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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.

 

“Priority” Wages and Benefits Owed to Employees

September 14th, 2016 at 7:00 am

If you owe an employee wages or benefits, it’s likely a priority debt. Same if you are owed wages or benefits.  More likely to be paid.

 

We’ve been writing in recent blog posts about “priority” debts, such as child/spousal support and income taxes.

In a Chapter 7 case the bankruptcy trustee pays these in full ahead of paying anything whatsoever on other debts. See Section 726(a)(1) of the U.S. Bankruptcy Code. (That’s only if the trustee has any of your assets to liquidate, which is usually not the case.)

In a Chapter 13 case you have to pay priority debts in full during the life of the case. See Section 1322(a)(2).

Employee Wages and Benefits

There’s a type of priority debt that doesn’t come up nearly as often as child/spousal support or income taxes. But when it does it could be very important.

Under certain conditions a debt for unpaid employee wages, salaries, commissions, or benefits is a priority debt. If you’ve operated a business and owe this type of debt, it’s important to know how it’ll be treated.

Why It’s Important

Whether or not a debt for unpaid wages and benefits meets the conditions for being a priority debt especially matters if:

  • You are filing a Chapter 7 case in which the trustee is paying creditors, and you prefer that your employee(s) get paid ahead of other creditors. Then you want the wage/benefits debt to be a priority debt. That way it’s more likely your employee debt(s) will get paid.
  • You are filing a Chapter 13 case and you have very limited amount of money to pay your debts. Then you prefer the wage/benefits debt not to be a priority debt. That way you are not required to pay that debt in full. That makes your Chapter 13 plan less expensive to fund, perhaps turning an impossible situation into a feasible one.

The Conditions that Make a Debt to an Employee a Priority Debt

The basic rule:

  1. a debt for wages, salaries, or commissions (including vacation, severance, and sick leave pay)
  2. earned by an individual within 180 days of the bankruptcy filing or the closing of the business, whichever comes first
  3. up to $12,850

is a priority debt.

Chapter 7 Example

Let’s use two examples reflecting the scenarios mentioned above.

First, imagine you operated a business in your name that you closed the same day you filed a Chapter 7 case. You didn’t have the money to pay your single employee $3,000 for her final month of wages. You really want her to get paid. You also owe $100,000 in other personal and business debts.

You’re pleased to hear that $3,000 is a priority debt because it meets the 3 conditions listed above.

As your bankruptcy lawyer told you to expect, your Chapter 7 trustee asks you to turn over the last of your business equipment. The trustee liquidates the equipment, receiving $4,000. Out of that the trustee pays himself a fee of 25%, $1,000. (See Section 326(a).) The trustee pays your former employee the remaining $3,000, paying her off in full, because it’s a priority debt. Your other debts receive nothing, and are discharged (permanently written off).

Chapter 13 Example

Second, imagine you operated a business in your name that you just closed. Your single employer had quit 6 months ago. You suspect that one of the reasons your business failed is because that employee had been referring customers to a competitor, and getting paid a kickback fee. He started working for that competitor as soon as he stopped working for you. You have some evidence backing up your suspicions, but a lawyer has told you your legal case is weak against both your former employee and your competitor and simply not worth pursuing.

This employee’s regular salary was $4,000 per month. Because money was so tight during the final 6 months of working for you he agreed to let you hold back $1,500 of that salary monthly until you could afford to pay it back. The amount of back pay totaled $9,000. You feel like he owes you many times that amount of money for cheating you. And you certainly don’t want to pay him that $9,000 as a priority debt in the Chapter 13 case you’re filing.

So you’re happy to learn that this $9,000 debt is not a priority debt. It meets two of the 3 conditions listed above, but not the third one. Your former employee did not earn any of that $9,000 within 180 days of the close of the business or of the filing of your Chapter 13 case. So that debt is just a “general unsecured” debt. You pay it only to the extent you have enough disposable income to pay it, after living expenses and other more important debt. In many Chapter 13 cases the “general unsecured” debts are paid only pennies on the dollar. Sometimes they’re paid nothing.

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