Blog
Law Offices of Chance M. McGhee

Call Today for a FREE Consultation

210-342-3400

Archive for the ‘commissions’ tag

Paying Employee Debt in Bankruptcy

February 24th, 2020 at 8:00 am

If you prefer to pay back wages to a present or prior employee, bankruptcy can help you do so if you use the law in that employee’s favor.  

 

Our last two blog posts were about debts owed to your employees or independent contractors. Specifically we discussed the conditions in which past wages, commissions, or benefits qualify as “priority” debt. Two weeks ago we got into the conditions that apply to both employees and independent contractors. Last week the focus was on a special additional condition that only independent contractors must meet.

Whether a debt qualifies for priority status is often crucial. That’s because this can determine whether or not you pay that debt in the bankruptcy case.   In a no-asset Chapter 7 case none of the debts receive any payment within the case. So whether an unpaid wage or commission qualifies as priority or not doesn’t matter in this situation. But in an asset Chapter 7 case it makes all the difference. It’s common that priority debts receive payment in part or in full, while the rest of the debts receive little or nothing. There’s a similar result in a Chapter 11 business reorganization or 13 adjustment of debts case. Priority debts generally receive payment in full while other debts receive little or nothing.

Assume that you’d prefer that your past or present employee/independent contractor receive payment for what you owe him or her at the time of your bankruptcy filing. If so, you need to know the conditions for making that debt a priority debt, and how to apply them. Today we’ll review the conditions and then apply them an asset Chapter 7 example. Next week blog post will demonstrate an example in a Chapter 13 case.

The Conditions

We covered the conditions that an unpaid wage or commission is a priority debt the last two blog posts. We’ll review them very briefly here.

For a debt you owe either an employee or independent contractor:

If you owe the debt to an independent contractor, he or she needs to meet an additional condition. The debt is a priority debt ONLY if

during the 12 months preceding that date [of bankruptcy filing or cessation of business], 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.

Section 507(a)(4)(B) of the Bankruptcy Code (bold added).

Our Chapter 7 Asset Case Example

Assume you owe a prior employee $7,500 for wages and benefits. Your employee earned these wages and benefits over a period of four months, from 150 to 30 days ago, when you had to lay her off.

Your sole proprietorship business is still operating. You intend to close it and file a Chapter 7 bankruptcy soon.

Your bankruptcy lawyer has advised you that your business equipment is not exempt. This mean it’s not protected from collection and liquidation by the Chapter 7 bankruptcy trustee. He or she will take it from you, sell it, and use the proceeds to pay your creditors.

This equipment has a liquidation value of about $10,000. You don’t need the equipment after closing the business because you don’t intend to be in this kind of business ever again. But you do wish you could put it’s value to some good use.

You owe $150,000 on all of the rest of your debts. These consist of unsecured trade debt, business and personal unsecured credit cards, and medical bills. These are all considered “general unsecured” debts. None are priority debts except potentially the $7,500 you owe to your prior employee. You have a home mortgage but you’ve managed to keep current on it. Your home has a bit of equity but it’s protected by the homestead exemption.

Timing the Filing of Your Chapter 7 Case

You may have reasons to delay filing your case. You may have new employment lined up but it doesn’t start for several months. You may have business customer paying you soon and you’ll need the money for your home mortgage in the meantime. There can be countless legal and/or practical reasons for filing your case later.

However, your prior employee would likely really benefit from you filing your case within about a month. Then, because of the 180-day condition cited above, there’s a good chance she’d receive all or most of her $7,500.

How? The Chapter 7 trustee would liquidate your business equipment. The trustee would receive a fee—likely about $1,750. (By law, no more than 25% of the first $5,000 liquidated and 10% on the second $5,000. Section 326(a) of the Bankruptcy Code.) $10,000 minus $1,750 leaves $8,250. (25% for the first $5,000 is $1,250, plus 10% for the second $5,000 is $500, totaling the trustee’s $1,750 fee.) The remaining $8,250 would go to pay priority debts first, before paying anything to the general unsecured debts.

The $7,500 debt to your prior employee would all be priority debt. That’s because in our scenario it was all earned within the 180-day period before your simultaneous business closure and bankruptcy filing. Plus the $7,500 amount is less than the $13,650 limit referenced above.

So in this example your prior employee would receive her $7,500 in full.

Of course if the business equipment sold for less, your employee would receive only partial payment. Assume it sold not for $10,000 but rather only $7,000. $7,000 minus the trustee’s $1,450 would leave $5,550 for the trustee to distribute. Likely all of this would go to your employee. So she’d receive at least a significant portion of her debt.

If You Delayed Filing Bankruptcy

Assume instead that you closed your business and filed your Chapter 7 case five months from now. At that point all of her wages and benefits would have been earned more than 180 days earlier. So, none of the $7,500 would qualify as priority. The debt would be a general unsecured one, lumped in with other $150,000 of such debt.

Then, your employee would receive very little. Assume again that the bankruptcy trustee sells your business equipment for $10,000, leaving $8,250 for payment of the debts. This would be distributed pro rata to the $157,500 in general unsecured debt (her $7,500 plus the other $150,000). $8,250 divided by $157,500 amounts to all debts receiving only about 5 cents on the dollar. So your prior employee would receive only about $375 on her $7,500 debt.

Conclusion

There are many factors that come into play for determining what day you file your bankruptcy case. Some of those factors may well be much more important than helping your employee/independent contractor receive payment. But sometimes a business owner has some flexibility on timing. And getting an employee/independent contractor some money may be a high priority for various personal or business reasons. This would be especially true if that money would otherwise go to a debt you don’t care about getting paid. In such situations you and your bankruptcy lawyer may well be able to put these priority laws to good use, as we showed in today’s blog post.

 

Commissions Owed to Independent Contractor

February 17th, 2020 at 8:00 am

If you owe sales commissions to an independent contractor when you file bankruptcy, it may be a priority debt. Here’s what determines this

 

Our last blog post was about conditions in which wages, commissions, or benefits owed to an employee are “priority” debt.

But what if your debt was not to an employee but an independent contractor? Especially in today’s “gig economy,” small businesses (and large ones, too) often have independent contractors instead of employees.

Why “Priority” Matters

As discussed last week, whether a debt qualifies as a priority debt can make a huge difference.

This most often matters in a Chapter 13 “adjustment of debts” case. You have to pay all priority debts in full during the 3-to-5-year court-approved payment plan. In huge contrast, usually you only pay the non-priority “general unsecured” debts to the extent you can afford to pay. The common result is that you pay priority debts 100%, while those that don’t qualify as priority little or nothing.

The distinction between priority and general unsecured also matters in an “asset” Chapter 7 case. That’s the relatively uncommon situation in which a debtor needs to surrender an unprotected asset to the Chapter 7 trustee. In that situation the trustee liquidates the asset and pays priority debts in full before paying any general unsecured debts. The result: priority debts often get paid in full or in part, while there’s nothing for any general unsecured debts.

The distinction between priority and general unsecured does not directly matter in a simple, “no-asset” Chapter 7 “straight bankruptcy” case. That’s the common situation when everything you own is “exempt”—protected from the Chapter 7 trustee. Many Chapter 7 cases are “no-asset” ones. (However, note that most priority debts can’t be discharged in a Chapter 7 bankruptcy. So while such debts won’t receive anything from the trustee, you’ll likely still have to pay the debt afterwards yourself.)

The Basic Amount/Timing Rule

Whether you owe an employee or an independent contractor, some of the conditions to make the debt priority are the same.

First is the maximum dollar amount. The maximum amount of a debt that would qualify as priority is $13,650. See the discussion in our last blog post about this amount. (Also see the original statute’s $10,000 amount in Section 507(a)(4) of the U.S. Bankruptcy Code, the cost-of-living provision in Section 104 of the Bankruptcy Code, and the current $13,650 amount since April 1, 2019 in this notice in the Federal Register.)

The second condition is the timing. The debt owed must be

earned within 180 days before the date of the filing of the [bankruptcy] petition or the date of the cessation of the debtor’s business, whichever occurs first

Section 507(a)(4) of the Bankruptcy Code.

So, any amount owed to an employee/contractor beyond $13,650 would be a general unsecured debt, not a priority one. Same with any amounts earned outside the specified 180-day period.

The Special Independent Contractor Rule

Beyond the above amount/timing conditions, there’s another significant condition especially for independent contractors. The debt is a priority debt ONLY if

during the 12 months preceding that date [of bankruptcy filing or cessation of business], 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.

Section 507(a)(4)(B) of the Bankruptcy Code.

So if your independent contractor earned less than 75% of its overall income during that one-year period from you, then none of what you owe it is priority.

Presumably the purpose of this condition is so that it applies only to independent contractors who are more like employees. It includes only those independent contractors who work mostly for you. It is not meant to apply to debts owed to suppliers of goods and services that serve many customers. Those are more like conventional payables, which are general unsecured debts, not entitled to priority.

 

Wages Owed to an Employee

February 10th, 2020 at 8:00 am

If you owe wages to an employee when you file bankruptcy, that may or not be a priority debt. Here’s what determines this and why it matters.  

 

Our last dozen blog posts have been about “priority” debts. These are special unsecured debts that bankruptcy law treats better than the rest, called “general unsecured” debts.

(Secured debts are a third main category of debts, distinctive because they are attached to your assets as security. We’ve covered those before and will again later. But now we’re addressing priority debts, which are not secured by any of your assets.)

The most common priority debts in consumer bankruptcy cases are income taxes and child/spousal support. So our recent blog posts have focused on these two. But if you have been operating a business with employees or independent contractors there are other important potential priority debts. These involve unpaid wages, salaries, commissions and benefits owed at the time of bankruptcy filing. Our next few blog posts will focus on these.

The Conditions of Priority

If you owe a wage, salary, commission, or employee benefit when filing bankruptcy, that may or not be a priority debt. It depends on timing and the amount owed. The pertinent statute says that priority debts include those:

only to the extent of $13,650 for each individual or corporation, as the case may be, earned within 180 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… wages, salaries, or commissions, including vacation, severance, and sick leave pay earned by an individual

Section 507(a)(4) of the U.S. Bankruptcy Code.

The $13,650 Dollar Limit

This dollar limit is mostly self-explanatory. Any amount owed to an employee up to $13,650 is a priority debt. Any amount beyond that is just a general unsecured debt.

This amount may seem odd. That’s because it’s been adjusted for inflation every 3 years as mandated by law. Section 104 of the Bankruptcy Code. It was originally $10,000. It’s been $13,650 for bankruptcy cases filed since April 1, 2019 (and will likely increase on April 1, 2022). See this notice in the Federal Register of February 12, 2019.

Timing

The wage, commission, etc. must have been earned within a very strict time period of 180 days. This is 180 days before your bankruptcy filing date or before you stopped operating your business, whichever happens first. So for example if you stop operating your business on January 1 and then file bankruptcy on the following March 1, the pertinent period would be the 180 day period before January 1. Wages, etc. earned during that period would count as priority. Earnings outside that period would be general unsecured debt.

Why Priority Matters

Whether a debt is a priority or general unsecured one sometimes doesn’t matter. But often it matters a lot.

This distinction of itself does not matter in a simple, “no-asset” Chapter 7 “straight bankruptcy” case. That’s one in which everything you own is “exempt”—protected from collection by the Chapter 7 trustee. Most straightforward consumer Chapter 7 cases are “no-asset.” If you operated a business you may also have a “no-asset” Chapter 7 case although that’s less likely.

The priority-general unsecured distinction matters a lot in an “asset” Chapter 7 case. That’s because the trustee pays debts out of the collected and liquidated non-exempt assets. The trustee pays priority debts in full before paying anything to general unsecured debts. Often that means that priority debts are the only ones that receive any funds from the trustee. Or priority debts may be paid in full while general unsecured debts only receive a few pennies on the dollar.

The priority-general unsecured distinction also matters a lot in all Chapter 13 “adjustment of debts” cases. A 3-to-5-year court-approved Chapter 13 payment plan must pay all priority debts in full. In contrast, the plan usually pays general unsecured debts only if and only to the extent there’s any money left over after paying all priority (and often secured) debts first. The result is that priority debts stand a much better chance of getting paid. In contrast, general unsecured debts often receive only a small portion of the amount owed, and sometimes absolutely nothing. (This also largely applies to Chapter 11 business reorganizations and Chapter 12 farm reorganizations.)

So under “asset” Chapter 7s and all Chapter 13s, whether a wage, etc. meets the priority conditions or not usually makes a tremendous difference about whether and the extent to which it is paid.

Order of Priority

There’s one more important consideration in whether a wage, etc. gets paid and to what extent. The law doesn’t just make a distinction between priority and general unsecured debts. Some priority debts have higher priority than others. The higher priority debts receive payment in full before the lower priority ones receive anything.

This doesn’t matter so much under Chapter 13 in which you must pay all priority debts in full. Nor does it matter in an asset Chapter 7 case in which there’s plenty of money to pay all priority debts. But it does matter in an asset Chapter 7 case in which there are more than one type of priority debts and there’s only enough money to pay some of them.

The order of priority for wages and such is fourth out of the ten listed priority debts. Some of these ten are obscure ones that seldom apply. Focusing on the most common ones, the wage priority is lower than child and spousal support debts but higher than income taxes.

 

Call today for a FREE Consultation

210-342-3400

Facebook Blog
Back to Top Back to Top