An employee who felt he had been wrongfully discharged by his employer filed a complaint with the National Labor Relations Board (NLRB). However, ten days later, the company filed for Chapter 11 relief.

The employee won his case in court and was told he should receive $13,069.40 representing back pay and net fringe benefit contributions.

Editor's Note: This article originally appeared in the Credit & Collection Manager's Letter, which Credit Today purchased in 2006.

The NLRB filed its proof of claim with the bankruptcy court and asked that the claim be treated as a first priority administrative expense. It said that since the company's actions had been wrongful, the wages deserved special priority. To treat them otherwise would mean the company would be allowed to profit (or conversely that the employee would suffer) as a result of the wrongful discharge.

The court did not agree. It noted that "Administrative expenses are defined as 'the actual, necessary costs and expenses of preserving the [bankruptcy] estate, including wages…for services rendered after the commencement of the case.'"

Wage claims not entitled to administrative priority are treated as general unsecured claims entitled to the lowest priority except that the first $2,000 of an individual's wages earned within the 90-day preference period are accorded a third priority.

Therefore, only wages deemed necessary for the preservation of the bankruptcy estate--i.e. wages paid to workers who kept the company running while it was reorganizing--could be considered administrative expenses.

The court noted that this employee had not even been in the company's hire when post-petition work was being done. The NLRB argued that if the company hadn't fired the employee illegally, he would have been available for work during the reorganization stage. It insisted that it was unfair to punish the employee for the wrongdoing of his employer. The court replied that any suffering by the employee "will be identical to that of similarly situated creditors and, whatever [the company's] wrongdoing in laying off [the employee]…is defunct and any attempt to 'punish' the bankruptcy estate for [the company's] sins would only hurt innocent creditors."

Next, the NLRB tried to argue that it should be federal labor law, and not bankruptcy law, that determined how the employee's money should be handled. Again, the court disagreed. It said that since the issue was not whether the unlawfully discharged employee had a claim, but rather whether that claim should have priority status, the Bankruptcy Code governed the issue.

Therefore, since the employee's wages had not been earned after the company filed for bankruptcy, they could not be given administrative priority. However, some of the back wages ordered by the court had been earned within the 90-day preference period. Therefore, that portion of the claim would be given a third priority while the remaining amount would be treated as a general unsecured debt.

In re Palau Corp., 18 F.3d 746 (9th Cir. 1994)

Comment: If you are involved with a customer that is reorganizing under Chapter 11, pay close attention to how employee wages are handled. Only those wages earned by employees after the bankruptcy filing are given a first priority--and they must have been doing work that was necessary to the preservation of the bankruptcy estate. If the company had failed to pay its workers prior to filing for bankruptcy, monies earned in the 90-day preference period are given a third priority. Any wages that fall outside this period are treated as general unsecured claims.

Editor's Note: The above article originally appeared in the Credit & Collection Manager's Letter, a newsletter purchased by Credit Today in 2006. This article originally appeared prior to 2000.