Restructuring & Insolvency

Traditionally, a cross-border “migration” of a company from one European Union (EU) Member State to another EU Member State, while technically possible, has been cumbersome and costly.  Such a migration would involve either a wholesale move of the subject company’s business seat (i.e., the location of its chief executive office) or a cross-border merger of national companies could be considered.  But that has now changed. 

Recently, however, the VALE judgment of the European Court of Justice issued on July 12, 2012 has opened the door for EU companies to take advantage of a cross-border “conversion” (i.e. , the transfer of the registered office from one jurisdiction to another, including a change of applicable law, without the requirement of winding up, liquidating the company ).  Even though the VALE judgment was handed down in 2012, the precise procedural rules, in particular how local commercial registers would apply the rulings of the VALE judgment, remained unclear until recently.

In a recent judgment, the High Court of Nuremberg has become the first German High Court to apply the rulings of the VALE judgment.  The case concerned a conversion of a private limited liability company organized under the laws of Luxemburg into a private limited liability company organized under the laws of Germany.  Upon application, the company was deregistered from the Luxemburg register.  Subsequently, the subject company applied for registration with the German commercial register and for conversion into a German limited liability company.  The registration was rejected by the German Regional Court.  This decision was recently overruled by the High Court of Nuremberg citing the VALE judgment and its authorization of cross-border conversions.

The case is of key importance for companies that plan a corporate migration within the EU and, in particular, the relocation of their business to Germany.  Such a migration might be necessary in course of an international restructuring, a post-acquisition integration or after a change of market conditions.  The key aspect of a conversion is that the company maintains its legal identity, which means that no transfer of company contracts and assets occurs.  In practice, the cross-border conversion is one of the simplest ways to move business activities from one EU Member State to another EU Member State and should be taken into account in the future by companies considering international reorganization or restructuring.

The end of a legal saga

On April 7, 2014, the Commercial Court of Paris put an end to the Coeur Défense’s legal saga by acknowledging the implementation of the two safeguard plans adopted for Heart La Défense (HoLD), a French corporation, and Dame Luxembourg S.à r.l. (Dame), HoLD’s sole shareholder.  As a reminder, HoLD subscribed to a 1.64B-Euro loan in July 2007 in order to purchase “Coeur Défense”, the largest office building in Europe.  In 2008, further to Lehman Brothers’s bankruptcy, safeguard proceedings were initiated to the benefit of HoLD and Dame.  Under the safeguard plans, HoLD had to repay the principal of the loan on July 10, 2014 to Windermere XII, a French securitization mutual fund.  From the beginning of these proceedings, Coeur Défense has attracted the attention of French courts, authors and specialists due to its potential impact on French bankruptcy proceedings.

The reform of the French safeguard proceedings: the rebalancing of powers between debtors and creditors

The end of Coeur Defense’s legal proceedings happened to occur at the same time as the introduction of Order No. 2014-326 dated March 12, 2014, modifying the French safeguard proceedings and due to enter into force on July 1, 2014 (the Order).  This reform aims at restoring balance in the powers of the debtor and its creditors, and grants the latter a significant role in the preparation of a safeguard plan implemented by a distressed company.  One would say this reform is creditor-friendly and makes French bankruptcy laws closer to U.S. laws.

Mainly, the Order modifies Article L. 626-30-2 of the French Commercial Code and enables creditors to take part in the preparation of the safeguard plan.  As a consequence, in the presence of creditors’ committees, creditors are now allowed to submit their own plan to the court.  In introducing a countervailing strength to the debtor’s power to elaborate a safeguard plan, the reform should foster discussions between creditors and debtors, and prevent debtors from forcing an inefficient plan onto creditors by threatening them to implement a more traditional 10-year plan.  In fact, one of the issues in Coeur Défense was that Windermere XII, the main creditor, had failed to introduce to the court modifications that HoLD had previously refused to integrate in its plan.

In addition, as of the entry into force of the Order, if creditors’ committees fail to adopt a safeguard plan and if closure of the proceedings would lead, in a short period of time, to a “cessation of payments” (or inability of the company to meet its financial obligations), the safeguard proceedings may be converted into reorganization proceedings at the request of the court-appointed officers or the public prosecutor (in addition to the debtor, as provided prior to the reform).  Taken together with Article 55 of the Order, which allows the court to order the sale of all or part of a debtor company in the event the submitted safeguard plans seem clearly unlikely to lead to a recovery of the company or in the event no safeguard plan was submitted, the reforms should deter debtors from seeking subsequent extensions of the observation period in order to gain additional time.  In addition, such ability to convert safeguard proceedings into reorganization proceedings may be detrimental to the shareholders if the company is under-capitalized.  Indeed, Article 52 of the Order states that the court may, in the framework of reorganization proceedings, appoint a representative who will be in charge of voting in lieu of the shareholders, should such shareholders refrain from restoring the equity capital when it is required by the plan.

A key takeaway is that French bankruptcy laws, which used to be debtor-friendly, are now alerting reluctant shareholders of the consequences of their resistance to reorganization proceedings.

The Worker Adjustment Retraining and Notification Act (WARN Act) requires certain employers to give employees 60 days’ notice of plant closings and mass layoffs.  The goal of the WARN Act is to “provide workers and their families transition time to adjust to the prospective loss of employment, to seek and obtain alternative jobs and, if necessary, to enter skill training or retraining that will allow these workers to successfully compete in the job market.”  Employers who violate the WARN Act are liable to affected employees for up to 60 days of compensation and benefits.

On December 10, 2013, the Second Circuit in Guippone v. BH S&B Holdings LLC addressed whether a holding company (HoldCo) and certain investors (Investors) should be deemed “employers” under the WARN Act, and thus liable for violations thereof.  The Investors created various entities to purchase and manage Steve & Barry’s Industries, Inc., which it acquired out of bankruptcy.  HoldCo served as the holding company and sole managing member of another entity (Holdings), which employed the plaintiff and putative class members.  After the acquisition, Holdings experienced its own financial issues and subsequently filed bankruptcy.  On the same day of the bankruptcy filing, Holdings began sending WARN Act notices and termination to employees.  The plaintiff in Guippone filed a complaint against HoldCo and the Investors seeking damages on behalf of the terminated employees.

The Second Circuit adopted the following non-exclusive factors from the Department of Labor regulations to determine whether related entities are “single employers” under the WARN Act: (i) common ownership, (ii) common directors and/or officers, (iii) de facto exercise of control, (iv) unity of personnel policies emanating from a common source and (v) the dependency of operations.  Although equity investors are typically shielded from WARN Act liability, the court held that these five factors should also be applied to determine whether equity investors who exercise control over an operating company’s decision to terminate employees should be subject to WARN Act liability.  The court clarified that application of the five factors requires a fact-specific inquiry, no one factor is controlling, and all factors need not be present for liability to attach.

Ultimately, the court affirmed the district court’s order granting the Investors’ motion to dismiss, but reversed the district court’s order granting summary judgment in favor of HoldCo, instead finding that the evidence would have allowed a jury to conclude that Holdings was so controlled by HoldCo that it lacked the ability to make any decisions independently.

This case has important implications for private equity funds and other equity investors.  Although the Second Circuit dismissed the case with respect to the Investors, it did so only because the plaintiff had not presented sufficient evidence to satisfy the five-factor test for determining single players.  The implication that equity investors could find themselves liable for WARN Act claims serves as a reminder to current or future investors to ensure that legal separateness exists, is vigilantly enforced and that the company’s executives retain operational autonomy, especially with respect to closings and mass layoffs.

One of the primary advantages to acquiring businesses through asset sales as opposed to stock sales is the buyer’s ability to avoid successor liability.  There are exceptions to this rule in most states, including:  (i) impliedly or expressly assuming the liability in the asset purchase agreement; (ii) fraudulent sales of assets for the purpose of escaping liability; (iii) sales that are de facto mergers; and (iv) where the purchase is a mere continuation of the seller.  As a general matter, these exceptions are difficult to prove for parties seeking to establish successor liability.

In Teed v. Thomas & Betts Power Solutions, LLC, the U.S. Court of Appeals for the Seventh Circuit recently addressed the limits of successor liability and ruled that an asset purchaser was liable for the seller’s pre-sale violations of the Fair Labor Standard Act (FLSA).  The company, faced with a lawsuit for FLSA violations, defaulted on their bank loan.  The company’s subsidiary ended up in receivership and its assets were sold for $22 million.  The sale agreement provided that the sale was “free and clear of all liabilities” and expressly excluded any liabilities related to the existing FLSA litigation.

The Seventh Circuit ruled that a determination of successor liability for FLSA claims should be made pursuant to federal common law, not state law.  Although the buyer in this case appropriately disclaimed all successor liability for most claims under applicable state law, the buyer was not absolved of successor liability for FLSA claims.  Under federal law, unless there is a “good reason” to withhold it, successor liability should be enforced with respect to federal labor and employment laws.

The Seventh Circuit discussed hypothetical examples of “good reasons.”   Certain examples are fairly straightforward, such as lack of notice of the claim.  The court also discussed the possibility that finding successor liability existed gave preference to litigation creditors over secured creditors because the buyer would have paid less at auction if it knew FLSA claims were being assumed.  The court rejected the argument because the buyer clearly priced the transaction assuming that the FLSA claims would be left behind.

While addressing various arguments, the Seventh Circuit discussed sales in Chapter 7 or 11 bankruptcy cases, noting that the estate has obligations to maximize recovery for all creditors and to enforce a rigid statutory priority scheme.  The court implied that a sale in bankruptcy could occur free of FLSA obligations.  There is substantial authority in other jurisdictions for the proposition that sales pursuant to Bankruptcy Code section 363 can occur free and clear of labor and employment liabilities.

The Teed case serves as a cautionary tale to purchasers of distressed assets.  Purchasers should not get too comfortable in the assumption that pursuing asset sales avoids all successor liability and carefully evaluate both federal and state standards for successor liability for all claims, especially labor and employment claims.  If substantial risk exists, purchasers should consider requiring that the sale occur pursuant to a formal bankruptcy case.

Where have all the transactions gone?  The first quarter has quietly passed by.  Just a few weeks ago, looking through the pipeline, one could see almost unimpeded to the other side, relatively empty as the bankers say.  But hope exists, as suddenly activity seems to be reemerging.  We call it letter of intent flow (more poetically, LOI Flow).  The beginnings of real transactions.  Concurrently with these beginnings, we launch our inaugural Corporate Deal Source Blog.  And perhaps timing is on our side and we are well positioned to ride the next wave of deal activity from its very beginning.

We set out here to provide commentary, not intended for other lawyers, but for our clients and those we hope will find benefit from becoming our clients.  Our goal is to dialogue as much as one can in the blogosphere and that our followers will help drive our content through comment and suggestion.  The Corporate Deal Source Blog aims to be a professional, yet light-hearted source of pertinent information.  Some posts will be pithy updates of the LOI Flow, announcements and important releases; others will be more comprehensive analysis of meaningful changes in law, pitfalls in transacting globally or recent trends in private equity buyouts.  We will also cover issues affecting family office direct investing, corporate finance, real estate transactions and other topics of interest.  But all well tied with a common theme: deal-making and the people who make them.

With that, we invite you to follow Corporate Deal Source—a must for any true deal-maker.  We promise to excite as much as any band of lawyers possibly can.