Articles & Advisories Publication: American Bankruptcy Institute Committee Newsletter

Bankruptcy Basics: Employee Wage Motions in Chapter 11 Cases

A company’s decision to file for chapter 11 bankruptcy protection will inevitably cause disruption to the debtor’s operations, communications and daily routine, especially at the start of the bankruptcy case. In order to minimize these disruptions and to provide reassurance to its employees, creditors and vendors, a chapter 11 debtor generally files a series of “first day” motions concurrently with, or shortly after, the filing of its chapter 11 petition.

First-day motions can be administrative or operational in nature. Administrative first-day motions are those that seek orders from the bankruptcy court to allow the bankruptcy case itself to run efficiently, such as first-day motions filed by large debtors that seek the joint administration of its bankruptcy cases. Operational first-day motions, on the other hand, are those that seek relief from the bankruptcy court so that the debtor may continue its normal business operations during the bankruptcy case without interruption. Employee wage motions are one type of operational first-day motion.

In employee wage motions, debtors seek authority from the bankruptcy court to pay pre-petition employee claims, including wages and salaries, business expenses, benefit programs (including medical, dental and insurance programs), 401(k) and other plan contributions, and vacation, sick and other paid leave benefits. It is not practical for a debtor to pay these types of employee claims prior to the bankruptcy filing because employees, like most creditors, are paid in arrears. Employee wage motions are therefore crucial to a debtor’s continued operations because once the debtor files for bankruptcy, it no longer has authority to pay any pre-petition claims, including pre-petition employee wages and claims, except under a plan of reorganization or other court approval. The debtor hopes that by making these payments, its employees will continue working for the debtor, thus preserving the debtor’s value as a going concern and minimizing any disruptions in its business operations.

Employee wage motions generally seek relief pursuant to § 105(a) of the Bankruptcy Code. That section empowers the court to issue any order that is “necessary or appropriate” to carry out the provisions the Bankruptcy Code. This equitable power granted to bankruptcy courts led to the development of the “doctrine of necessity” or “necessity of payment” rule, which provides that bankruptcy courts may “authorize a debtor in a reorganization case to pay prepetition claims where such payment is essential to the continued operation of the debtor.”[1]

Debtors will also rely on § 507(a)(4) and (a)(5) of the Bankruptcy Code, which provides that employee claims for “wages, salaries, or commissions, including vacation, severance, and sick leave pay” earned within 180 days before the debtor’s petition date, and claims against the debtor for contributions to employee benefit plans arising from services rendered within the 180 days before the petition date, are afforded unsecured priority status to the extent of $12,475 per employee. Most employee wage claims will fall under the limits imposed by the statutory cap provided in § 507(a)(4) and (a)(5).

The debtor should include as much information as possible in the motion about its employees and the nature of its employee claims. Certain bankruptcy courts have issued administrative orders specifically requiring certain information to be provided in first-day motions, including employee wage motions. In the U.S. Bankruptcy Court for the Eastern District of New York, for example, employee wage motions must include, among other items, the gross amounts to be paid per employee and in the aggregate, as well as an estimate by category (salaries, commissions, reimbursable business expenses, etc.) of the aggregate amounts proposed to be paid by the debtor.[2]

On Dec. 8, 2014, the ABI Commission to Study the Reform of Chapter 11 released its Final Report and Recommendations.[3] The Commission spent three years analyzing the workings of chapter 11 bankruptcies, and the Final Report summarizes (at a slim 400 pages!) the Commission’s recommendations to improve and reform the chapter 11 process. With respect to employee wage motions, the Commission recommended two reforms. First, the Commission recommends that § 507(a)(4) and (5) of the Bankruptcy Code be combined to create a single priority in the aggregate amount of $25,000 per employee, without an earnings period limit, the amount of which would be applied first toward wage claims and second toward employee benefit plan contributions. Second, the Commission recommended that debtors be allowed to pay wage and benefit plan priority plans in an amount up to the per-employee statutory cap, without an order of the court, provided that the debtor files a notice of the amount of such proposed payments. This recommendation, if adopted, would obviate the need for a first-day employee wage motion to be filed by a chapter 11 debtor and would provide the debtor with a greater opportunity to continue its normal payroll operations without interruption.

1. In re Ionosphere Clubs Inc., 98 B.R. 174, 176 (Bankr. S.D.N.Y. 1989).

2. Administrative Order No. 565, In re Adoption of Guidelines for First Day Motions, Bankr. E.D.N.Y. (July 2010).

3. See commission.abi.org/full-report (page last visited on Aug. 25, 2015).

This article was originally published in the September 2015 edition of the American Bankruptcy Institute’s Young and New Members Committee Newsletter.