Rudolph Di Massa

Lawrence Kotler

Catherine Heitzenrater

Whether a claimant is entitled to an administrative expense claim, or simply a prepetition claim, can mean the difference between full ­payment of the claim and the recovery of only pennies on the dollar. Accordingly, a significant amount of litigation in bankruptcy cases centers around the priority status to which certain claims are ­entitled. The U.S. Bankruptcy Court for the Northern District of Illinois has recently issued a decision granting priority status to claimants seeking damages for violation of the Worker Adjustment and Retraining Notification Act (the WARN Act). Given the significant ­liability that debtors could face under the WARN Act, this decision is relevant to all bankruptcy practitioners.

On Feb. 24, in In re World Marketing Chicago, 564 B.R. 587 (Bankr. N.D. Ill. 2017), the U.S. Bankruptcy Court for the Northern District of Illinois addressed an application for allowance of a class of administrative expense claims against three debtors under the WARN Act. The WARN Act claimants were all employees of the debtors who were terminated from their employment on the date on which the ­debtors filed for protection under the Bankruptcy Code. The WARN Act claimants asserted that their claims for damages under the WARN Act were entitled to administrative priority in the bankruptcy cases, but the liquidating trustee acting on behalf of the estates argued in the alternative that either there was no liability under the WARN Act or, to the extent there was such liability, the claims were not entitled to administrative priority.

Facts and Arguments of the Parties

On the same day on which they filed for bankruptcy protection, World Marketing Chicago, World Marketing Dallas and World Marketing Atlanta (collectively, the debtors) terminated a significant number of their employees (the WARN Act claimants) with no notice. The WARN Act claimants asserted that such termination was in violation of the WARN Act, and filed an application for allowance of their claims as a class claim in the debtors' bankruptcy cases, allegedly entitled to administrative priority under 11 U.S.C. Section 503(b)(1)(A)(ii). The trustee of the debtors' liquidating trust (the trustee) opposed the application, ­arguing that the debtors' estates had no WARN Act liability, based upon the "liquidating fiduciary" exception to the WARN Act, and that even if WARN Act liability was established, such liability should not be entitled to administrative priority.

The Court's Analysis

The bankruptcy court first addressed whether claims under the WARN Act for termination of ­employment immediately following the commencement of a Chapter 11 bankruptcy case could be entitled to administrative priority, assuming no exception to the WARN Act is present. The statutory predicate for such administrative priority is 11 U.S.C. Section 503(b)(1)(A)(ii), which provides that: After notice and a hearing, there shall be allowed administrative expenses, ... including—(1)(A)(ii) wages and benefits awarded pursuant to a judicial proceeding ... as back pay attributable to any period of time occurring after the commencement of the case under this title, as a result of a violation of federal or state law by the debtor ... .

The court easily found that the WARN Act claimants had satisfied their burden in demonstrating the existence of all the elements necessary to establish administrative priority under this section of the Bankruptcy Code: WARN Act liability is calculated in terms of "wages and benefits;" any award granted by the bankruptcy court to the WARN Act claimants would be "awarded pursuant to a judicial proceeding;" the WARN Act classifies damages under the statute as "back pay;" WARN Act claims are in the nature of severance and, therefore, "attributable to the period of time occurring after the commencement of the case;" liability would arise directly from federal law—the WARN Act; and given that the debtors had already ceased operations, allowance of the WARN Act claim would not increase the likelihood of the layoff or termination of other employees.

Following precedent from the U.S. Court of Appeals for the Seventh Circuit, the court next turned to whether the WARN Act claim would provide a benefit to the estate as a whole, or just to the WARN Act claimants. Should the claim benefit only the WARN Act claimants, payment of the claim would not satisfy Seventh Circuit precedent for an administrative priority claim. In finding for the WARN Act claimants, however, the court noted that the WARN Act is a statutory form of severance pay, in lieu of notice, which is earned at the moment of termination. WARN Act liability is not earned continuously through employment, but accrues only upon termination without warning. Because the court found that ­severance in lieu of notice is based upon the bargain at the time of termination (i.e., the estate did not have to continue to employ the employees for the statutory notice period)—which, in this case, was postpetition—the court concluded that the estate as a whole was conferred a benefit by not providing the required notice, and that the WARN Act claimants were entitled to priority status under 11 U.S.C. Section 503(b)(1)(A)(ii).

Given the determination that the claims of the WARN Act claimants would ­otherwise be entitled to administrative priority, the court next turned to the validity of the WARN Act claims and the trustee's argument that an exception to the WARN Act applied in this case. The parties did not dispute the fundamental facts alleged by the WARN Act claimants and, indeed, the trustee conceded that WARN Act liability would usually be triggered by such factual circumstances. However, the trustee argued that the "liquidating fiduciary" exception to the WARN Act applied in this case.

The WARN Act contains three text-based statutory exceptions: the "faltering ­company" exception, the "unforeseeable business circumstances" exception, and the "natural disaster" exception. The trustee did not rely on any of these enumerated exceptions, but rather based his argument on the "liquidating fiduciary" exception, which is found in the Department of Labor's commentary on the WARN Act. According to this commentary, a fiduciary whose sole function in a bankruptcy case is to liquidate a company shall not have liability for the company's WARN Act obligations. The trustee argued that he was just such a liquidating fiduciary and, therefore, that the estates should be free of liability for the WARN Act claims.

The court disagreed. The court noted that while Chapter 7 trustees are likely just the type of fiduciary to be entitled to the benefit of the "liquidating fiduciary" exception, a further analysis was required to determine whether Chapter 11 trustees are similarly entitled. The court analyzed two approaches with respect to the application of the "liquidating fiduciary" exception. First, a plain language approach, which is based upon the powers that the fiduciary is entitled to exercise rather than its actions in the case, and second, a "hindsight" ­approach that looks beyond the plain language of the commentary and instead focuses on whether the debtor's actions demonstrate an intent to liquidate from the outset of the case.

While the court disagreed with the hindsight approach employed by other ­bankruptcy courts, the court found that the result would be the same regardless of which approach was used in this case. First, given that a Chapter 11 trustee or debtor-in-possession has powers to operate a business and not just liquidate it, the plain language interpretation of the "liquidating fiduciary" exception would not apply in this case. Second, the court found that the facts of this case did not warrant application of the "liquidating fiduciary" exception even under the "hindsight" approach. The court cited numerous pleadings filed by the debtors in which the debtors indicated their intent to reorganize, and determined that in light of such public representations, the court could not conclude that the debtors' intent was to liquidate from the outset of the cases. Accordingly, the court found that the "liquidating fiduciary" exception did not apply to the trustee, and that the WARN Act claimants were entitled to ­administrative claims against the ­debtors' estates.

Conclusion

The court's decision in this case resulted in approximately $4 million in administrative liability to these liquidating debtors, which was required to be paid in full. Liability for significant administrative ­expense claims can have a substantial impact, not only on debtors, but on all other creditors and parties-in-interest in a bankruptcy case. Accordingly, an awareness of WARN Act obligations, and how a debtor's actions may result in liability to the estate, can be relevant to all parties to a bankruptcy case, and can have a significant impact on the debtor's post-petition obligations as well as on the amount of the distribution ultimately paid to unsecured creditors.

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors' rights. Lawrence J. Kotler, a partner with the firm, practices in the area of reorganization and finance. Catherine B. Heitzenrater is an associate with the firm and practices in the areas of bankruptcy, corporate reorganization, creditors' rights, commercial finance and secured transactions.

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.