension withdrawal liability under the “investment plus” standard. Here, a court has ruled that employer liability may be expanded to include holding corporate entities commonly utilized by private equity investment firms to effectuate, acquire and manage portfolio companies. This decision is another reminder that investment companies should not ignore the consequences of deciding how much control they exercise over portfolio companies.

Disallowance of Purchased Bankruptcy Claims Affirmed

In a 2012 column, we discussed U.S. Bankruptcy Judge Kevin J. Carey of the District of Delaware’s decision in In re KB Toys, 470 B.R. 331(Bankr. D. Del. 2012). Carey held the purchaser of a claim from a claimant that received a preference prior to the bankruptcy filing would be disallowed because the original claimant failed to return the preference payment to the estate. In rendering its decision, the bankruptcy court did not adopt a contrary ruling issued by the U.S. District Court for the Southern District of New York in Enron v. Springfield Associates (In re Enron), 379 B.R. 425, 434 (S.D.N.Y. 2007), which held that Section 502(d) only applied to the original claimant, not a subsequent purchaser who buys the claim. Carey’s decision was later affirmed by the U.S. District Court for the District of Delaware, and the claimants appealed to the Third Circuit.

In a decision issued Nov. 15, 2013, the Third Circuit affirmed the decisions of the lower courts. The Third Circuit adopted the bankruptcy court’s view that Section 502(d) analyses should be on the claim, not the claimant. As such, claims that are disallowed under Section 502(d) should be disallowed regardless of the holder. In reaching its conclusion, the Third Circuit disagreed with the Enron court. The Enron court reasoned that the language of Section 502(d) focused on the identity of the claimant, not the claim, and disallowance is a personal disability of a claimant, not an attribute of the claim.

Until this issue is resolved, claims purchasers should take notice that the law is unsettled on this issue.

Andrew C. Kassner is the chair of the corporate restructuring practice group of Drinker Biddle & Reath, practicing in the firm’s Philadelphia and Wilmington, Del., offices. He can be reached at or 215-988-2554.

Joseph N. Argentina Jr. is an associate in the firm’s corporate restructuring practice group in the Philadelphia and Wilmington offices. He can be reached at or 215-988-2541.