Employee Claims--Priority and Treatment in Chapter 11

Employee Claims--Priority and Treatment in Chapter 11

by Kenric D. Kattner and Arthur T. Carter


Certain types of employee related claims are accorded priority treatment under the Bankruptcy Code. Generally, unsecured claims against a debtor are only entitled to priority treatment if: (a) the Bankruptcy Code explicitly grants priority treatment or (b) the claim arose postpetition and can qualify as an administrative expense of the bankruptcy estate under section 503(b). Section 507 lists the priorities of certain types of unsecured claims against a debtor. Specific provisions of section 507 address the priority of particular employee claims. If an employee claim is not entitled to priority treatment, then it is treated as a general unsecured claim against the debtor.

A debtor must pay its administrative expense claims in full to confirm a chapter 11 plan. Thus, a debtor will want to pay particular attention to employee claims that arise postpetition and take steps to avoid incurring unnecessary employee claims entitled to administrative expense status. Similarly, certain employee claims that are granted priority status under section 507 must be paid in full, either over time, or on the effective date of a chapter 11 plan. The timing of when an employee related claim arises, and its resulting administrative or priority status, is of significant importance to confirming a chapter 11 plan and a successful exit from bankruptcy. This section provides a brief introduction to the priorities given to common employee related claims under the Bankruptcy Code, including section 507.

Claims for Unpaid Wages, Salaries, or Commissions: Section 507(a)(4)

Section 507(a)(4) provides that an employee claim for unpaid wages, salary, or commissions, including vacation, severance, and sick leave pay, is entitled to fourth priority treatment. Section 507(a)(4) also grants fourth priority treatment to sales commissions earned either by an individual or by a corporation with only one employee acting as an independent contractor in the sale of goods and services for the debtor. Sales commissions are only granted priority treatment if at least 75 percent of the commissions earned during the 12 months preceding the petition date (or, if earlier, the date of cessation of the debtor's business) were earned from the debtor.

The amount of the claim entitled to priority under section 507(a)(4) is limited to $11,725, and the claim must have been earned by the employee within 180 days before the petition date or the date of cessation of the debtor's business, whichever is earlier. Any part of the claim in excess of $11,725 or earned prior to the 180-day window is a general unsecured claim. A claim for unpaid wages, salaries, or commissions is generally considered "earned" at the point when the employee had a right to payment of such amounts under the applicable contract, rather than the point when the amounts were to be paid. [footnotes omitted]

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Kenric D. Kattner (Ch. 12, "Employment and Labor Issues in Bankruptcy") is a partner in the Houston office of Haynes and Boone, LLP, where he specializes in bankruptcy, insolvency, and litigation matters and has been involved in numerous bankruptcy, reorganization, and litigation cases involving heavily litigated and complex legal issues. He has experience with many reorganization efforts representing debtors, secured and unsecured creditors, committees and asset purchasers in a wide range of cases involving manufacturing companies, airlines, computer and software firms, hospitality businesses, strategic asset acquisitions, retailers, wholesalers, real estate companies, service firms, travel agencies, and individuals. Mr. Kattner is a graduate of Southern Methodist University (B.A., 1983; B.B.A., 1983) and the Southern Methodist University Dedman School of Law (J.D., 1988).

Arthur T. Carter (Ch. 12, "Employments and Labor Issues in Bankruptcy") is a partner in the Dallas, Texas, office of Haynes and Boone LLP. Mr. Carter is Board Certified, Labor and Employment Law, Texas Board of Legal Specialization, and has more than 30 years of labor and employment law experience. He advises clients on the labor law aspects of complex business transactions including mergers, acquisitions, asset and stock sales, business reorganizations and bankruptcy. He also counsels employers on strategic considerations relating to collective bargaining and labor relations, and regularly serves as principal spokesman for management in labor contract negotiations. In litigation matters, he handles whistle blower complaints under the health safety and environmental laws administered by OSHA, wrongful discharge, breach of employment contract, employment discrimination, employment related torts and restrictive covenants. In addition to his legal practice, Mr. Carter is an Adjunct Professor at Dedman School of Law, Southern Methodist University, and teaches labor law, and labor and employment law arbitration. Mr. Carter is a graduate of the the University of Minnesota (B.A., 1973) and University of South Dakota School of Law (J.D., 1976).