News of protests among the 33,000 Toys R Us employees impacted by the retail giant’s bankruptcy grabbed headlines last week. The Wayne, New Jersey-based institution announced the immediate closure of nearly 200 stores upon filing for bankruptcy last fall, and liquidation sales at the remaining 700+ stores are well underway. Employees are outraged by their lack of severance pay, particularly when the executives received millions in retention bonuses on the eve of the bankruptcy filing, and the bankruptcy court approved an additional bonus plan during the proceedings.
Why the disparate treatment of employees and executives? It’s complicated.
Payment of employee and executive compensation in bankruptcy proceedings is the product of a web of applicable bankruptcy and non-bankruptcy state and federal laws. Within bankruptcy law alone, there are no less than nine (9) different classifications of claims, broadly falling within three general categories: (1) administrative, (2) priority, and (3) general unsecured.
• Bankruptcy Claims and Priorities. The difference in priority and timing of payment to employees in the event of bankruptcy is explained, in large part, by the bankruptcy claim classification scheme. Administrative claims, as the name signifies, comprise the costs and expenses of administering the bankruptcy case, which necessarily includes the fees and expenses of the legal, financial, and other professionals charged with conducting the proceedings. Administrative status is also bestowed upon the employees that are retained to operate the business while the bankruptcy case is pending. As a result, executives and other key employees tend to move to the head of the line when the company’s assets are disbursed during the bankruptcy case. Whereas employees who are subject to layoffs and store closings, as in the Toys R Us case, are, with some exceptions, paid like other creditors, as general unsecured claims. Executive bonuses are more controversial, because they involve the discretion of the bankruptcy courts.
• Non-Bankruptcy Law. Non-bankruptcy law also factors into employee compensation in bankruptcy.
- Employees have some protection in bankruptcy under federal and state laws, such as the U.S. Worker Adjustment and Retraining Notification (WARN) Act of 1988 (29 U.S.C. § 2101, et seq.) and in New Jersey, WARN Act (N.J.S.A. 34:21-1, et seq). These laws generally require businesses of a certain size to provide 60 days’ written notice before a mass layoff, or, upon an immediate termination, pay 60 days’ of wages and benefits. Bankruptcy courts in most jurisdictions recognize the continued applicability of the WARN Acts in bankruptcy, but to varying degrees. The nature of the bankruptcy case and the timing of a layoff may determine the priority of employees’ claim.
- For example, if an employee is laid-off prior to a Chapter 11 bankruptcy filing, the courts will generally permit the employee to assert a priority claim in the bankruptcy case for only a portion of the amount owed. The remaining balance will be relegated to the general unsecured class. Even then, the priority portion of the claim may not be paid, as administrative priority claims, such as claims of the retained employees and other professionals that administer the case, may exceed the funds available for distribution.
- If an employee continues to work for a company in a Chapter 11 reorganization, after the petition is filed, the employee’s paycheck should receive top-level administrative priority treatment.
- Timing is also an issue. Administrative priority claims are often paid during the course of the bankruptcy case; whereas, priority and general unsecured claims are paid, if at all, upon the conclusion of the case - either through a bankruptcy plan or in a liquidation.
• Executive Compensation
- Executives that continue to operate the business through bankruptcy are paid on the top-priority administrative level, and may receive bonuses, subject to court approval, based on, for example, benchmarks achieved in the bankruptcy case. Bonuses in bankruptcy tend to raise controversy. The justification for executive compensation in bankruptcy is typically rooted in the need to retain the individuals who have institutional knowledge of the business. This knowledge is critical to the success of a bankruptcy case. Many businesses file for bankruptcy with plans to reorganize but end up in a liquidation scenario due to the company’s inability to propose a viable plan.
- By the math, a company’s successful emergence from bankruptcy, with the going concern value that will be salvaged for the enterprise and its employees, far outweighs the expense of paying key executives to steer the business through the troubled waters of bankruptcy. In addition, without bonuses, well-performing executives have a strong incentive to find work elsewhere upon a bankruptcy filing. Running a business in bankruptcy is a round-the-clock job. Executives not only operate the day-to-day of the struggling business, they are frequently required to testify in depositions and/or in court, compelled to justify their every decision, and otherwise charged with navigating the legal morass of bankruptcy proceedings.
For more information, contact Lauren Paxton at or 908-964-2453.
Lauren is an Employment and Bankruptcy lawyer at the Firm, and former Assistant United States Attorney and bankruptcy lawyer for the United States government. She has represented a wide-range of creditors and insiders in both large and small Chapter 11 bankruptcy cases in the Bankruptcy Courts for the Southern and Eastern District of New York, the District of New Jersey, and the District of Delaware.