Bankruptcy and Creditors’ Rights Issues for Employers Terminating Employees

In response to the coronavirus (COVID-19) pandemic, many employers in various industries have been reducing hours and pay, or in many cases, closing their sites indefinitely. Employers can reference the article below for strategic ways to limit their liability when terminating or laying off employees during the coronavirus pandemic and contact Ice Miller LLP for additional information and assistance.

WARN Act
As employers continue to evaluate the impact of coronavirus on their workforce, they should consider whether any workforce decisions will trigger notice requirements under the federal Worker Adjustment and Retraining Notification (WARN) Act or state-law equivalents. The WARN Act, in sum, requires employers with 100 or more full-time employees (or 100 or more employees who in the aggregate work at least 4,000 hours per week, exclusive of overtime work) to give 60 days advance notice of “plant closings” and “mass layoffs” to employees. If the WARN Act applies, an employer should provide notice to impacted employees as soon as possible to minimize potential liability. It is important to:
 

1. Analyze whether the employer is entitled to a reduced notice period under applicable WARN Act exceptions recognized in the employer’s jurisdiction—i.e., (i) the faltering company exception, (ii) the unforeseen circumstances exception, or (iii) the natural disaster exception—and whether the current coronavirus (COVID-19) pandemic is likely to meet such exceptions. Note that as more time passes, some of these exceptions are less likely to apply.
2. Assess whether it is financially possible or practical to continue paying employees for the 60-day WARN Act period. If it is not, weigh the financial implications of complying with the WARN Act against the ramifications for not complying in case courts do not recognize an exception to the WARN Act for the employer.
3. Assess whether the employer could face bankruptcy or an insolvency proceeding in the future. Courts have held that a bankruptcy filing does not necessarily relieve an employer from its obligations under the WARN Act or from its liability for violating the WARN Act. Any unsecured claims for WARN Act violations could be entitled to priority status under the Bankruptcy Code, especially for employees terminated after the bankruptcy filing.
4. Remember that the WARN Act provides for stiff penalties for non-compliance, including up to 60 days of pay back and benefits, along with civil penalties of up to $500 per day. More significantly, it provides for a private cause of action in federal court, which means that employers may soon be responding to lawsuits arising under the WARN Act.
5. Consult with counsel if you are in doubt of whether your current situation triggers a WARN Act qualifying event or whether your business is in compliance with the WARN Act. Here is a link to an earlier article from our Labor, Employment & Immigration Group that addresses some additional WARN Act questions to consider.

Employment Separation Agreements to Limit Potential Future Liability
If an employer has to terminate employees as a result of the coronavirus (COVID-19) pandemic, it will be vital to draft separation agreements strategically to limit potential liability. Note the following:
 

1. If you can afford to offer terminated employees severance payments, you should obtain enforceable releases that can be written to effectively fix your liability in connection with the terminations to no more than the severance payments and prevent additional liability for wrongful termination claims and related legal costs. Generally, the separation agreement and release should be drafted such that upon signing it, the employer is released of all potential liability except for the contractual obligation to render the severance payments.
2. If you are terminating employees and, for some reason, cannot obtain a release and there are no grounds to terminate for cause, termination letters should clearly state that the employees’ positions are being eliminated due to economic necessity. However, you should not expressly admit that you are insolvent or unable to pay debts as they become due because creditors may use that admission to help force you into an involuntary bankruptcy. For extra caution, the employer should also be sure that this is not reflected in any corporate minutes.
3. If you are terminating employees, consultants, or independent contractors governed by agreements for fixed terms (as opposed to “at-will” employees), consider any force majeure clauses or defenses to early termination of the agreement.
4. The current crisis has reminded us that anything can happen and economic conditions may worsen for many employers. Thus, employers may consider including in their separation agreements a detailed force majeure or impossibility clause to help reduce or delay the obligation to make severance payments that will become due in the future if the employer is unable to pay.

Priority of Liabilities in Bankruptcy—Terminate Employees Sooner Rather than Later
If you are going to terminate employees at some point in the near future, it is wise to terminate them sooner rather than later. You must keep in mind the priority of liabilities in bankruptcy:
 

1. Wages earned before bankruptcy. An employer will still be liable for claims for wages, salaries, or commissions—including vacation, severance, and sick leave pay earned before the bankruptcy filing—that will be treated as unsecured claims with no priority (i.e., other things that may be more important to your restructuring can be paid first and you will have greater leverage to pay less than the full amount of such pre-bankruptcy wage claims) except that any such wages earned within 180 days before the bankruptcy or cessation of the business will be given priority in bankruptcy up to $13,650 per employee.
2. Wages earned after bankruptcy. Wages earned after a bankruptcy filing will be given higher “administrative expenses” priority and will have to be paid in full in order for the employer to confirm a bankruptcy plan. So, if bankruptcy is possible in the future, an employer will want to terminate employees who are not needed sooner (rather than later) to limit the number and amount of wage claims that may be entitled to priority.
3. Characterization of “severance” and “termination.” Termination notices and separation agreements should effectively state that employment is terminated and clearly characterize payments as severance earned as of the date of termination to prevent it from being misconstrued as wage claims earned at a later date and potentially entitled to priority in a bankruptcy in the future.

Severance Payments to “Insiders”
Severance payments to “insiders” (generally defined under the Bankruptcy Code as officers, directors, persons in control of the business, and relatives of such individual(s)) could be subject to lawsuits to avoid or clawback the severance payments. This is especially likely if the payments are unreasonably generous and unfair to the employer. Such a lawsuit could be commenced as a fraudulent conveyance brought by creditors of the employer if the employer becomes insolvent. The lawsuit can also be brought on behalf of the employer’s bankruptcy estate if the employer files bankruptcy, even if the filing is as much as one year after the severance payments to “insiders.”

Conclusion
When nearing or within the zone of insolvency, the fiduciary duties of officers and directors may expand to include creditors and other stakeholders. It is imperative that the fiduciary duties are assessed under applicable law and complied with and that corporate formalities are satisfied.


Tami A. Earnhart is a partner in Ice Miller’s Labor and Employment Group and Health Care Group. She represents employers in all aspects of employment and labor law, including discrimination and other litigation, claims filed with administrative agencies, and labor arbitrations. She helps employers avoid employment disputes, when possible, and advises companies in making personnel decisions, drafting agreements, and creating policies in compliance with state and federal laws.
 
Chelsea Abramowitz is a law clerk in Ice Miller’s Business group (admission to the New York state bar pending). Chelsea earned her juris doctor from Fordham University School of Law and has a degree in public health from Tulane University.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.