WARN Act Claims Can Create Potential Lender Liability Exposure
- The financial impact caused by the COVID-19 pandemic has left many businesses with little choice but to lay off significant numbers of employees. Financial institutions that had previously extended credit to impacted businesses are often faced with a need to exercise one or more remedies as the related credit defaults put at risk their ability to collect payments and protect collateral securing the related obligations.
- Two recent cases in New York, although they involved businesses that were in distress before the arrival of COVID-19, serve as reminders to financial institutions of the risks associated with taking remedies against businesses that have recently had to engage in mass layoffs and may be unable to survive the economic consequences of COVID-19.
The financial impact caused by COVID-19 has left many businesses with little choice but to lay off significant numbers of employees. Financial institutions that had previously extended credit to impacted businesses are often faced with a need to exercise one or more remedies as the related credit defaults put at risk their ability to collect payments and protect collateral securing the related obligations. Two recent cases out of New York illustrate the potential dangers faced by financial institutions and other creditors that, in the act of protecting their own interests and minimizing losses associated with troubled debt, were exposed to potential liability under the Worker Adjustment and Retraining Notification Act (WARN Act). Although both cases involve businesses that were in distress before the arrival of COVID-19, the cases act as reminders to financial institutions of the risks associated with taking remedies against businesses that have recently had to engage in mass layoffs and may be unable to survive the economic consequences of COVID-19.
Two Recent Cases: A Closer Look
In a recent case decided in New York state court involving the Doral Arrowwood Conference Center and Hotel, Case Index No. 53946/19 (Sup. Ct. Westchester 2020), the court, in a 43-page opinion, reached a very cautionary result in deciding which parties were liable under the WARN Act to the employees of the Doral Arrowwood. In December 2018, the hotel's creditor, a commercial mortgage-backed securities trust (Trust) holding a $75 million loan to the business, sought to foreclose and successfully obtained the appointment of a receiver, which then struggled for the next 12 months to keep the hotel afloat. In mid-December 2019, the Trust sold the loan to an investor (Creditor), who immediately indicated, notwithstanding the court's stated concerns for the employees, that no additional funding would be provided. As a result, on Christmas Eve, the hotel issued a notice that all of its employees would be laid off on Jan. 12, 2020 – far less notice than the 90 days required by the WARN Act.
After granting the receiver's motion to be discharged, the court considered whether the Trust and/or the Creditor were liable under the WARN Act liability and for unpaid receivership expenses. The court held that both the Creditor and the Trust were jointly and severally liable because they were aware that their respective decisions to provide no further funding (and, in the Trust's case, to sell the note when it did) left the hotel with no choice but to close and terminate its employees. The court further held that if the Trust had elected to withhold funding earlier, the hotel's operations could have been wound down in an orderly way and the Christmas Eve announcement that all employees would soon lose their jobs could have been avoided. Both the Trust and Creditor were held jointly and severally liable for $2.7 million of WARN Act liability and additional amounts owed the receiver. The case is now on appeal.
In In re TransCare Corp., 614 B.R. 187 (Bankr. S.D.N.Y. 2020), a decision issued in May, the U.S. Bankruptcy Court for the Southern District of New York used lender liability principles when determining whether an employer's creditors could be held liable for violations of the WARN Act and state law wage payment claims. In TransCare, a large ambulance business serving the New York City area filed for bankruptcy. Because the debtor lacked assets, employees asserted claims against several creditors that were owned by the owners of the debtor and had provided financing at various times. These "insider" creditors and their principals moved for summary judgment.
After a lengthy recounting of the structure of the business, the court invoked lender liability principles to determine whether any creditors "exercised control over the debtor beyond that necessary to recoup some or all of what is owned" and were therefore subject to WARN Act liability. Id. at 205. Based on a well-developed factual record, the court determined that certain defendants exercised sufficient control to potentially subject both the "insider" creditors and their owners to liability. In so ruling, the court notably observed that there was no evidence any of the institutional lenders had operational control over the debtor or had promised to provide additional funding that could implicate WARN Act liability.
Conclusion and Considerations
Both cases demonstrate that, especially now with an increasing number of businesses in distress because of the COVID-19 crisis, lenders and other creditors need to be very careful about the remedies they exercise and even should consider the circumstances under which they sell debts. If you have additional questions regarding these issues and how they could specifically impact your organization, please contact the authors.
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Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem. Moreover, the laws of each jurisdiction are different and are constantly changing. If you have specific questions regarding a particular fact situation, we urge you to consult competent legal counsel.