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Employment Issues for Bankrupt Employers
Kerry Notestine, Ashley Zimmermann and Liquita Thompson
Littler Mendelson
Special to law.com
April 9, 2002
The stock options are underwater, the balance sheet is in the red, and the creditors are at the door. The heady days for corporate America in the last decade of the 20th century have given way to a new 21st century reality, which for some companies includes bankruptcy. Particularly with some of the largest bankruptcies in history, including Enron and Global Crossing, corporate America should know what a declaration of bankruptcy means to employees. In some ways, the U.S. Bankruptcy Code favors employees by placing some employee claims high on the priority list in relation to other creditors. In other ways, the bankruptcy code can mean the loss of security through cancellation of contracts and collective bargaining agreements. This article will address this interplay between the bankruptcy code and employment law.
The bankruptcy laws establish an orderly mechanism for payment to creditors of a bankrupt company. Secured creditors receive compensation through the liquidation of collateral and generally are not subject to the priority scheme under the bankruptcy code. For unsecured creditors, the bankruptcy code provides for a series of priorities that must be paid before the bankruptcy estate is distributed to those creditors without priorities (like law firms with amounts due at the time of the bankruptcy filing). Several of these priorities relate to employee claims. Amounts that do not fall within the indicated priorities are treated as general unsecured claims. These claims are not paid until all priority claims are satisfied.
EMPLOYEE WAGE CLAIMS
The first priority under the bankruptcy code is for administrative expenses. Administrative expenses encompass the actual, necessary costs and expenses of preserving the estate, including wages, salaries, or commissions for services rendered after the commencement of the case. 11 U.S.C. § 507(a)(1); 11 U.S.C. § 503(b). Thus, employee wages for employees working for a bankrupt estate after the filing of a petition get first priority.
Wages earned within 90 days of the bankruptcy filing fall under the third priority, which provides for:
[a]llowed unsecured claims, but only to the extent of $4,000 for each individual or corporation … earned within 90 days before the date of the filing of the petition or the date of the cessation of the debtor's business, whichever occurs first, for (A) wages, salaries, or commissions, including vacation, severance, and sick leave pay earned by an individual; or (B) sales commissions earned by an individual or by a corporation with only one employee, acting as an independent contractor in the sale of goods or services for the debtor in the ordinary course of the debtor's business if and only if, during the 12 months preceding that date, at least 75 percent of the amount that the individual or corporation earned by acting as an independent contractor in the sale of goods or services was earned from the debtor.
11 U.S.C. § 507(a)(3). Any claim for wages brought for work prior to 90 days pre-petition or cessation of business is a general, unsecured claim.
Notably, the third priority allows for recouping of vacation, severance and sick leave pay in addition to that of wages, salaries and commissions. Thus, the analysis for vacation, sick and severance pay is conceptually the same as that for wages. However, the priority assigned to an employee's claim for vacation, sick leave or severance pay will depend upon his employer's policies regarding how and when vacation, sick leave or severance pay is earned or awarded, and employers differ in these areas.
If vacation pay accrues at a certain rate over time, (even if it is not considered "earned" until a later-occurring "triggering date,") the amount accrued during the 90 days pre-petition will be that which falls under the third priority. Anything which accrued prior to the 90 days will be unsecured and anything earned post-petition will be given first priority. Any vacation pay earned during the 90 days pre-petition must be combined with other third-priority claims for wages to not exceed the $4,000 cap per individual. The same would apply for sick leave. Where it was earned during the 90 days pre-petition, it would fall under the third priority. Anything earned post-petition would fall under the first priority and anything earned but not used prior to the 90 days would be a general, unsecured claim.
In regard to severance, the issue becomes slightly more complicated. For example, if an employer has a severance plan which is not conditioned on amount of service and instead triggered on termination and awarded in lieu of notice of termination, it will be considered fully earned at the time it is awarded. Thus, if it occurs within the 90-day period pre-petition or pre-cessation of operations, it will be given third priority status in its entirety. Whereas, if an employer has a severance plan that affords a certain amount of pay based on an employee's entire tenure with the company, and the employee is discharged during the post-petition period, the employee would be entitled to first priority status only for the portion of the severance that was earned post-petition. The amount earned during pre-petition would be given third priority, and the amount earned from time served previous to that would be unsecured. On the other hand, if the employer offers severance to induce an employee to continue working for the employer through bankruptcy and later terminates the employee after petition, it will be considered a post-petition claim entitled to administrative first priority in its entirety.
WAGE CLAIMS UNDER TERMINATED EMPLOYMENT CONTRACTS
A specific provision in the Bankruptcy Code applies to an employee's claim for payment under a terminated employment contract. Under § 502(b)(7) of the Bankruptcy Code, 11 U.S.C. § 502(b)(7), an employee's damages resulting from termination of an employment contract is limited to one year following the termination of the contract or one year after the date the employer filed the bankruptcy petition, whichever occurs first. Specifically, the provision rejects a "claim of an employee for damages resulting from the termination of an employment contract," which is in excess of the following:
(A) the compensation provided by such contract, without acceleration, for one year following the earlier of --
(i) the date of the filing of the petition; or
(ii) the date on which the employer directed the employee to terminate, or such employee terminated, performance under such contract; plus
(B) any unpaid compensation due under such contract, without acceleration, on the earlier of such dates.
11 U.S.C. § 502(b)(7). Congress adopted this provision to prevent a debtor's estate from being subjected to wage claims arising from employment contracts that exceed one year.
This provision applies not only to employment contracts, such as those entered into with highly paid executives, but also to collective bargaining agreements to the extent that they create an employer-employee relationship. In addition, the provision is applicable to all claims resulting from the termination of the employment contract, whether or not it terminated pre- or post-petition. In that regard, courts have held that the provision applies even where the termination of the contract has no nexus to the bankruptcy.
REJECTION OF COLLECTIVE BARGAINING AGREEMENTS
Bankruptcy and employment laws also intersect with respect to collective bargaining agreements. In 1984, the U.S. Supreme Court held that a bankruptcy court may allow a debtor-in-possession to reject a collective bargaining agreement upon a showing that the collective bargaining agreement burdens the estate, that the equities balance in favor of rejection, and that rejection would further the purpose of the bankruptcy. See N.L.R.B. v. Bildisco & Bildisco, 465 U.S. 513, 526 (1984). The Court further held that a debtor in possession could unilaterally amend an existing collective bargaining agreement prior to the bankruptcy court authorizing rejection. Id. at 534.
Congress immediately responded to, and effectively overruled, the Bildisco opinion by enacting § 1113 of the Bankruptcy Code, which now governs the rejection of collective bargaining agreements after an employer files bankruptcy. This provision gives a bankruptcy court the power to reject a collective bargaining agreement if rejection is necessary to the reorganization of the debtor. In determining whether to allow rejection of a collective bargaining agreement, most courts weigh the following nine factors:
1) The debtor in possession must make a proposal to the union to modify the collective bargaining agreement.
2) The proposal must be based on the most complete and reliable information available at the time of the proposal.
3) The proposed modifications must be necessary to permit the reorganization of the debtor.
4) The proposed modifications must assure that all creditors, the debtor and all of the affected parties are treated fairly and equitably.
5) The debtor must provide the union such relevant information as is necessary to evaluate the proposal.
6) Between the time of the making of the proposal and the time of the hearing on approval of the rejection of the existing collective bargaining agreement, the debtor must meet at reasonable times with the union.
7) At the meetings the debtor must confer in good faith in attempting to reach mutually satisfactory modifications of the collective bargaining agreement.
8) The union must have refused to accept the proposal without good cause.
9) The balance of the equities must clearly favor rejection of the collective bargaining agreement.
In re American Provision Co., 44 B.R. 907, 909 (Bankr. D. Minn. 1984). The debtor in possession has the burden of proving each factors by a preponderance of the evidence. Id. at 99. However, at least one court has held that the ninth factor must be proved to a higher standard than a preponderance of the evidence. See In re U.S. Truck Co. Holdings Inc., 165 LRRM 2521, 2531 (E.D. Mich. 2000).
Generally, the debtor in possession must make negotiation proposals prior to the rejection hearing. A hearing on an application for rejection must be scheduled "not later than fourteen days after the date of the filing of such application." 11 U.S.C. § 1113(d)(1). However, the court may extend this time frame in the interests of justice for a period not to exceed seven days. The court must rule on an application for rejection within 30 days of the commencement of the hearing. 11 U.S.C. § 1113(d)(2). If the court does not rule within this 30-day limit, or within an extended time period agreed upon by the parties to the hearing, the trustee may terminate or alter any provisions of the collective bargaining agreement pending the court's ruling. Courts are split as to whether a bankruptcy court's power to allow rejection of a collective bargaining agreement extends to ordering modification of a specific provision of a collective bargaining agreement.
Prior to a rejection hearing, a debtor in possession may apply for interim relief from the obligations under the collective bargaining agreement at any time during the agreement's term, whether or not the debtor in possession has filed a motion to reject the collective bargaining agreement. 11 U.S.C. § 1113(e). After notice and hearing, the court may authorize interim changes in the terms, conditions and benefits provided by the collective bargaining agreement until rejection of the agreement can be approved or disapproved. However, similar to the standard used for a temporary restraining order, the debtor in possession must show that interim relief is necessary to avoid irreparable damage to the estate or is essential to the continuation of the debtor's business. See, e.g., In re Salt Creek Freightways, 47 B.R. 835 (Bankr. D. Wyo. 1985). If a court grants interim relief, the relief may remain in effect until the expiration of the collective bargaining agreement, and may even be extended past the expiration date. In re Chas P. Young Co., 111 B.R. 410, 415 (Bankr. S.D. N.Y. 1990).
It is important to note when a court authorizes a debtor in possession to reject a collective bargaining agreement, it essentially has the same effect as a bargaining proposal at impasse. In that regard, the debtor remains obligated to comply with its NLRA requirements to bargain in good faith, the union continues to represent the employees, and the employees retain the right to strike.
The provisions of § 1113 only apply to a collective bargaining agreement that is in effect at the time the debtor files the bankruptcy petition. Court approval is necessary for any collective bargaining agreement entered into after the filing of the bankruptcy petition by the employer, unless it is considered a routine contract entered into "in the ordinary course of business." 11 U.S.C. § 363(c). In analyzing whether a collective bargaining agreement is entered into in the ordinary course of business, courts consider both a vertical and a horizontal test. Under the vertical test, the bankruptcy court analyzes the transaction from the vantage point of a hypothetical creditor and considers whether the economic risks of the collective bargaining agreement is within the scope of the economic risks that the creditor accepted when the creditor decided to extend credit to the employer. The horizontal test considers the collective bargaining agreement in the setting of similar agreements within the same industry.
EMPLOYEE BENEFIT PLANS
The fourth priority under the Bankruptcy Code is for unsecured claims for contributions to an employee benefit plan arising from services rendered within 180 days prior to the bankruptcy filing. The amount of this priority is $4,000 for each employee of the business less the wage claims paid under the third priority. 11 U.S.C. § 507(a)(4). Courts have defined employee benefit plans broadly to include both welfare and pension benefits under the Employee Retirement Income Security Act (ERISA). Generally, this will include both insured and self-funded medical, as well as life, disability, dental and other welfare plans.
Significant litigation often results when a bankrupt employer is part of a multi-employer pension plan. ERISA provides special rules and requirements for payments of unfunded liability that results from an employer's withdrawal from a multi-employer pension plan. 29 U.S.C. §§ 1341a, 1381-1386. ERISA also limits an employer's liability if it is insolvent when it withdraws, and the withdrawal liability (which may involve substantial sums) also can be considered when determining an employer's solvency. 29 U.S.C. § 1405.
A distressed employer also may terminate an underfunded pension plan according to procedures under ERISA for this purpose. The employer seeking to terminate a pension plan must provide notice to the Pension Benefit Guarantee Corporation (PBGC), which is a wholly-owned U.S. government corporation that provides insurance for defined benefit pension plans. 29 U.S.C. § 1341. The PBGC then conducts a review under established procedures and may provide insurance to participants in certain situations. Related companies that are part of a "control group" may be liable for underfunding. The PBGC also may institute proceedings to terminate an employer's plan if the plan is unable to pay benefits currently due. Where the plan is terminated and there is underfunding, the PBGC takes control of the plan assets and pays benefits to participants from plan assets and/or PBGC funds. 29 U.S.C. § 1342.
The PBGC has the power to impose a lien on the employer and related companies for part of the companies' net worth. The PBGC's lien is entitled to secured status when the plan is terminated prior to bankruptcy filing and the PBGC has filed notice of its lien 90 days prior to the bankruptcy filing date. In other situations, the PBGC may have a priority claim equivalent to a tax lien, which is entitled to the eighth priority under the Bankruptcy Code. 29 U.S.C. § 1368; 11 U.S.C. § 507(a)(8). The PBGC also may be eligible for other and additional amounts as a general creditor.
Depending on plan language and statements made to participants while employed, an employer may have significant flexibility to change or terminate benefits provided to retired employees. If, however, the employer declares bankruptcy, the cost of retiree medical benefits can become a significant issue in the bankruptcy court. The Bankruptcy Code provides procedures for addressing issues of payment of insurance benefits to retired employees. 11 U.S.C. § 1114. The Bankruptcy Code requires the bankruptcy court to appoint a committee of retired employees if the employer seeks to modify or not pay benefits to retirees. If the retirees were represented by a union while employed, the union is presumed to be the authorized representative for the retirees. Because of concerns relating to conflicts of interest that a union may have between representing retirees and current employees, the code also allows for a "party in interest" to petition the court to have a committee appointed to represent the retirees rather than the union. The code requires an employer to present proposals for modification of benefit plans to the retiree representative along with relevant information necessary to evaluate the proposal before the employer can change or terminate retiree medical benefits. The bankruptcy court can only allow modification or termination of benefits if the employer has made the proposal, the retiree representative has failed to accept the proposal "without good cause," and the modification is necessary to permit the reorganization of the debtor while providing fair and equitable treatment of all affected parties. 11 U.S.C. § 1114.
AUTOMATIC STAY PROVISIONS
One of the key features of any bankruptcy is a stay of most litigation pending at the time of the bankruptcy filing or which could have been commenced prior to the commencement of the bankruptcy case. Once the claimant files a proof of claim with the bankruptcy court, the stayed actions then are administered in the bankruptcy court with a hearing held to determine the value of the claim. That claim then is paid according to the schedule determined for claims in that particular category, which typically is general, unsecured claims. If the claimant fails to file a proof of claim, the claimant generally loses the right to receive a distribution. 11 U.S.C. § 362(a).
The Bankruptcy Code excepts from the stay proceedings actions by a governmental unit to enforce the governments policy or regulatory power. 11 U.S.C. § 362(b)(4). Actions by the Equal Employment Opportunity Commission (EEOC) and the National Labor Relations Board (NLRB) typically fall within this police power exception and may proceed without being stayed, although relief available to an individual claimant nevertheless may be adjusted by the bankruptcy court. Depending on the particular state scheme, workers' compensation proceedings also may be an exercise of police power and not subject to the automatic stay.
PLANT CLOSINGS
An employer often will close facilities or lay off significant numbers of employees after a declaration of bankruptcy. These actions may trigger notice obligations under the Worker Adjustment and Retraining Notification Act (WARN) that requires an employer to provide employees with 60 days' notice of covered plant closings and mass layoffs. 29 U.S.C. § 2101-02. The statute provides two limited exceptions that sometimes may apply in bankruptcy situations. These exceptions are for unforeseen business circumstances where sudden, dramatic and unexpected events outside of the employer's control make it impossible to provide the required notice, and for faltering companies where providing notice would prevent an employer from securing business or capital that it was in the process of actively seeking. 29 U.S.C. 2102(b). The courts construe these exceptions narrowly and prudent employers will be careful in relying on these exceptions to avoid notice to employees. Even where the exceptions excuse providing 60-days notice, the statute requires as much notice as possible. 29 U.S.C. § 2102(b)(3). Employers failing to give the required notice are liable for pay and benefits in lieu of notice.
CONCLUSION
Bankruptcy is a difficult option for any company. The impact on employees can be significant. Careful planning often is difficult in the hectic periods that generally precede bankruptcy, but knowledge of the effects that the bankruptcy process has on employees can diminish the disruption that the bankruptcy will cause employees. Furthermore, the Bankruptcy Code provides important options for addressing problems in collective bargaining agreements, executive contracts, and benefits that may not be possible in other situations. Addressing such problems through the mechanism of bankruptcy may allow the company to emerge from bankruptcy in a better competitive position and proceed as a successful entity.
Bibliography
Dowling, D., "The Intersection Between U.S. Bankruptcy and Employment Law," 10 Lab. Law.57 (Winter 1994).
Hardin, P., The Developing Labor Law, 3d ed. (1992)
Phelan, R. "Employer/Employee Problems in Bankruptcy Cases," 649 PL1/Comm 43 (1993)
Sacher, Steven, Employee Benefits Law, 2d ed. (2000)
Kerry E. Notestine, a shareholder with Littler Mendelson, www.littler.com in Houston, represents employers in all aspects of employment matters including employment litigation under federal, state, and local anti-discrimination statutes; federal and state administrative proceedings; union/management relations; and the employment aspects of mergers and acquisitions. Mr. Notestine may be reached at (713) 951-9400, e-mail: knotestine@littler.com. Ashley Zimmermann and Liquita Thompson, both associates at Littler, may be reached at (713) 951-9400 or by e-mail at: azimmermann@littler.com or lthompson@littler.com.
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