Bankrupt Companies and their Employees: Conscious Uncoupling

I know, the phrase "conscious uncoupling" is extremely trite by now, but even The Economist joined in on the joke, so I thought, "why not"? Plus, it's actually relevant to this post, I promise.

Brookstone, a specialty retailer of luxury gadgets like massage chairs, has filed for bankruptcy with a deal to sell its assets to Spenser Spirit. The retailer has been cutting costs for a while, however, and it appears that many of the personnel cuts have happened prior to the announcement.

"Jim Speltz, Brookstone president and CEO, said the deal would have no impact on customers, that "business will continue uninterrupted," and that all existing customer programs, including warranties, gift cards, returns and exchanges, would be honored.

The company also plans to maintain employee benefit and payroll as they currently exist, he said. Brookstone's largest creditors support the deal to salvage the retailer that has seen declining sales in recent years." NH Union Leader

Not only are the current employees being retained, but Brookstone is handing out large bonuses to some of its management team. 

"Under the proposal, four executives would earn bonuses tied to the sale price as well as the company’s cash flow. For example, if Brookstone closes the $147 million deal currently on the table, then the executives would share roughly $840,000 in bonuses, although this doesn't take the cash-flow targets into account.

Another 33 non-executive employees would share up to $1.28 million in bonuses as long as they stick with Brookstone throughout the sale process. These employees come from the company’s finance, e-commerce, human resources and other departments." WSJ Bankruptcy Beat

It looks like Brookstone is doing a decent job of transitioning its employees, which is not always the case for companies in distressed situations. Not having an acceptable transition period for the employees could impact shareholders or even sponsor private equity firms!

The WARN Act, which was codified in 1998, gives guidance for lay-offs for both healthy and stressed companies. 

"The WARN Act "provides that a business enterprise that employs 100 or more employees must provide at least 60 days advance written notice of any “plant closing” or “mass lay-off” to each employee who will be terminated.  A “plant closing” is a shutdown (permanent or temporary) that results in the loss of employment of 50 or more full-time employees at a single site of employment.  A “mass layoff” is the loss of employment of 500 or more people or the loss of employment of at least 50 employees constituting more than 33 percent of the full-time employees at a single employment site." JD Supra

Although employers must still provide notice as soon as practicable, there are three stated defenses to the 60 day notice requirement under the WARN Act:

1. "when an employer reasonably believes that advance notice would impede its active pursuit of capital or business;
2. unforeseeable business circumstances; and
3. natural disasters.

Somewhat naturally, companies seeking bankruptcy protection are often forced to abruptly terminate employees before providing the required notice.   In addition to developing the “liquidating fiduciary” principal discussed above, bankruptcy courts have examined, and often disagreed, about certain applications of the WARN Act once the “employer” is bankrupt."  JD Supra

When a company lays off workers in turbulent times, the second defense of the WARN Act may apply, in which case, the company may not have liability under the Act. However, it gets interesting if that company is owned by a private equity sponsor.

In 2000, Outboard Marine Corporation, a designer and manufacturer of outboard motors, filed for Chapter 11 protection and laid off 6,500 employees without notice. Employees filed a class action lawsuit (Vogt case) alleging violation of the WARN Act. However, since Outboard had limited assets, the plaintiffs sued the three private equity firms, Greenmarine Holdings, Quantum Industrial Partners and Quantum Industrial Holdings, along with entities that owned interest in those firms. Goodwin Proctor.

The court determined that those three private equity firms and Outboard constituted a single owner since majority of the shares and board seats were held by those private equity firms.

"The Court focused on the fact that the defendants were heavily involved in the preparations for Outboard’s bankruptcy and ultimately made the decision to file for bankruptcy and close the company’s facilities. The Court concluded that these allegations supported the plaintiffs’ contention that the three private equity firms acted as a single employer and thus could be held liable for Outboard’s failure to comply with the notice requirements of WARN." Goodwin Proctor.

When we think of distressed private equity firms instituting a turnaround of their portfolio companies, lay-offs and closings can be part and parcel of the reorganization. When implementing a personnel restructuring, sponsors need to balance being transparent about cuts and avoiding operational distractions. Moreover, restructuring professionals advising a company in distress ought to tread lightly and make sure that all of the boxes are checked when recommending downsizing. In order to avoid liability under the WARN Act, and even more importantly, to treat employees in a decent manner, a "conscious uncoupling" is crucial.