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Third Circuit Embraces Department of Labor Guidelines as Test for Corporate Liability Under the WARN Act


The Employment and Labor Law Alert

September 26, 2001

The Worker Adjustment and Retraining Notification Act of 1988, 29 U.S.C. ? 2101 et seq. (“the WARN Act”), requires employers to provide employees with 60 days’ notice before a plant closing or mass layoff. When an employer fails to provide that notice, the WARN Act awards employees back pay and benefits. In a recent decision, Pearson v. Component Technology Corporation, 247 F.3d 471 (2001), the Third Circuit considered whether a defunct corporation’s secured lender must pay former employees of the corporation for the corporation’s violation of the WARN Act.

Component Technology (“CompTech”) manufactured plastic objects for business machines and medical products. In June, 1989, in anticipation of a manufacturing agreement with Kodak, CompTech’s holding company, Chicago Plastics, obtained a $2,500,000 loan from General Electric Capital Corporation. As security for the loan, General Electric received pledge agreements for all stock in Chicago Plastics, in CompTech, and in CompTech’s subsidiary, R & R Plastics, as well as voting rights in the event of default. Within two years, the Kodak agreement was canceled and CompTech defaulted on the loan. General Electric, in light of its agreement, utilized its voting rights to install a new boards of directors at all three corporations. Through the new directors, a new CEO was hired to oversee all three companies, new corporate officers were installed at each, debt restructuring was implemented, and, over a two-year period, the companies were restructured by mergers and acquisitions. Pursuant to its loan agreements, General Electric either suggested or was consulted regarding all of the corporate transactions, including the termination and employment of officers and consultants. However, General Electric never exercised authority over CompTech’s business decisions, including strategic planning, client relations, marketing, product design or selection, or quality control. CompTech continued to have financial problems and required heavy financing to maintain operations. Unable to obtain that money, in October 1994, CompTech informed employees that the plant was closing, effective immediately.

CompTech’s former employees filed a complaint in the District Court against CompTech and General Electric, alleging in part that General Electric was liable for damages resulting from CompTech’s failure to comply with the WARN Act. The District Court found that General Electric had not exhibited sufficient control over CompTech so as to become liable as an “employer” under the WARN Act or as a parent corporation. The former employees appealed to the Third Circuit, asserting that General Electric was in fact both an “employer” and CompTech’s parent corporation so as to be liable under the WARN Act.

Noting the variations in standards applied by different jurisdictions in determining whether entities should ultimately be held liable for the acts of affiliated entities, the Third Circuit concluded that the Department of Labor (“DOL”) regulations, promulgated in conjunction with the WARN Act, set forth the proper inquiry for considering whether a corporation should assume WARN Act liability for an affiliate’s violation. See 20 C.F.R. ? 639.3(a)(2). The multi-pronged DOL test elucidates five factors for review: (1) common ownership; (2) common directors and/or officers; (3) de facto exercise of control; (4) unity of personnel policies emanating from a common source; and (5) the dependency of operations. See 20 C.F.R. ? 639.3(a)(2). In applying the multi-factored DOL test, the Court also noted that the factors are not exhaustive, and so determining liability requires “balancing.” The Court further noted that the formal label corporations have attached to their association – parent, subsidiary, lender ? do not change the applicability of the DOL test. The level of ownership interest and the nature and degree of control one entity has over the other, however, should be carefully evaluated in light of the parties’ relationships.

After extensive analysis and application of each prong of the DOL test, the Court found that General Electric was not an “employer” under the WARN Act, and that General Electric’s actions as a lender never reached the point at which liability for CompTech’s actions would be appropriate. Thus, Plaintiffs were denied recovery from General Electric.

In light of Third Circuit’s decision, corporate entities should be aware that, regardless of the formal label placed on their association with other entities, their liability under the WARN Act will be assessed under the five-pronged, fact-sensitive DOL test. These five factors should be considered when structuring corporate associations, as should further decisions applying this test.