By Eric Chafetz, Esq. & Michael Papandrea, Esq.

Lowenstein Sandler LLP[i] 

• Introduction
   A recent decision by the Third Circuit Court of Appeals (the “Third Circuit” or the “Court”) may have a lasting impact on financially distressed companies selling themselves in bankruptcy and the rights of their employees.  In the In re AE Liquidation, Inc.decision, the Court ruled that the Debtor did not violate the Worker Adjustment and Retraining Notification (“WARN”) Act—which generally requires employers to provide 60-days’ notice of a mass layoff—when it waited until the day on which its proposed going concern sale fell through to notify employees that the company would shut down immediately.  In so ruling, the Court established that the test to determine whether notice is required under the WARN Act is if the mass layoff is probable, or, “more likely than not” to occur, rather than merely possible.

Given that the Third Circuit’s decisions are binding on the country’s most active district for large chapter 11 filings (the District of Delaware), this decision is important for all companies.  However, as the standard is both vague and flexible, it raises questions as to how exactlyit will affect distressed companies in the future. Does the AE Liquidation decision blur the line as to when an insolvent company needs to provide notice, such that any company whose bankruptcy sale falls through need not give notice to its employees of a potential closure? Or, is the AE Liquidation decision merely the result of an exceptionally unique set of facts such that, as a practical matter, it will have little impact on many cases going forward?

• Background of theAE Liquidation Decision
  There are not many bankruptcy decisions that involve the Russian government or, for that matter, Vladimir Putin himself.  However, the AE Liquidation decision involves both.  In AE Liquidation, the bankruptcy court approved the Debtor’s sale of its business as a going concern to their largest shareholder, European Technology and Investment Research Center (the “ETIRC”).  The transaction, which the Debtor knew was its only hope of continuing to operate, was to be financed by a state-owned Russian bank, Vnesheconomban (“VEB”).  However, after the sale was approved, VEB began experiencing financial difficulties and needed to be recapitalized by the Russian government.  This required the personal approval of Mr. Putin, which caused considerable delays.

Despite these delays, two of the Debtor’s board members, who were in direct communication with Russian government officials and who were also affiliated with ETIRC, consistently reassured the rest of the Debtor’s board (including the Debtor’s independent directors) that any issues with the financing would be resolved by February 24, 2009.  The reassurances were based on representations made to the board members by VEB and, allegedly, Russian government officials.  After what the Third Circuit referred to as a “roller coaster ride of promises and assurances that never came to fruition,” the Debtor’s financing was not approved.  As a result, on February 24, 2009, the Debtor sought to convert its chapter 11 case to a chapter 7 liquidation, ceased operations, and notified the employees they would be terminated immediately.

A class of former employees sued the Debtor, alleging violations of the WARN Act’s requirement that 60 days-notice be given where there is a mass layoff or closing, and shortly thereafter moved for summary judgment. In response, the Debtor asserted that, due to the aforementioned “roller coaster ride,” it was entitled to rely on the “unforeseeable business circumstances” defense to the WARN Act’s 60-day notice requirement.  Both the bankruptcy court and district court agreed with the Debtor, and the employees appealed the decision to the Third Circuit.

The Third Circuit determined that in order to successfully invoke the “unforeseeable business circumstances” defense, the employer must show that: (1) the business circumstances causing the layoff were not reasonably foreseeable, and (2) those circumstances caused the layoff.  While it was obvious that the Debtor’s lack of financing for the sale caused the mass layoff, the Court questioned whether the mass layoff was “reasonably foreseeable.”

In applying the “reasonably foreseeable” standard, the Court rejected the employees’ argument that the WARN Act’s notice requirement is triggered when the mass termination is “merely possible.”[ii]  Rather, the Third Circuit concluded that the notice obligations are triggered where, at the time notice was required, objective facts reflect that it was probable (or, “more likely than not”), that the mass layoff would occur.[iii]

The Third Circuit then applied the probability standard, reviewing various different points in time and assessing whether, at any of those times, it was more likely than not that VEB’s funding would fall through and the Debtors would need to cease operations and terminate their employees.  Ultimately, the Court decided that, given the constant oral reassurances by the Debtor’s board members, “and taking account of the historical relationship between the companies, it was commercially reasonable for [the Debtors] to believe that the sale was still at least as likely to close as to fall through before February 24th, so that no WARN Act notice was required prior to that time.”

III.           AE Liquidation’s Impact on Bankruptcy Sales

 While it is impossible to predict how future courts will apply the AE Liquidation decision —especially because of the unique facts involved —it appears that, going forward, chapter 11 debtors engaged in a bankruptcy sale process may be able to avoid providing their employees with 60 days’ notice as required by the WARN Act.  As the Court noted, there is a presumption that a going-concern sale involves the hiring of the seller’s employees.  In fact, the Court explained that this presumption holds true even when the asset purchase agreement contains boilerplate language that the buyer may, but is not required to, offer employment to any or all employees.  Accordingly, the Court held it was impossible to conclude that it was probable that the Debtor would shutter its doors at the 60-day mark when WARN Act notice would have been due, because at that time, the Debtor was preparing to sell its business as a going-concern through a bankruptcy court-approved sale process with a stalking horse purchaser.

Many recent chapter 11 cases involve this type of sale process, where a debtor enters bankruptcy with an initial bidder lined up (commonly referred to as a “stalking horse purchaser”), seeks the bankruptcy court’s approval of bidding procedures and an auction process, and subjects the stalking horse’s bid to higher and better offers.  Thus, even if there are no alternative bidders, there will still ultimately be a buyer.  This was the case in AE Liquidation, where ETIRC was the stalking horse.  Thus, the decision could be construed as a de facto determination that a chapter 11 debtor selling its assets is absolved from any WARN Act liability, because at no point during the sale process is it “more likely than not” that the debtor’s employees will be laid off.

In fact, this arguably was the Third Circuit’s intent.  The Court was very cognizant of unintended consequences and how requiring premature WARN Act notice could cause trade creditors and lenders to refuse to conduct business with a debtor or cause employees to leave their jobs, ultimately increasing the chance of hurting the very people the WARN Act seeks to protect.  The Court explained, “if reasonable foreseeability meant something less than a probability, nearly every company in bankruptcy, or even considering bankruptcy, would be well advised to send a WARN notice, in view of the potential for liquidation of any insolvent entity.”  The court implicitly realized that this was a very slippery slope and an unacceptable result.

                However, an argument can also be made that the practical effect of the decision may be limited.  In AE Liquidation, the lender seemingly did not show signs of distress until after the sale was approved.  Had the lender’s financial wherewithal been in question prior to the sale’s approval, it is possible the Court would have concluded that the mass layoff was more probable than not prior to February 24, 2009.  Also, it is rare, and possibly unprecedented, for a bankruptcy sale to hinge upon the approval of a foreign prime minister and be predicated upon alleged reassurances made by representatives of a foreign government directly to the Debtor’s directors.  Accordingly, the unique facts of AE Liquidation may affect how future courts apply this decision.

• Conclusion

The AE Liquidation decision could have a lasting impact on when and whether a WARN Act notice must be provided by a distressed company.  By adopting the “more likely than not” standard and implying that it is improbable that a debtor involved in a chapter 11 sale process would suddenly close its business, the Third Circuit may have insulated distressed companies engaged in a bankruptcy sale from WARN Act liability.  That said, the probability standard employed by the Third Circuit is very fact-specific and highly unpredictable.  While future courts will likely never draw a clear line as to when WARN Act notice must be provided due to the fact the intensive nature of the analysis, the Court’s debtor-friendly decision should benefit insolvent companies.  However, until there is a reported bankruptcy court decision which cites or relies upon AE Liquidation, the impact of the Court’s decision will remain uncertain.

[i]Eric Chafetz, Esq. is counsel and Michael Papandrea, Esq. is an associate with Lowenstein Sandler LLP’s Bankruptcy, Financial Reorganization & Creditors’ Rights Department.  The views expressed herein are those only of the authors and are not necessarily shared by the firm or any attorney at the firm.

[ii] The employees argued that notice should be required where a mass layoff is possible even if the layoff was not more likely than other possible outcomes.  The employees also argued that where two outcomes are equally possible, the exception should not apply because the possibility that a mass layoff would not occur is not more likely than the possibility that it would.

[iii] In adopting this standard, the Third Circuit joined the five other Circuit Courts of Appeals, the Fifth, Sixth, Seventh, Eighth and Tenth Circuits, that have addressed this issue and applied the probability standard.