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Archive for the ‘paying employee’ tag

Avoiding Paying Prior Employee Debt

March 9th, 2020 at 7:00 am

If you prefer NOT to pay back wages to a present or prior employee, bankruptcy can help you use the law to prevent it being a priority debt.


Imagine that in the near future you’re closing down a business and filing bankruptcy.  You owe an employee or independent contractor back wages or commissions. But you’d rather not pay that debt because you believe that employee had a major role in the business failing. You’d much rather have your scarce money go towards, for example, paying your income taxes. How do you use the law to your advantage to accomplish this?

Our last blog post showed how to use the law to pay a favored prior employee or independent contractor. Today we show how to avoid doing so.

It’s All about the Timing

We fully laid out the rules about “priority” wage/commission debts in our blog posts of 3 and 4 weeks ago. Briefly, a wage or commission is a priority debt if it meets two conditions. One’s a timing condition and the other a dollar-amount one. The wage/commission money owed:

  1. must have been “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;  and
  2. the amount earned can be no more than $13,650. Section 507(a)(4) of the Bankruptcy Code, with a cost-of-living adjustment of the $10,000 stated there.

Assume that the amount you owe your prior employee or independent contractor is less than $13,650, thus meeting that condition. So the other, timing condition is what we’re focusing on.

A wage/commission is a priority debt if it was earned within the indicated 180-day period. If it wasn’t earned within that period, the wage/commission is instead a “general unsecured” debt. As we’ll show in our two examples below, general unsecured debts are much less likely to get paid in bankruptcy.

Some Facts for Our Example

Imagine the following basic facts.

You owe your prior employee $7,500 for wages and benefits. He earned these wages and benefits over a period of four months, from 180 to 60 days ago. That’s when you laid him off, suspecting embezzlement or other inappropriate behavior.

Your sole proprietorship business is still operating, but you intend to close it and file personal and business bankruptcy soon.

You owe $10,000 in last year’s personal income taxes. In addition you owe $150,000 more 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.

Not Paying Employee in Asset Chapter 7

An asset Chapter 7 case is one in which you have some assets which are not protected. They are not protected from a Chapter 7 trustee taking and liquidating them to pay your creditors. The crucial fact is that the trustee pays any priority debts in full before paying a dime of general unsecured debts. Often there’s only enough money to pay priority debts—in full or pro rata—with nothing or very little left for the general unsecured debts.

In our example assume that your bankruptcy lawyer has advised you that your business equipment is not protected. It’s not “exempt.” It has a liquidation value of $10,000. If you file a Chapter 7 case it’s the asset that your bankruptcy trustee would use to pay your creditors.

This equipment has a liquidation value of about $10,000. You won’t need the equipment after closing the business. But you do want to put its value to the best use possible.

The point is to use the above timing condition to turn this prior employee debt into a general unsecured one. You do that by either closing your business or filing the Chapter 7 case so that the $7,500 wage debt was not earned during the 180 days before either of those two events. Under our facts the wages were most recently earned 60 days ago. So wait 120 more days to either close down the business or file the Chapter 7 case. That way none of the wages would have been earned within the 180-day period  (It’s the earlier of those two events that counts so you can’t do either for 120 days. But once you do one—such as close down the business—you can file the bankruptcy case at any point later.)

The Result in the Asset Chapter 7 Example

Under our facts the trustee would do the following with the $10,000 from sale of the business equipment. After paying his or her legally-allow fee, all the rest would go to your income tax debt. None would go to your disfavored prior employee.

The trustee’s fee would likely be no more than $1,750. It’s calculated at a maximum of 25% of the first $5,000 liquidated amount and then 10% on the second $5,000. Section 326(a) of the Bankruptcy Code. $10,000 minus $1,750 leaves $8,250. That remaining $8,250 would go to pay priority debts first, before paying anything to the general unsecured debts. In our example the wage debt is all general unsecured debt, not priority debt. So all of the remaining $8,250 would all go to your last year’s income tax debt of $10,000. You’d owe the rest—about $1,750. But you would have used most of your equipment value towards a debt you would have otherwise had to pay anyway, leaving a relatively low balance. And again, you met your goal of having none of your equipment value go to your prior employee.

Not Paying Employee in Chapter 13

In a Chapter 13 case you must pay all priority debts in full during the 3-to-5-year court-approved payment plan. Usually you must pay general unsecured creditors only as much as you can afford to pay them. This is AFTER paying priority debts in full, and often after paying secured debts as well. General unsecured debts often receive little, sometimes nothing at all. So whether a debt is a priority debt usually has a huge impact on whether and how much you must pay it.

In our example, if you were to close down the business or file bankruptcy right away, the $7,500 prior employee wage would be a priority debt. During the course of the payment plan you’d have to pay it in full. That’s in addition to paying the $10,000 income tax priority debt in full.  What happens if your budget would not allow you to do that in 3 years? The payments could be extended as long as 5 years to accomplish that. That is, you could be in your case years longer if your employee debt was a priority one.

However, if you waited the 120 day mentioned in the Chapter 7 example above to close down your business and file the Chapter 13 case, the $7,500 wage debt would likely receive much less. It may receive nothing. It would be a general unsecured debt, mixed in with the other $150,000 of general unsecured debts. This pool of $157,500 of general unsecured debts would only get paid to the extent your budget allowed. It would receive something only after you paid the $10,000 priority income tax debt in full. Plus your bankruptcy lawyer fees and Chapter 13 trustee fees receive payment usually before the general unsecured debts receive anything.

The Result in the Chapter 13 Example

So, if you’d close the business or file the Chapter 13 case right away, you’d have to pay your prior employee’s prior wage debt in full. If you couldn’t do so (and pay the income tax debt, etc.) within 3 years, you’d have to pay as much as 2 years longer.

If instead you’d wait until the wage debt turned into a general unsecured debt, you’d likely pay it very little. There’s a decent chance (depending on your budget) that you’d pay nothing on it at all.

 

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.

 

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