A “WARN”ing to Companies in Bankruptcy
 
June 29, 2005
 

It is not uncommon for a company that has filed for bankruptcy to be faced with winding down the company and terminating employment relationships. Bankruptcy trustees and debtors in possession should, however, be aware that when plant closings and mass layoffs are involved, they may need to comply with the Worker Adjustment and Retraining Notification Act (the WARN Act).¹ The WARN Act requires employers to give their employees 60 days’ notice prior to a mass layoff or plant closing. If a company has filed for bankruptcy, the question arises as to whether the bankruptcy trustee or debtor in possession has any notice obligations under the WARN Act. If the answer is in the affirmative and the trustee or debtor in possession has not complied, the bankruptcy estate would be obligated to employees for 60 days of back pay. The question then becomes whether the back pay is given priority status under the United States Bankruptcy Code (the Code). If the back pay is given priority status, the Code would require that the back pay claim be paid prior to general unsecured claims.

This article first examines the criteria for determining whether a bankruptcy trustee or a debtor in possession is classified as an “employer” for purposes of the WARN Act and, if so, examines the ramifications of not providing adequate notice of termination to employees. The article then considers whether a back pay claim pursuant to a WARN Act violation is given priority status, and if so, whether the claim is entitled to a first, or lesser, priority under the Code.

Who Is an Employer for Purposes of the WARN Act?

An employer, for purposes of coverage by the WARN Act, is defined as a “business enterprise that employs – (A) 100 or more employees, excluding part-time employees; or (B) 100 or more employees who in the aggregate work at least 4,000 hours per week (exclusive of hours of overtime).” 29 U.S.C. § 2101(a)(1). An employer’s WARN obligations are triggered by either a “plant closing” or a “mass layoff,” as defined in the WARN Act.

The WARN Act and the Department of Labor’s WARN Regulations define “employer” as a business enterprise, but they do not explicitly address whether a bankrupt company falls within the definition of “employer.” However, the comments to the Department of Labor Regulations state that if a fiduciary’s only purpose is liquidation for the benefit of creditors, the fiduciary is not obligated to give WARN notice. On the other hand, if a fiduciary continues the business operations for the benefit of creditors, the employer would be subject to WARN obligations.

When determining whether a bankrupt entity is an “employer” under the WARN Act, the courts have focused on the nature and extent of the entity’s business and commercial activities while in bankruptcy, and not merely on whether the entity’s employees continue to work on a daily basis. In re United Healthcare System, Inc., 200 F.3d 170, 177 (3d Cir. 1999), cert. denied mem., 530 U.S. 1204, 120 S.Ct. 2199 (2000). If the business is operated to preserve the assets for liquidation or sale, the notice requirement will not apply because the operation of the business is not continued in the normal commercial sense. See Chauffeurs et. al v. Weslock Corp., 66 F.3d 241, 244 (9^th Cir. 1995).

In the leading case addressing these issues, In re United Healthcare, supra, a not-for-profit corporation that provided hospital and health care services could no longer continue operations and meet daily expenses. Therefore, the hospital advised the New Jersey Department of Health that the hospital would close and surrendered its certificates of need, which prevented the hospital from providing further medical services. On that same day, the hospital filed a voluntary bankruptcy petition and issued a WARN notice to its employees. Thereafter, the hospital’s employees were no longer engaged in their regular duties but, instead, were performing tasks solely designed to prepare United Healthcare for liquidation. The employees continued to perform these tasks for approximately two more weeks at which point the hospital informed 1,200 of its 1,300 employees that they were no longer to report to work. The Third Circuit found that United Healthcare, as a fiduciary in bankruptcy, was operating as a business liquidating its affairs and not as a business operating as a going concern, and therefore, WARN liability did not attach. If the appellate court had found that the WARN Act applied, United Healthcare would have been required to give the employees 60 days notice prior to their termination, and if such notice had not been given, the employees would have been entitled to 60 days of back pay.

The Department of Labor Regulations and the In re United Healthcare decision indicate that if a bankruptcy trustee or a debtor in possession is in the process of liquidating a company in bankruptcy, a court will be more likely to find that the WARN notice requirement does not apply. However, if the bankruptcy trustee or debtor in possession are carrying on the business as a going concern for the benefit of the creditors, the company is more likely to be considered an “employer” and the WARN notice requirement would apply.

Is Back Pay Entitled to Priority Status?

If a company in bankruptcy is determined to be an “employer” under the WARN Act, the debtor is required to give its employees 60 days notice prior to any termination of employment. If the company fails to provide such notice, the debtor is liable for up to 60 days of back pay for each employee. 29 U.S.C. § 2104(a). In bankruptcy, the question then becomes whether the back pay claim is entitled to priority status.

Under the Code, certain types of claims are given priority status, i.e., they are paid by the bankruptcy estate prior to general unsecured claims. Priority is first given for claims and expenses incurred during the administration of the bankruptcy case. This priority is granted pursuant to section 507(a)(1) of the Code, and, pursuant to section 503(b) of the Code, priority claims include administrative expenses for wages earned after the filing of the bankruptcy case. Pursuant to section 507(a)(3) of the Code, there is also a third priority status afforded to wages, salaries and commissions earned within 90 days before the date of the filing of the bankruptcy petition or the date of the cessation of the debtor’s business, whichever occurs first. However, this third priority status is capped at $4,650, i.e., the creditor is not entitled to priority status for wages in excess of $4,650.² If the employee’s wage claim is greater than that allowed as a priority claim under section 507(a)(3) of the Code, the balance of the employee’s claim is a general unsecured claim. In re Kitty Hawk, Inc., 255 B.R. 428, 438 (Bankr. N.D. Texas 2000).

Any “back pay” to which an employee is entitled under the WARN Act, is considered “wages” under the Code and, therefore, may be entitled to either a first or third priority status. Whether the employee will receive priority status for the back pay claim will depend on whether the back pay satisfies the statutory requirements of the Code provisions that award priority status. In re Sher-Del Foods, Inc., 186 B.R. 358, 361 (Bankr. W.D. N.Y. 1995).

Back pay wages are considered earned upon the termination of employment. In re Kitty Hawk, 255 B.R. at 438; In re Cargo, Inc. 138 B.R. 923, 928 (Bankr. N.D. Iowa 1992). As such, whether the back pay is entitled to third priority status under section 507(a)(3) depends on whether the employee was terminated within the applicable time period (either 90 days with respect to bankruptcy cases pending on April 20, 2005, or 180 days with respect to bankruptcy cases commenced on or after such date). For example, in Sher-Del Foods, the bankruptcy court held that the employees were entitled to priority status under section 507(a)(3) for WARN back pay because the claim was earned within the 90 days before the date of the filing of the petition. In re Sher-Del Foods, 186 B.R. at 362-63.

For bankruptcy cases commenced on or after April 20, 2005, section 507(a)(3) entitles the employee to third priority status for back pay claims up to $10,000. If the employee wants priority status for back pay in excess of $10,000, the employee must seek priority status as an administrative claim under sections 507(a)(1) and 503(b) of the Code. The timing of the petition date and the date of the claim is important in determining whether the employee is entitled to priority status thereunder because the claim is only classified as a first-priority administrative expense claim if the claim is incurred after the bankruptcy petition date.

In In re Kitty Hawk, the bankruptcy court held that employees entitled to back pay under the WARN Act were not entitled to priority status under section 503(b) because the employees did not provide services to the debtor after the commencement of the bankruptcy case. In In re Kitty Hawk, the employees were terminated on April 29 and 30, 2000, and the debtor company filed chapter 11 only one day later, on May 1, 2000. In contrast, when a company filed its petition for bankruptcy on March 25, 1997, and did not terminate its employees until July 3, 1997, the bankruptcy court held that the union’s claim to back pay under section 503(b) was entitled to priority status because the claim was earned as a result of post-petition events that occurred as part of the administration of the bankruptcy estate. In re Beverage Enterprises, Inc., 225 B.R. 111, 116 (Bankr. E.D. Penn. 1998). In short, in order for a creditor to receive priority status for back pay as a first-priority administrative claim under sections 507(a)(1) and 503(b) of the Code, the back pay must have been earned, i.e., the employee must have been terminated, after the bankruptcy petition date. Finally, in the event employees are terminated on the bankruptcy filing date, any severance pay would likely be treated as prepetition and would, therefore, not be entitled to a first priority status as an administrative expense claim. In re Sher-Del Foods, 186 B.R. at 362.

Conclusion

A company in bankruptcy may be subject to the 60-day WARN Act notice requirement depending on whether the company is considered an “employer.” When analyzing whether to give WARN Act notice, the debtor in possession or the bankruptcy trustee should look to whether the goal is liquidation of the company or continued operation. A fiduciary of a bankrupt company in the process of liquidation is most likely not considered an “employer” under the Act and, therefore, is not obligated to give employees a 60-day notice before a mass layoff or plant closing. In contrast, if a company continues the operation of the business for the benefit of creditors, the company may be considered an employer obligated to give WARN notice.

If a bankruptcy trustee or debtor in possession is required to give a WARN Act notice prior to a mass layoff and fails to do so, the affected employees may be entitled to 60 days of back pay, which claim is given priority status if the terms of the Code are satisfied. If the employees receive priority status for their claims to back pay, the employees’ claims are entitled to be paid prior to general unsecured claims. Accordingly, whether or not a WARN Act notice is required and given plays a role in the ultimate payout to all creditors of a company in bankruptcy, and the WARN Act is something that fiduciaries should be cognizant of when they determine how to proceed with the administration of the bankruptcy estate.

For more information, e-mail Richard Lear at richard.lear@hklaw.com, or call toll free, 1-888-688-8500.

¹ Certain states have similar laws that may also be relevant, however, this article only addresses the federal WARN Act.

² On April 20, 2005, the Bankruptcy Abuse and Consumer Protection Act of 2005 became law. Consequently, with respect to any bankruptcy case commenced on or after that date, the section 507(a)(3) administrative priority cap has been increased to $10,000 per employee, and the applicable time period has been increased from 90 days to 180 days.

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