A debt to an employee for wages and benefits is a priority debt if it meets certain conditions. Here’s why that matters.
We’ve been writing in recent blog posts about “priority” debts, such as child/spousal support and income taxes.
In a Chapter 7 case the bankruptcy trustee pays these in full ahead of paying anything whatsoever on other debts. See Section 726(a)(1) of the U.S. Bankruptcy Code. (That’s only if the trustee has any of your assets to liquidate, which is usually not the case.)
In a Chapter 13 case you have to pay priority debts in full during the life of the case. See Section 1322(a)(2).
Employee Wages and Benefits
There’s a type of priority debt that doesn’t come up nearly as often as child/spousal support or income taxes. But when it does it could be very important.
Under certain conditions a debt for unpaid employee wages, salaries, commissions, or benefits is a priority debt. If you’ve operated a business and owe this type of debt, it’s important to know how it’ll be treated.
Why It’s Important
Whether or not a debt for unpaid wages and benefits meets the conditions for being a priority debt especially matters if:
- You are filing a Chapter 7 case in which the trustee is paying creditors, and you prefer that your employee(s) get paid ahead of other creditors. Then you want the wage/benefits debt to be a priority debt. That way it’s more likely your employee debt(s) will get paid.
- You are filing a Chapter 13 case and you have very limited amount of money to pay your debts. Then you prefer the wage/benefits debt not to be a priority debt. That way you are not required to pay that debt in full. That makes your Chapter 13 plan less expensive to fund, perhaps turning an impossible situation into a feasible one.
The Conditions that Make a Debt to an Employee a Priority Debt
The basic rule:
- a debt for wages, salaries, or commissions (including vacation, severance, and sick leave pay)
- earned by an individual within 180 days of the bankruptcy filing or the closing of the business, whichever comes first
- up to $12,850
is a priority debt.
Chapter 7 Example
Let’s use two examples reflecting the scenarios mentioned above.
First, imagine you operated a business in your name that you closed the same day you filed a Chapter 7 case. You didn’t have the money to pay your single employee $3,000 for her final month of wages, but really want her to get paid. You also owe $100,000 in other personal and business debts.
You’re pleased to hear that $3,000 is a priority debt because it meets the 3 conditions listed above.
As your Louisville bankruptcy lawyer told you to expect, your Chapter 7 trustee asks you to turn over the last of your business equipment. The trustee liquidates the equipment, receiving $4,000. Out of that the trustee pays himself a fee of 25%, $1,000. (See Section 326(a).) The trustee pays your former employee the remaining $3,000, paying her off in full, because it’s a priority debt. Your other debts receive nothing, and are discharged (permanently written off).
Chapter 13 Example
Second, imagine you operated a business in your name that you just closed. Your single employer had quit 6 months ago. You suspect that one of the reasons your business failed is because that employee had been referring customers to a competitor, and getting paid a kickback fee. He started working for that competitor as soon as he stopped working for you. You have some evidence backing up your suspicions, but a lawyer has told you your legal case is weak against both your former employee and your competitor and simply not worth pursuing.
This employee’s regular salary was $4,000 per month. Because money was so tight during the final 6 months of working for you he agreed to let you hold back $1,500 of that salary monthly until you could afford to pay it back. The amount of back pay totaled $9,000. You feel like he owes you many times that amount of money for cheating you. And you certainly don’t want to pay him that $9,000 as a priority debt in the Chapter 13 case you’re filing.
So you’re happy to learn that this $9,000 debt is not a priority debt. It meets two of the 3 conditions listed above, but not the third one. Your former employee did not earn any of that $9,000 within 180 days of the close of the business or of the filing of your Chapter 13 case. So that debt is just a “general unsecured” debt. You pay it only to the extent you have enough disposable income to pay it, after living expenses and other more important debt. In many Chapter 13 cases the “general unsecured” debts are paid only pennies on the dollar. Sometimes they’re paid nothing.