Opinion
No. 01-80225
April 2, 2003
OPINION
Before the Court are the objections filed by Charles F. Covey, the Chapter 7 Trustee (TRUSTEE), to various claims filed by the former employees (EMPLOYEES) of the Debtor, Redco, Inc. (DEBTOR), seeking priority treatment for separation pay benefits.
The DEBTOR, a manufacturer of electrical machine components, shut its doors on January 12, 2001. An involuntary petition for relief under Chapter 7 was filed on January 19, 2001, and an order for relief was entered on Feb. 20, 2001. Proofs of claim were filed by many of the EMPLOYEES, seeking priority treatment for wage claims, including vacation pay, personal hours and separation benefits due under the provisions of their Collective Bargaining Agreement. The TRUSTEE objected to those claims, contending that only some of the EMPLOYEES were entitled to priority status for a portion of their claims for severance pay, and that the remainder of the EMPLOYEES' claims should be treated as general, unsecured claims. The EMPLOYEES responded to the TRUSTEE'S objection, and the Court took the matter of the EMPLOYEES' right to separation pay benefits under advisement. Both sides have filed briefs and the Court has carefully considered the issue.
The following numbered claims, filed by the EMPLOYEES, are at issue: 14, 15, 17 through 22, 24 through 27, 29, 30, 32 through 41, 43 through 51, 54, 55, 57, 58, 60 through 63, 65, 66, 68 through 71, 74 through 77, 81, 82, 84 through 86, 90, 94, 147, and 159. The Court will not apply its ruling to each claim individually, but will direct the TRUSTEE to submit an order allowing the EMPLOYEES' claims in accordance with its ruling.
The right of the DEBTOR'S EMPLOYEES to separation pay benefits is set forth in Section 11.12 of the Collective Bargaining Agreement between the DEBTOR and the EMPLOYEES' union, captioned "Plant Closing/Separation Payment," which provides, in pertinent part:
The EMPLOYEES were members of the Local Union #34 of the International Brotherhood of Electrical Workers.
Should the Company totally cease manufacturing operations within the Greater Peoria Area as defined in Section 11.11 the Company shall provide a separation payment for each employee. (Personnel who accept a transfer to any location within the Greater Peoria Area and those who have declined a transfer to a new location within the Greater Peoria Area will not be eligible for a separation payment), then employed with seniority status, equal to one (1) weeks pay for each full year of seniority up to a maximum of ten (10) years or ten (10) weeks of pay at the then current hourly rate of pay This separation payment will be in addition to any other benefit contained in this Agreement and will be made within thirty (30) days of the cessation of operations. Payment will be made on a separate check.
The Collective Bargaining Agreement does not define "seniority" but from a reading of the agreement as a whole, it would appear to have the meaning ordinarily attributed to it under such contracts of "length of continuous service in the employment of the [company]." See Perez v. City of Laredo, 82 S.W.3d 605 (Tex.App. 2002); See, also, Mwachande v. System Parking, Inc., 2003 WL 366581 (N.D.Ill.).
Article XI of the agreement, captioned "Seniority" does not contain a definition, but Section 11.01, dealing with an employee's probationary period, supports this conclusion. It provides that an employee retained beyond the prescribed probationary period, "shall have his original date of hire as his seniority date."
Whether an employee's claim is entitled to priority status is determined by Section 507(a)(3)(A) of the Bankruptcy Code, which establishes priority treatment for allowed unsecured claims for wages earned by an individual, specifically including severance pay. That section provides:
(3) Third, allowed unsecured claims, but only to the extent of $4,300 for each individual . . . earned within 90 days before the date of the filing of the petition or the date of the cessation of the debtor's business, whichever occurs first, for—
(A) wages, salaries, or commissions, including vacation, severance, and sick leave pay earned by an individual. . . .
Contending that the Collective Bargaining Agreement provides that severance pay accrues only during the first ten (10) years of employment, the TRUSTEE takes the position that EMPLOYEES who had reached that benchmark prior to the ninety-day (90) period preceding the bankruptcy, are not entitled to priority status for any portion of their claim, because no portion would have been "earned" within the ninety (90) days of the DEBTOR'S filing. As for the remaining EMPLOYEES, the TRUSTEE contends that they are entitled to a priority claim only for that portion of the separation payment which accrued during the ninety-day (90) period preceding the filing of the petition.
The EMPLOYEES, relying on the rationale that severance pay is compensation for the hardship resulting from job loss, argue that the full amount of the separation pay was earned by the EMPLOYEES on January 12, 2001, when the DEBTOR closed its factory. Alternatively, the EMPLOYEES contend that in order to qualify for a separation payment, they were required to maintain "seniority status" on the date the DEBTOR ceased operations, a standing which imposed certain continuing obligations upon them. For instance, under Section 11.05 of the Collective Bargaining Agreement, governing loss of seniority, an employee's seniority would be terminated if the employee was absent from work for three (3) consecutive days without notice to the DEBTOR. In addition, the EMPLOYEES assert that they were required to remain in good standing by complying with company rules and to avoid taking any actions or engaging in behavior which would result in being terminated for cause under the agreement.
The EMPLOYEES refer to the "holding" of Trustees of Amalgamated Ins. Fund v. McFarlin's, Inc., 789 F.2d 98 (2d Cir. 1986), but, as noted by the court in In re Commercial Financial Services, Inc., 233 B.R. 885 (Bankr.N.D.Okla. 1999), aff'd 246 F.3d 1291 (10th Cir. 2001), McFarlin's did not involve claims for severance pay, but was a pension withdrawal liability case. Distinguishing cases involving severance pay claims from that presently before it, the court in McFarlin's noted that "[t]hese decisions rest on the basis that severance pay is compensation for the hardship which all employees, regardless of their length of service suffer when they are terminated and that it is therefore `earned' when the employees are dismissed." The court's passing commentary is often cited as authoritative by other courts.
The cases cited by the EMPLOYEES involve allowance of severance payments payable by a debtor in possession as administrative claims, rather than the allowance of prepetition claims, thus raising different considerations.
Historically, employee's claims for severance pay have been separated into two (2) categories. See In re Public Ledger, 161 F.2d 762 (3d Cir. 1947); 4 Collier on Bankruptcy ¶ 507.05[5][b] (15th Ed. Rev.). The first type is awarded an employee when the employer fails to give the employee notice of termination as required under the employment agreement. This type of severance pay is regarded as being "earned" when the employee is terminated, and is afforded priority treatment, to the extent permitted under Section 507(a)(3)(A). In re Jeannette Corp., 118 B.R. 327 (Bankr.W.D.Pa. 1990). The second type of severance pay is based upon the length of the employee's service, and is generally considered to be earned pro-rata over the employee's period of employment. Matter of Health Maintenance Foundation, 680 F.2d 619, 620-21 (9th Cir. 1982); In re Roth American, Inc., 975 F.2d 949, 957 (3d Cir. 1992); Public Ledger, supra. Only that portion which is "earned" during the ninety-day (90) period preceding the bankruptcy filing is entitled to priority. Jeannette, supra.
Not all severance payments fit neatly into those two (2) categories, however. See, In re M Group, Inc., 268 B.R. 896 (Bankr.D.Del. 2001); In re Uly-Pak, Inc., 128 B.R. 763 (Bkrtcy.S.D.Ill. 1991). It is apparent from the briefs and oral arguments that both the TRUSTEE and the EMPLOYEES interpret Section 11.12 as providing for a separation payment based upon the EMPLOYEE'S length of service with the amount of the payment increasing by one (1) week's pay for each additional year of seniority up to a maximum of ten (10) weeks. This Court questions that interpretation. However, since the provision in question is that of a contract, not a statute, the Court will adopt the parties' agreed interpretation for the purpose of this Opinion.
Since Uly-Pak and M Group involved severance payments triggered postpetition and the allowance of those claims as administrative expouses, the analysis made by those courts is of little assistance here. The policy underlying the treatment of administrative claims, of encouraging creditors to extend credit to the debtor-in-possession in order to facilitate rehabilitation is far different from that underlying Section 507(a)(3)(A), of assuring employees that they will receive a minimum level of payment for their final days of work. The court in M Group, relying on Matter of Jartran, Inc., 732 F.2d 584 (7th Cir. 1984), concluded that in order for a separation payment to be entitled to administrative priority, the right to the payment (1) must have arisen from a transaction with the debtor and (2) must have benefitted the debtor. Because neither of those conditions was satisfied in either of those cases, the payments were not entitled to administrative claim status.
Section 11.12, with its errors in punctuation, presents a textbook example of poor draftsmanship. It seems to provide for two alternative calculations for the separation payment: 1) an amount equal to one (1) weeks pay for each full year of seniority up to a maximum of 10 years, or 2) ten (10) weeks of pay at the then current hourly rate of pay. If so, every rational employee would choose the second option, rendering the first option meaningless. More importantly for the purpose of this Opinion, the presence of the second option would mean that the separation pay provision could no longer be interpreted as dependant upon the accrual of seniority. Both parties agree, however, that the provision should be interpreted as seniority based, perhaps read as follows:
. . . then employed with seniority status, equal to one (1) weeks pay for each full year of seniority, up to a maximum of ten (10) years (i.e., capped at ten (10) weeks of pay), calculated using each employee's hourly rate of pay in effect as of the date of separation.
The EMPLOYEES' right to the separation pay became effective on June 1, 2000, the first day of the term of the Collective Bargaining Agreement, but was not payable unless the EMPLOYEES were working on the day of closing, having maintained seniority status on that day. Like the provisions before the court in M Group and Uly-Pak, the provision in this case is not contingent upon the employer's failure to notify the employee of termination, and although it is calculated based on length of service, it is capped at ten (10) years seniority. Those EMPLOYEES with less than ten (10) years' seniority continued to earn their separation payment throughout the ninety-day (90) period before the DEBTOR'S closing. Those employees with at least ten (10) years seniority, however, were no longer accruing additional severance pay benefits by their continued employment. They were, however, preserving their right to receive the maximum ten (10) weeks pay which was, in fact, conditioned upon their continued employment. In this Court's view, this was sufficient to satisfy the requirement of Section 507(a)(3), that the severance pay be "earned" within ninety (90) days before the date of the cessation of the DEBTOR'S business. Therefore, those EMPLOYEES with more than ten (10) years seniority have the same priority status with respect to separation pay, as those with less than ten (10) years seniority, despite the fact that under the contract, additional separation pay no longer accrues after an employee's tenth anniversary date.
It would be an absurd result indeed if only those EMPLOYEES with less than ten (10) years seniority were entitled to a priority claim for separation pay.
Interpreting a similar provision in In re Wean Inc., 171 B.R. 528 (Bankr.W.D.Pa. 1994), the bankruptcy court rejected the debtor's contention that employees who had completed the length of service requirements for severance pay under their collective bargaining agreement outside the priority period were not entitled to a priority claim, holding that the employees were entitled to a priority claim for severance pay "attributable" to services provided during the ninety-day (90) period, finding no requirement that a specific amount of severance benefit actually accrue during that period.
This result is consistent with the reasoning of the Seventh Circuit's decision in Matter of Northwest Engineering Co., 863 F.2d 1313 (7th Cir. 1988), holding that, for the purpose of Section 507(a)(3), vacation pay is considered to have been earned continuously over the work period, notwithstanding a contractual vesting schedule to the contrary. In that case, employees of the debtor became entitled to receive vacation pay for the previous year upon working one (1) day in the following year. The employees, having fulfilled the requirement of working one (1) day in the current year, contended that their claims for a full year's vacation were "earned" on that day, and were entitled to priority because the debtor's petition was filed within the ninety-day (90) period. Relying on the provision of the contract providing that vacation would be earned in the year prior to the year in which it would be taken, the debtor contended that none of the claims were entitled to priority because it had been "earned" in the prior year and the bankruptcy was filed more than ninety (90) days after the last day of that year.
The Seventh Circuit rejected the district court's view that either all of the vacation was earned or that none of the vacation was earned, finding that the application of the statute, based upon a continual-accrual method of awarding compensation under which a benefit vests as the work is performed by the employee, was not as clear as pictured by its drafters. The court drew upon the distinction made by the court in U.S. v. Munro-Van Helms Co., 243 F.2d 10 (5th Cir. 1957), between the actual earning of wages and the accrual of the employee's right to receive them, stating:
The Fifth Circuit distinguished, however, between the vesting requirement and the work requirement. Vesting is essential to the existence of a debt, and addressing this requirement the court remarked that "[t]he rights of the employees . . . were conditional, contingent or inchoate prior to July 1. On that day their rights became unconditional and absolute and these rights then accrued." 243 F.2d at 13. So there was a debt. But when had the pay been "earned"? The court remarked that "it is wages which are earned and the right to receive them which accrues." Id. at 12. Vacation pay was "earned" continuously as work was done, even though the right to receive a year's worth "accrued" on a single date.
The court reasoned that the structure of the statute suggests treating "earned" as a work rather than a vesting requirement. 863 F.2d at 1315. Determining that a strict application of the statute would result in denial of the employees' claims, because none of the vacation pay the employees were entitled to receive on the date the petition had been filed had actually been earned in the preceding ninety (90) days, the court adopted a pragmatic rule, holding that vacation pay is "earned" continuously, regardless of any specific vesting provisions in the employment contract.
As to the amount entitled to priority, the court used the ninety (90) days' earnings dictated by the statute as a "measuring rod," allowing the obligation to vest before the ninety-day (90) period, with the "measure of priority" to "come from the work done in the ninety (90) days before the bankruptcy." 863 F.2d at 1317. The court concluded that "[t]his approach leads to a sensible outcome, in accord with the statute's goal: the employee gets a priority equal to the value of services rendered in the ninety (90) days before bankruptcy." Id.
In In re Demert Dougherty, Inc., 1999 WL 1140859 (Bankr.N.D.Ill.), the court applied the approach taken by the Seventh Circuit in Northwest Engineering to claims asserted by employees for severance pay under Section 507(a)(3). Like the case before this Court, that case also dealt with a contractual right to severance pay calculated on a basis other than continuous accrual over time. Citing Northwest Engineering, the court held that the better view is that severance benefits should be considered to be earned pro-rata over the period of the employee's employment.
In Demert Dougherty, additional severance pay was earned only for every five (5) years of additional seniority. For example, management personnel with ten to fourteen (10-14) years of continuous employment were entitled to twelve (12) weeks of severance pay; those with fifteen to nineteen (15-19) years got sixteen (16) weeks of pay; those with twenty to twenty-four (20-24) years received twenty (20) weeks pay. Rather than being earned continuously, additional severance pay was earned only on every fifth anniversary date.
In the case at bar, the DEBTOR'S obligation to the EMPLOYEES for severance pay vested on June 1, 2000, the day the Collective Bargaining Agreement went into effect. The "debt" for separation pay, created on that day, clearly preceded the bankruptcy filing. It matters not that no new debt for additional separation pay accrued within the ninety (90) day pre-filing period. Under the Seventh Circuit's rationale, there can be a priority without a new debt, as long as the firm is indebted to the worker for at least as much as the priority amount. Northwest Engineering, 863 F.2d at 1317. Since the DEBTOR'S EMPLOYEES earned one (1) week of separation pay after accruing one (1) year of seniority under the Collective Bargaining Agreement, it appears that the DEBTOR was indebted to each EMPLOYEE for separation pay in an amount in excess of the priority award calculated as follows.
If any of the EMPLOYEES had less than one (1) year of seniority, they would not be entitled to a priority for separation pay since no debt existed.
The formula to be applied to determine the amount that each EMPLOYEE is entitled to as a third priority for separation pay is readily discernable. Under the Collective Bargaining Agreement, separation pay was being earned at the rate of one week's pay per year. Ninety (90) days is 24.7% of one (1) year (90/365). Therefore, each EMPLOYEE is entitled to 24.7% of one (1) week's pay, at their individual rate of pay in effect as of January 12, 2001, the date the plant closed. Section 4.01 of the Collective Bargaining Agreement provides that a normal work week consists of forty (40) hours. Therefore the formula to determine each EMPLOYEE'S priority claim amount for severance pay (X) is:
40 (hours) times the EMPLOYEE'S hourly wage rate times .247 = X
Since the third priority category also includes regular wages, vacation pay and sick leave pay, and is capped at an aggregate amount of $4,300, some EMPLOYEES may be maxed out without taking into account their separation pay. The TRUSTEE will have to determine, for each EMPLOYEE individually, the total amount of his allowed priority claim under Section 507(a)(3), taking into account unpaid wages, vacation and sick leave pay earned within the ninety (90) days before the plant closed, and should submit an order listing the allowed priority amount for each EMPLOYEE by name. Any amounts to which an EMPLOYEE is contractually entitled in excess of $4,300 should be allowed as a nonpriority unsecured claim.
This Opinion constitutes this Court's findings of fact and conclusions of law in accordance with Federal Rule of Bankruptcy Procedure 7052. A separate Order will be entered.
ORDER
For the reasons stated in an Opinion filed this day, IT IS HEREBY ORDERED:
1. That the separation benefit payable to the EMPLOYEES under Section 11.12 of the Collective Bargaining Agreement is entitled to priority under Section 507(a)(3)(A), in part, in accordance with the foregoing Opinion.
2. Within sixty (60) days of the date of this order, the Trustee is directed to submit to the Court an order allowing the EMPLOYEES' claims in accordance with the foregoing Opinion.