David J. Woolf, Author at Laborsphere

WARN Act Liability And Private Equity Firms

Last month’s decision out of the Delaware District Court in Woolery, et al. v. Matlin Patterson Global Advisers, LLC, et al. was an eye opener for private equity firms and other entities owning a controlling stake in a faltering business. Breaking from the norm, the Court refused to dismiss private equity firm MatlinPatterson Global Advisers, LLC (“MatlinPatterson”) and affiliated entities from a class action WARN Act suit alleging that the 400-plus employees of Premium Protein Products, LLC (“Premium”), a Nebraska-based meat processer and MatlinPatterson portfolio company, hadn’t received the statutorily-mandated 60 days advance notice of layoffs.

According to the plaintiffs, Premium’s performance began to decline in 2008 and, upon the downturn, the defendants became more and more involved in Premium’s day-to-day operations, including by making business strategy decisions (e.g., to enter the kosher food market), terminating Premium’s existing President, and installing a new company President. Things got bad enough that, in June 2009, the defendants decided to “furlough” all of Premium’s employees with virtually no notice and close the plant. The defendants then, in November 2009, converted the furlough to layoffs, and Premium filed for bankruptcy. According to the plaintiffs, Premium’s head of HR raised WARN Act concerns back in June, when the decision to close the plant and furlough the employees was made, and the defendants ignored the issue.

With Premium in bankruptcy, the plaintiffs, unsurprisingly, turned to MatlinPatterson and the other defendants as the targets of their WARN Act claim, asserting that they and Premium were a “single employer.” The Court then applied the Department of Labor’s five-factor balancing test, 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 did so in Woolery too, with the Court finding that the plaintiffs had made no showing as to three of the five factors. The Court nevertheless refused to grant the defendants’ motion to dismiss, holding that the complaint alleged that the defendants had exercised de facto control over Premium and then essentially giving that factor determinative weight.

No one should be surprised by the decision given the plaintiffs’ allegations, which had to be accepted as true at the motion to dismiss stage. They presented an ugly picture of a private equity firm dictating the most critical decisions (to close plant, layoff employees) and then attempting to duck the WARN Act’s dictates. The decision is nevertheless a cautionary tale for private equity firms and at first blush it presents a catch 22: (a) do nothing and watch your investment sink or (b) get 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’s 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 execute employment 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
Allow the employer to maintain its own personnel policies and practices, as well as HR oversight and function

What the courts are primarily concerned with in these cases are (a) a high degree of integration between the private equity firm or lender and the actual employer, particularly as 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, and should continue to have, success in avoiding WARN Act liability and returning the focus of the WARN Act discussion to the actual employer.

Former Executive’s Race to California Hits a Roadblock in New York

Like many things in life, there is a perceived formula for success in non-compete cases: If you are the former employee or his or her new or would-be new employer, conventional wisdom dictates that you identify the restrictions early and consider filing a preemptive declaratory judgment action in a state that is hostile to such agreements (provided the facts permit). California is the most well-known example, but there are others. The plan works best if the former employee lives in California (or similarly hostile state) or has other significant connections by virtue of his past or intended future employment. But now, a New York appellate court has thrown conventional wisdom a curve.

Michael Cusack and Peter Arkley were former Aon executives. They left Aon on June 13, 2011 to pursue lucrative opportunities with a competitor, Alliant Insurance Services. The same day, 38 other Aon employees also left, and 22 more followed shortly thereafter. Aon’s clients came too, with over $20 million in client revenue allegedly flowing from Aon to Alliant.

Arkley and Cusak, along with Alliant, following the familiar formula, filed for a declaratory judgment to invalidate their restrictive covenant agreements in California federal court on the same day they resigned. Arkley’s chances of success in California seemed particularly good because, although his employment agreement was governed by Illinois law, he both lived and worked in California, and he planned to continue to do so with Alliant.

Aon responded by filing suits in Illinois and New York state courts, and found success in New York in particular. The New York trial judge, undeterred by the action in California and Arkley’s California connections, enjoined him soliciting business from, and entering into any business relationship with, any of Aon’s clients whom he either procured or whose accounts he worked on in the 24 months prior to his departure. She also enjoined him from soliciting any Aon employees to work for Alliant.

In January, a New York appellate court affirmed. The court rejected Arkley’s calls to defer to the first-filed California action, calling it “a preemptive measure undertaken to gain a tactical advantage so as to negate the force and effect of the restrictive covenants, which the parties had freely agreed upon.” The New York court seized upon the fact that the parties’ agreement had selected Illinois law to govern and held that Illinois law provided for enforcement.

Although the outcome was arguably an unusual one insofar as a New York court entered an injunction against someone who lived and worked in California and intended to do so in his new employment, so too were the facts involved, on many levels. First, the conduct at issue was particularly egregious in that it involved, among other things, former employees allegedly taking the equivalent of hundreds of thousands of printed pages of documents, including highly-sensitive documents; a coordinated departure strategy that included filing a declaratory judgment action in California within an hour of the key executives’ resignations; a mass exodus of both employees and clients; and alleged violations of an earlier-issued temporary restraining order. Second, the executives involved were high-level employees, who received seven-figure compensation from Aon, at least in part in consideration of the very restrictions they sought to avoid. Third, the restrictive covenants at issue were not blanket non-competes, but rather restricted the executives from disclosing confidential information, from calling on the customers that they serviced for Aon, and from soliciting other Aon employees for employment. In different circumstances, involving lower-level employees, who are alleged to have engaged in less egregious conduct and/or who are subject to broader restrictive covenants, the former employer may not fare as well.

Still, the takeaways are unmistakable. First, choice of law is critical, and an employer loses a tactical advantage when it fails to select a state law that, if not favorable to it, at least gives it a fair shot. Second, living and working in California is not the end all be all, and racing into a California court does not guarantee the former employee and his new employer freedom from the employee’s post-separation obligations. Solid facts and a solid agreement, presented in a jurisdiction that follows a more traditional approach to restrictive covenants, can still result in success for the former employer.

Georgia’s Pro-Employee Restrictive Covenant Law Is Back (If Only Briefly)

Just when it seemed safe for companies with employees in Georgia to try to enforce their restrictive covenant agreements, the Eleventh Circuit has brought back to life – if only for one last hurrah – the old Georgia law that made non-competition and other restrictive covenant agreements virtually impossible to enforce. The Court did so in Becham, et al. v. Synthes USA, et al., No. 11-14495, 2012 U.S. App. LEXIS 11225 (11th Cir. June 4, 2012), by holding that Georgia’s first attempt to re-write the State’s non-competition law was unconstitutional and that the second attempt did not apply to the agreement at issue.

The backdrop, well known to those who practice in Georgia, is a frustrating one for employers who have attempted to enforce restrictive covenant agreements. For years, Georgia statutory and constitutional law disfavored non-competition and other restrictive covenants and, through a very narrow view of what is reasonable and a refusal to reform overly broad agreements, made them nearly impossible to enforce. This changed beginning in 2009 when the Georgia legislature approved a law allowing the enforcement of previously unenforceable covenants, by, among other things, creating presumptively reasonable time periods for restrictions, removing the requirement of an expiration date for certain confidentiality covenants, and, perhaps most importantly, giving Georgia courts the ability to reform overly broad agreements. The law was subject to a constitutional amendment permitting the change, which occurred on November 2, 2010 through Georgia’s citizens’ ratification of the amendment.

The confusion then began. The new law went into effect on November 3, 2010, the day after the constitutional amendment was ratified. The constitutional amendment, however, did not take effect until January 1, 2011. Fortunately, the Georgia General Assembly recognized the gap and passed a second law that repealed the first law and authorized a second, virtually identical law effective May 11, 2011. Problem solved, right?

Not so fast. Unfortunately for Synthes, the restrictive covenants at issue were reaffirmed on December 1, 2010, after the effective date of the first law, but before the effective date of the second law. The Eleventh Circuit thus focused on the first law and held that, because the law was implemented before the constitutional amendment went into effect, it “was unconstitutional and void the moment it went into effect.” The Court then went back to “old” Georgia law, and like so many agreements before it, found Mr. Becham’s restrictive covenant agreement unenforceable.

Although the result was an unfortunate one for Synthes, the impact can be managed going forward by making note of the critical May 11, 2011 date. Restrictive covenant agreements entered into on or after May 11, 2011 will be subject to the second new law, and hence subject to more favorable court review. Agreements entered into prior to that date, even if after the November 2, 2010 constitutional amendment, will be judged under “old,” pro-employee Georgia law. Employers of Georgia employees will therefore want to make sure that their restrictive covenant agreements are effective on or after May 11, 2011 and, where they are not, arrange for the execution of new agreements.