The Intersection of Bankruptcy and… Labor/Employment Law

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attorneys, accountants, business owners and
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Disclaimer
The material in this webinar is for informational purposes only. It should not be considered
legal, financial or other professional advice. You should consult with an attorney or other
appropriate professional to determine what may be best for your individual needs. While
Financial Poise™ takes reasonable steps to ensure that information it publishes is accurate,
Financial Poise™ makes no guaranty in this regard.
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Meet the Faculty
MODERATOR:
Michael J. Kaczka - McDonald Hopkins LLC
PANELISTS:
Jonathan P. Friedland - Sugar Felsenthal Grais & Helsinger LLP
Gary W. Marsh - Troutman Pepper Hamilton & Sanders, LLP
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About This Webinar
The Intersection of Bankruptcy and… Labor/Employment Law
Even before a company files for bankruptcy protection, multiple employment and labor issues
can arise. This webinar examines employee wage and claim issues that are often triggered by
the filing for bankruptcy protection, as well as the special treatment provided by the
Bankruptcy Code for employment contracts, key employee programs, collective bargaining
agreements and retiree health care benefits. This webinar also addresses the ramifications of
the failure of a debtor to comply with the Worker Adjustment and Retraining Notification Act
(WARN), which requires employers to provide written notice in advance of covered plant
closings and mass layoffs under certain conditions and may subject the debtor to liability.
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About This Series
Bankruptcy Intersections
Bankruptcy law is generally a federal-based practice, and governed by title 11 of the United
States Code (the Bankruptcy Code). Bankruptcy law, however, is far from an insular practice;
there is substantial interplay between bankruptcy law and almost every other area of law due
to the myriad legal issues that arise during the course of a bankruptcy case. This webinar
series focuses on how issues involving employment and labor, intellectual property,
environmental, and commercial law are treated through the prism of bankruptcy.
Each Financial Poise Webinar is delivered in Plain English, understandable to investors, business owners, and
executives without much background in these areas, yet is of primary value to attorneys, accountants, and other
seasoned professionals. Each episode brings you into engaging, sometimes humorous, conversations designed to
entertain as it teaches. Each episode in the series is designed to be viewed independently of the other episodes so that
participants will enhance their knowledge of this area whether they attend one, some, or all episodes.
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Episodes in this Series
#1: The Intersection of Bankruptcy and… Labor/Employment Law
Premiere date: 3/31/22
#2: The Intersection of Bankruptcy and… Intellectual Property Law
#3: The Intersection of Bankruptcy and… Environmental Law
#4: The Intersection of Bankruptcy and…the Uniform Commercial Code
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Episode #1
The Intersection of Bankruptcy and…
Labor/Employment Law
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The Overlaps of Bankruptcy Law with Labor &
Employment
• Unpaid wages accrued prior to filing
• Wages earned during a Chapter 11 case
✓ Other Chapter 11 Wage Issues
✓ Treatment of Employment Contracts in Employer Bankruptcies
• Key Employee Retention Programs/Key Employee Incentive Programs
• WARN Act
• CBA Rejection (11 U.S.C. § 1113)
• Modifying Retirement Benefits (11 U.S.C. § 1114)
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Compensation Accrued Prior to Bankruptcy Filing
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• General Priority of Distribution under Bankruptcy Code. Claims against and interest in
the debtor are paid in the following order of priority:
✓ Secured indebtedness (from collateral)
✓ Administrative expenses (post-petition obligations of bankruptcy estate). See
11 U.S.C. 503(b), 11 U.S.C. § 507(a)(2)
✓ Employee wage priority. Id. § 507(a)(4)
✓ Employee benefit plan priority. Id. § 507(a)(5)
✓ Other priority claims such as consumer deposits and taxes. Id. § 507(a)(7), (8)
✓ General unsecured claims. Id. § 726(a)(2)
✓ Equity. Id. § 726(a)(6)
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(cont’d)
• Wage Priority under 11 U.S.C. § 507(a)(4).
✓ Applies to “wages, salaries or commissions, including vacation, severance, and
sick leave pay” earned within 180 days before filing or cessation of business.
✓ Covers only up to $15,150 per individual (as of April 1, 2022).
o Amount is subject to periodic adjustments for inflation.
o Wages earned pre-petition but paid post-petition count toward $15,150 priority.
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(cont’d)
• Employee Benefit Priority under 11 U.S.C. § 507(a)(5).
✓ Applies to “unsecured claims for contributions to employee benefit plans.” 11
U.S.C. § 507(a)(5).
✓ Includes contributions due to 401(k) or other retirement plans.
✓ Claims must arise from services rendered 180 days before petition date [i.e.,
commencement of bankruptcy case] or date of cessation of business.
✓ Capped at $15,150 per employee, less aggregate amount paid on account of
§ 507(a)(4) of employee wage priority.
✓ Cap applies to employee benefit plans in the aggregate, not each one
separately.
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Compensation Accrued Prior to Bankruptcy Filing (cont’d)
• First Day Motions: A series of motions typically filed with chapter 11 petition, to help
ease transition of the company (now called the “Debtor”) into bankruptcy and maintain
operations while case is pending.
• First day motions nearly always include requests to the bankruptcy court to continue
prepetition operations with respect to employees, including:
✓ Motion to pay prepetition employee wages and to continue benefits programs;
✓ Motion to approve key employee retention and incentive plans
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Compensation Accrued Prior to Bankruptcy Filing (cont’d)
• Employees need reassurance they will be paid and business operations will continue.
• Wages and benefits are pre-petition or post-petition based on when services performed,
not when payment is due. Pre-petition amounts may not be paid without bankruptcy
court approval.
• First day motion to pay pre-petition employee wages up to the priority claim amounts are
almost always granted, and generally granted for non-priority claims as well when
amount is not too great. Rationale: Employees are critical to preserving value and
priority claims are typically paid in full anyway, and paying employees is a permissible
use of cash out of the ordinary course under 11 U.S.C. § 363.
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(cont’d)
• Planning Considerations for Chapter 11 Filing.
✓ Time chapter 11 filing to address payroll issues.
✓ Leave time to obtain relief at hearing on first day motions.
✓ Pre-fund wages with payroll service. Or pay employees in cash or by bank
check.
✓ Ensure all funds withheld from employees for payment of taxes and other
obligations are separately held and disbursed, and not used to pay other debts.
✓ Company officers may be held personally liable:
o to the IRS for unpaid federal withholding taxes;
o to employees, under some states’ laws, for unpaid wages;
o to employees for funds withheld but not remitted to a benefit plan.
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Compensation Earned During the Chapter 11 Case
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• Wages earned during case generally enjoy priority “administrative expense” status to
extent benefit is conferred upon the estate. 11 U.S.C. § 503(b).
✓ Like other administrative expenses that do not expressly require court approval,
wages earned post-petition may be paid in the ordinary course of business.
✓ Bankruptcy courts typically view prevailing wages or contract wages as reflecting
benefit provided to the estate, but in theory this can be challenged.
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(cont’d)
• Wages paid during chapter 11 case that are not in the “ordinary course of business” may
be recovered as unauthorized transfers. 11 U.S.C. § 363(b) (requiring bankruptcy court
authorization for non-ordinary transactions); Id. § 549 (permitting avoidance of
unauthorized post-petition transfers).
✓ Prior court authority for substantial increases in post-petition wages should be
obtained since such increased payments may not be ordinary course.
✓ Also, since ordinary course is an uncertain factual issue, having prior
authorization significantly reduces risk.
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(cont’d)
• Distressed companies, especially distressed companies in bankruptcy, often have
problems retaining key employees. Additional incentives may be needed.
• These are commonly known as Key Employee Retention Plans (“KERP”) or Key
Employee Incentive Plans (“KEIP”).
• Since KERPs/KEIPs may not be ordinary course, prior bankruptcy court approval should
be obtained in most instances.
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(cont’d)
• If such plans are designed to “induce such person to remain with the debtor’s
business,” such plans must in the case of directors, officers and other insiders (as
defined by 11 U.S.C. § 101(31)) meet the very difficult requirements of 11 U.S.C.
§ 503(c). Thus, it is difficult to structure and obtain court approval of a KERP.
• Courts have held that a plan is not subject to the requirements of § 503(c) if it
provides incentive compensation based on the employee’s and/or the Debtor’s
performance. Thus, a KEIP will be subject only to the same requirement as any
non-ordinary-course transaction under 11 U.S.C. § 363(b), namely, that it be
approved by the court as a reasonable exercise of the Debtor’s business judgment.
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(cont’d)
• Under § 503(c), Debtor cannot make payments to “insiders” unless:
✓ KERP/KEIP payments are essential to retain the person;
✓ Services of the person are “essential to the survival of the business”;
✓ Person has bona fide job offer at same or greater rate of compensation; and
✓ Payment does not exceed 10x amount of similar transfer to non-management
employee during calendar year, or if no such transfer has been made, it may
not exceed 25x amount of any similar transfer to insider during calendar year
preceding case.
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Compensation Earned During the Chapter 11 Case (cont’d)
• Special Rules for Professional Persons.
✓ Prior bankruptcy court approval is required for the bankruptcy estate to
“employ attorneys, accountants, appraisers, auctioneers, or other professional
persons.” 11 U.S.C. § 327(a).
✓ Court approval is also required to pay professionals. Id., §§ 328, 330 and 331.
✓ The term “professional person” does not apply to ordinary course employees,
such as in-house lawyers, who would be retained regardless of the bankruptcy.
✓ An executive such as a Chief Restructuring Officer retained for the bankruptcy
needs court approval under 11 U.S.C. § 363(b) or may in some jurisdictions be
considered a professional subject to above requirements.
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Treatment of Employment Contracts in Employer
Bankruptcies
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Employment Contracts in Employer Bankruptcies
• Debtor can reject, assume, and assign “executory contracts” in bankruptcy. See 11
U.S.C. § 365. Most unexpired employment contracts are executory contracts.
• What happens from the filing of the bankruptcy petition through the time the debtor
makes up its decision?
✓ During limbo period before the debtor assumes or rejects the contract, both
parties must continue to perform. This obligation ceases upon rejection.
✓ Employee with an unexpired contract may ask court to set a deadline for debtor
to assume or reject contract. Otherwise, debtor may delay the decision until
confirmation of a chapter 11 plan.
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(cont’d)
• Rejecting a pre-bankruptcy employment contract, even though (by definition) it occurs
post-petition, is treated as a breach immediately before the bankruptcy case, id.
§ 365(g)(1), so the employee has a pre-petition claim for breach of contract.
✓ The Bankruptcy Code limits the employee’s claim to one year’s compensation,
plus any amount due as of the date the employee was terminated or (if earlier)
the date of the bankruptcy petition. 11 U.S.C. § 502(b)(7).
• Assuming a pre-bankruptcy employment contract generally elevates any future claims
for breach to post-petition administrative status. Id., § 365(g)(2).
✓ Assumption requires curing any defaults and providing “adequate assurance” of
future performance. Id., § 365(b)(1).
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(cont’d)
• If employment contract is assumed, it can be assigned to a third-party. Id. § 365(f).
✓ Employee may demand adequate assurance of future performance from the
assignee. Id., § 365(f)(2)(B).
✓ Employment contract cannot be assigned if applicable law excuses employee
from being forced to work for a new employer. Id., § 365(c)(1)(A). This is
usually the case; however, employee must object to the assignment motion.
✓ Without the safeguards of § 365, an employment contract may effectively be
assigned to a new employer if that employer obtains the stock of the debtor
under a chapter 11 plan. If this is a default under the employment contract,
employee likely has a pre-petition claim for damages against the debtor.
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Treatment of Employment Contracts in Employee
Bankruptcies
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Treatment of Employment Contracts in Employee
Bankruptcies
• An employee can reject an employment contract in a personal bankruptcy case.
• Employee is typically able to discharge monetary obligations under employment
contract through the bankruptcy process.
• Despite rejection, employer will likely be permitted to enforce non-monetary
obligations under the contract such as confidentiality and non-competition
agreements.
✓ See, e.g., In re Annabel, 263 B.R. 19, 25 (Bankr. N.D.N.Y. 2001) (permitting
action to enforce non-competition agreement in contract for sale of chiropractic
practice to continue even after chiropractor received bankruptcy discharge).
30

Treatment of Collective Bargaining Agreements
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Collective Bargaining Agreements
• As with any other contract, the Debtor has the right to assume or reject a collective
bargaining agreement (“CBA”).
• As with any other contract, assuming a CBA simply requires the Debtor to obtain
court approval as a reasonable exercise of Debtor’s business judgment.
• Rejecting a CBA, however, requires the Debtor to follow the specific procedures of
11 U.S.C. § 1113, drawn from labor law on a modified basis.
• Contract rejection gives a union legal right to strike in cases governed by the
National Labor Relations Act. See Briggs Trans. Co. v. I.B.T., 739 F.2d 341 (8th Cir.
1984).
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Collective Bargaining Agreements (cont’d)
• To reject a CBA, the Debtor must show the bankruptcy court:
✓ Debtor made a proposal to the union to modify or terminate the CBA
✓ Proposal was based on the most complete and reliable information available
✓ Proposal providing modifications in employee benefits and protections
necessary for debtor to reorganize;
✓ Union rejected proposal without good cause; and
✓ Balance of equities clearly favors rejecting the CBA.
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Collective Bargaining Agreements (cont’d)
• Logically, rejection of a CBA should give rise to a damage claim by the union,
workers who benefited from the CBA, or both. Such claims could potentially be
enormous.
• Nevertheless, some courts have held that the rejection of a CBA does not create any
claims for damages against the employer. In re Northwest Airlines Corp., 483 F.3d
170, 120 & n.3 (2d Cir. 2007) (citing Blue Diamond Coal Co., 147 B.R. 720, 734
(Bankr. E.D. Tenn. 1992), aff’d, 160 B.R. 574 (E.D. Tenn. 1993)).
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Treatment of Retiree Benefits
35

Retiree Benefits
• Under 11 U.S.C. § 1114 Debtor cannot unilaterally stop paying “retiree benefits”
unless it follows process similar to CBA rejection under §1113.
• Retiree benefits are programs to provide health care or benefits in the event of
sickness, accident, disability or death. N.B., pension benefits are not covered. See,
e.g., In re Avaya, Inc., 573 B.R. 93 (Bankr. S.D.N.Y. 2017).
• As with a CBA:
✓ Debtor must make a proposal, provide relevant information, meet in good
faith, show the proposed modification is necessary to the reorganization, etc.
✓ Court must find that retirees’ representative rejected proposal without good
cause, the equities favor modification, etc.
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Retiree Benefits (cont’d)
• Unlike § 1113, § 1114 covers both union and non-union employees
✓ Union presumed (rebuttable) to act as retiree representative by 11 U.S.C.
§1114(c)(1)
✓ Non-union retirees may be represented by a committee. Id., § 1114(d)
• Unlike CBA-rejection, it is clear that rejection of retiree benefits give rise to a claim,
and such claim is not capped pursuant to 11 U.S.C. § 502(b)(7) as would a claim for
rejection of an individual employment contract.
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WARN Act
• What is it? The federal Worker Adjustment and Retraining Notification Act
enacted by Congress in 1988 and is codified at 29 U.S.C. §§ 2101 et seq.
• Purpose: To protect workers, their families, and their communities by requiring
employers provide 60-days’ advance notice of certain plant closings and mass
layoffs. Intended to allow workers to make arrangements for a new job or retraining.
• Who’s protected? Salaried as well as hourly employees. Managerial and
supervisory personnel as well as workers.
✓ Does not cover business partners.
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WARN Act (cont’d)
• Types of employers covered by WARN:
✓ Employers with 100 or more employees, not counting
o Employees who have worked less than 6 months in the preceding 12
months
o Employees working less than 20 hours a week on average.
✓ Included:
o Private for-profit employers.
o Non-profit employers.
o Public and quasi-public entities operating in a commercial context and
organized separate from the government.
✓ But WARN does not cover:
o Federal, state, and local government entities that provide public services.
40

WARN Act (cont’d)
• Triggering Events for WARN Act notification (or liability for failure to notify):
✓ Plant Closing: Shutdown of an employment site resulting in employment loss
of 50 or more employees during any 30-day period.
✓ Mass Layoff: A layoff other than from a plant closing, that will result in
employment loss during any 30-day period:
o of 500 employees at an employment site;
o or of 50-499 employees, if they make up at least 33% of the employer’s
total active workforce.
✓ Sale of Business: Sale of business resulting in a plant closing or mass layoff
as defined above will likely be covered by WARN.
41

WARN Act (cont’d)
• Penalty for WARN violation. Employer who fails to provide a required notice under
WARN is liable to each aggrieved employee for back pay and benefits.
✓ Amount of pay will be greater of:
o The average regular rate of the employee during the preceding 3 years; or
o The final regular rate received by the employee.
✓ Liability calculated for period of the violation, up to 60 days.
• Individual or class action suit may be brought in any district court where violation is
alleged to have occurred or where employer transacts business.
42

WARN Act (cont’d)
• Employer Defenses:
✓ Temporary Facility/Project
✓ Strikes/Lockouts
✓ Faltering Company
✓ Unforeseen Business Circumstances
✓ Natural Disaster
✓ Good Faith
✓ Liquidating Fiduciary
• But these are tightly drafted. Most employers do not qualify.
43

WARN Act (cont’d)
• Some states have “mini-WARN Acts” adding to the requirements of the WARN Act.
• For example, employer may be required to notify state agencies responsible for
employment benefits and/or worker retraining.
• Some mini-WARN Acts extend liability to persons and entities in control of the
debtor.
✓ Generally speaking, the employer’s bankruptcy will not protect third parties
from WARN liability.
✓ However, bankruptcy court may enjoin such third-party actions if the WARN
claimants will be paid in full through the bankruptcy, and the third-parties are
making necessary and substantial contributions to such efforts.
44

WARN Act (cont’d)
• Effect of WARN Act claims on bankruptcy estate.
✓ Pre-petition WARN Violations. Claims usually treated the same as wage
claims, afforded priority under 11 U.S.C. § 507(a)(4) up to priority amount
($15,150) and treated as general unsecured claims thereafter.
✓ Post-petition WARN Violations. Claims usually given administrative priority
status under 11 U.S.C. § 507(a)(2).
✓ WARN Act claims can have significant impact on prospects for reorganization
efforts because priority claims typically must be paid in full on effective date of
chapter 11 plan. See 11 U.S.C. § 1129(a)(9).
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About The Faculty
Michael J. Kaczka - mkaczka@mcdonaldhopkins.com
Michael is a member in Business Restructuring Services Department of McDonald Hopkins
and resides in the Cleveland office. With engagements throughout the United States, Michael
focuses primarily on representing clients regarding strategic alternatives, including: out-of-
court and in court restructurings, workouts, bankruptcies, and receiverships; mergers and
acquisitions; refinancings; and sale transactions (both in- and out-of-court). He also advises
clients on fiduciary duties and other governance matters. Michael has experience advising
clients in a variety of industries, including manufacturing & industrial, retail, franchises,
plastics, real estate, food & restaurants, healthcare, automotive, and chemical & metallurgical.
Michael earned a Juris Doctor from Case Western Reserve University School of Law and a
Bachelor of Arts, cum laude, from Washington and Lee University.
47

Jonathan P. Friedland – jfriedland@sfgh.com
Jonathan Friedland is a senior partner in Sugar Felsenthal Grais & Helsinger LLP’s Chicago
office. He is ranked AV® Preeminent™ by Martindale.com, has been repeatedly recognized
as a “SuperLawyer,” by Leading Lawyers Magazine, is rated 10/10 by AVVO, and has
received numerous other accolades. He has been profiled, interviewed, and/or quoted in
publications such as Buyouts Magazine; Smart Business Magazine; The M&A Journal; Inside
Counsel; LAW360; Business Week.com; Dow Jones LBO Wire; and The Daily Deal.
Jonathan graduated from the State University of New York at Albany, magna cum laude,
in 1991 (after three years of study) and from the University of Pennsylvania Law School in
1994. Jonathan is also an active angel, venture capital, and private equity investor, and is the
founder and publisher of DailyDAC and Financial Poise. Click here to see his full biography.
48
About The Faculty

About The Faculty
Gary W. Marsh - gary.marsh@troutman.com
Gary Marsh is a partner with Troutman Pepper Hamilton & Sanders, LLP in Atlanta. A
veteran restructuring attorney focused on all aspects of bankruptcy, workouts, debtor and
creditor law, Gary’s practice also encompasses general commercial litigation. He represents
debtors and creditors in Chapter 11 cases, out-of-court restructurings and litigation. He also
represents court appointed receivers, examiners and trustees. Gary’s practice primarily
involves representing financial institutions and servicers in and out of court in enforcing their
rights and remedies. He also analyzes and defends against preference and fraudulent
conveyance actions, represents buyers of assets out of bankruptcy and represents landlords
and other parties who have leases or contracts with debtors. Gary has deep industry
experience particularly with healthcare, energy and real estate insolvencies.
49

Questions or Comments?
If you have any questions about this webinar that you did not get to ask during the live
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the name of the webinar in your email and we will do our best to provide a timely response.
IMPORTANT NOTE: The material in this presentation is for general educational purposes
only. It has been prepared primarily for attorneys and accountants for use in the pursuit of
their continuing legal education and continuing professional education.
50

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