H.R. 5525 Would Increase Wage Priority And Recover Excessive Insider Compensation (Written by Prof. G. Ray Warner)

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.