What can HR do about pay, benefits and contracts when a company files Chapter 11?

When times get tough, many owners turn to lawyers to determine whether filing for bankruptcy might help. If they decide to file, it’s crucial for their Human Resources departments to stay on top of how bankruptcy law affects their employees. This article focuses on Chapter 11 reorganization. Chapter 7 bankruptcy would liquidate the company. What follows is an overview of some of the issues that human resources staff and executives typically run into during bankruptcy.

With Chapter 11, the debtor company keeps running as a “debtor-in-possession” while it tries to resolve its debts. The main goal is to restructure them by shedding some and cutting deals to pay off others. The court sometimes approves selling the business as a going concern, to keep it alive that way. When bankruptcy is filed, an automatic stay goes into effect. From the Petition Date (the filing date) on, there’s a kind of time warp that happens to your creditors. As far as they’re concerned, time stops. For one thing, they can’t collect from you. It’s an abrupt stop, intended to give the bankrupt a breather from the crush of debt, so it can try to get reorganized.

In general, you can keep operating and paying your people for the work they do from then on. The court expects you to keep up normal operations as a debtor-in-possession (DIP), so there should be no problem paying employees and administering benefits in the ordinary course of business, for “post-petition” employment. During bankruptcy, in what’s called the post-petition period, a company needs special permission to pay a pre-petition debt. That includes money owed to employees, or benefits like retirement plans they’re part of. But you should keep post-petition payments separate from amounts owed for work before the case was filed. In other words, you’re going to need two buckets: one for payroll post-petition, one for payroll pre-petition.

Usually, routine employee relations decisions about hiring, firing, promoting, transferring, and the like are allowed. But do things in the ordinary course. Anything out of the usual run of your business is questionable. Keep restructuring counsel informed of decisions in employee relations that are a little out of the routine. Your lawyer can let you know if court approval is needed. Besides the bankruptcy law itself, you also need to watch other parts of the law too, and not let them fall by the wayside. For example, the federal WARN Act might still require notice of mass layoffs. Many states have their own WARN laws. Bankruptcy isn’t an excuse for breaking this law.

Executive Contracts

Courts will often let you hire executives and give them the standard employment deal you give others. But you should always think about getting court approval beforehand. If the deal gets hammered out afterward, odds are it’s not what the business as usual rule covers, and you may have to seek approval before you make this hire. Judges look at three things for executive contracts that they want to approve: First, those with decision making authority have to have enough information about what’s at stake to be able to make a wise choice about whether to hire the person. Second, the good faith requirement means that there’s been no fraud or deceit among the company’s decision makers. And finally, they must honestly believe the deal serves the company’s best interests. You should always check with restructuring counsel before deciding what an executive’s salary should be, including pay, perks, the whole package. You may need court approval.

Top corporate officers, along with the directors and other insiders who run the company, are limited in what they can take as a retention bonus. The big test is whether there’s a job offer on the table from another company that pays at least as much. You also need to prove the services are necessary for the survival of the company. The third hurdle, a dollar cap, keeps retention deals to reasonable levels. An insider can’t be paid more than the average retention bonus the company pays rank-and-file employees that year, times ten. If they got none, the cap is 25% of any similar payment to that insider that calendar year. Look for the work-around here: they call it a key employee incentive plan (KEIP) instead. You’ve got to get court approval for one of these. You may be better off letting bankruptcy counsel design a key employee plan you can try to get court approval on. Bankruptcy counsel can tell you what the right paperwork is, in working with the judge on approval, and how to customize it for your situation.

Watch out for putting your company on the hook for severance deals you make in the weeks just before filing bankruptcy. Any employment or severance deal you make shortly before filing bankruptcy should get a lawyer’s review. The courts take a closer look at everything that’s signed close to bankruptcy. The court wants to see whether the bankrupt gets value from a transaction that’s close in time to filing bankruptcy. If it turns out the company was insolvent when it made the promise, or just didn’t get enough in exchange, the deal can be voided and payments clawed back. How far back that reaches depends on the law and the facts of the deal.

When you file for bankruptcy, existing severance agreements can also be vulnerable. To reject an executory severance contract (an agreement where both sides still owe each other something), you have to go to court to get it rejected. Rejection means you stop having to perform. You don’t have to make severance payments after the bankruptcy court approves rejection of a contract. The employee can then file a pre-petition breach of contract claim, which may be capped by the Bankruptcy Code. The Bankruptcy Code limits severance that insiders can get in Chapter 11. For one thing, you have to give all the full-time employees severance to cut insider deals at all. Besides that, it can’t be more than ten times the average severance paid that year to non-management personnel who aren’t insiders.

Unpaid Wages and Benefits

Think about how much pay and benefits your employees are already owed at the time of filing. To reorganize these debts will be a key part of your company’s Chapter 11 reorganization plan. Unpaid wages and benefits from before you filed for bankruptcy are typically a priority unsecured debt, which means it’ll get paid before general unsecured claims, but only after secured debts. The priority covers hourly pay, salary, commission, vacation pay, severance pay and sick days. Those benefits earned within the last 180 days before the business closes or files for bankruptcy protection are covered, up to a total of $13,650 per person, adjusted for inflation every three years. Pay that was earned outside the 180-day window or in excess of the priority claim cap loses priority. This portion of the wage claim becomes general unsecured. And don’t forget unpaid contributions to a pension plan. If certain conditions are met, those can count as priority debt too. One of the first things a bankruptcy lawyer will do after filing is ask the court for permission to pay pre-petition compensation claims like this. Most often, the request goes through without issue if the right hoops were jumped through beforehand. Your lawyers can help you map out a reorganization plan you can live with, one that jibes with the law, too.

Reject a Pre-petition Employment Contract

An employment contract not yet expired is also “executory.” Both parties still owe something under it, so unless it’s rejected, it will stick. If you want to reject a pre-petition employment contract, you need to file a motion and have the court approve it. The employee can then file a breach of contract claim against the estate for what was owed under the agreement. If there’s a collective bargaining agreement with a union, you can’t reject it or change its terms without first going through a kind of fast-track bargaining. If negotiation fails and the company still wants changes, it needs court approval to reject the CBA. But it has a few hoops to jump through. Three things have to happen to justify rejecting a CBA. First, the court has to see that the company proposed only the changes needed to get the business through the bankruptcy, treating all parties fairly. Second, the union has to be shown to have “refused to accept those changes without good cause.” Third, the balance of the equities has to tip strongly in favor of the rejection.

If the terminated worker has a contract with post-employment restrictions, like a nondisclosure agreement, a noncompete or a nonsolicitation clause, the Chapter 11 filing won’t excuse them from the duty to perform those obligations. That assumes the covenant is valid under applicable law.

The automatic stay only protects a Chapter 11 debtor. It stops suits against the company, but not others who could be liable, including officers. So an employee’s pending suit against the company is put on hold. But a manager or officer sued personally has to go on defending the case, because the automatic stay doesn’t shield individuals. And regulatory agencies have more leeway than other creditors. If there’s a regulatory proceeding, the enforcement action will probably go on, as long as the action is to enforce a police or regulatory power, not a claim for money. This is so even on a pre-petition claim.