H.R. 5525 Would Increase Wage Priority And Recover Excessive Insider Compensation

By: Prof. G. Ray Warner

Robert M. Zinman American Bankruptcy Institute Scholar in Residence
On October 2, 2002, Representative Gekas (R-PA) introduced H.R. 5525, the “Corporate Abuse Prevention and Employee Protection Act of 2002.” Like several pending bills introduced in both houses of Congress by both Republicans and Democrats, the Gekas bill would increase the wage priority, enhance the trustee’s powers to recover excessive pre-petition compensation paid to insiders, and protect retiree benefits. Unlike some of the competing bills, this bill would not apply to pending cases. The bill was referred to the Committee on the Judiciary.

Increased Wage Priority

The bill would increase the section 507(a)(3) wage priority and the section 507(a)(4) employee benefits priority from $4,650 to $10,000, and would extend the time period during which wages could qualify for priority from 90 days to 180 days. This amendment would apply to cases filed on or after the date of enactment. Since few employees will continue working without pay for an extended period, the principal effect of extending the time period to 180 days is that a greater portion of unpaid vacation, severance, and sick leave pay will be entitled to priority. In contrast, the recently introduced substitute for the Durbin-Delahunt bill, S. 2798, would increase the priority to $13,500 and would include all severance pay, not just the portion that accrued during the 180-day period.

Retiree Health Benefits

Current section 1114 prevents a Chapter 11 debtor from unilaterally modifying certain retiree benefits, such as retiree health insurance, during the case unless an authorized retiree representative is appointed and agrees to the modification, or the court authorizes the modification as necessary to the reorganization. The bill would amend section 1114 to prevent debtors from evading its requirements by terminating retiree benefit plans on the eve of bankruptcy. The bill would require retroactive reinstatement of retiree benefits that were modified within 180 days before filing if the debtor was insolvent on the date of the modification, unless the court finds that the balance of the equities clearly favors the modification. This amendment would apply to cases filed on or after the date of enactment.

Enhanced Avoidance of Fraudulent Transfers and Excessive Compensation

The bill would also enhance the recovery of avoidable transfers and excessive pre-petition insider compensation. Two changes would make it easier for the estate to avoid pre-petition transfers. First, the one-year reach-back period for fraudulent transfers under section 548 would be extended to two years. Thus, the estate could avoid both actual fraudulent transfers and constructive fraudulent transfers (transfers for less than reasonably equivalent value when the debtor is insolvent) if they occurred within two years before bankruptcy. This change would have relatively little impact in most cases since most such transfers already could be avoided under section 544(b) using very similar state fraudulent transfer laws. The provision would enhance the estate’s recovery in those cases where the state law was less expansive than section 548.

The bill would also expand section 548 to allow the recovery of excessive insider compensation during the two years prior to bankruptcy. In order to be avoidable, the transfer or obligation would have to satisfy four conditions: (1) the transfer or obligation must arise under an “employment contract;” (2) it must be to or for the benefit of an insider, including officers and directors of the debtor; (3) the debtor must have received less than a reasonably equivalent value in exchange for the transfer or obligation; and (4) the transfer or obligation must be outside of the ordinary course of business. Since the current provisions of section 548 could reach many of the transfers and obligations addressed by the amendment, the change will have limited effect. The principal differences between the amendment and current law are that the amendment would extend the reach-back period from one year to two years and would allow recovery in cases where the debtor was not insolvent but the transfer or obligation was outside the ordinary course of business. However, since the section 548(a)(1)(B)(ii) constructive fraud provision already includes prospective insolvency (unreasonably small capital and expectation of incurring debts beyond ability to repay) as an alternative to insolvency, there will likely be few cases where the estate will need to rely upon the new “non-ordinary course” alternative to insolvency.

The amendment expanding the section 548 reach-back period to two years has a delayed effective date and will apply to cases filed one year or more after the date of enactment. The remaining changes to section 548 apply to cases filed on or after the date of enactment.