Giving Effect to BAPCPA’s Back-Pay Administrative-Expense Provision

By Leonard H. Gerson

When the Bankruptcy Code was amended by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), the addition of § 503(b)(1)(A)(ii) provided an administrative-expense priority for back-pay claims resulting from violations of federal or state law (hereinafter “back-pay priority”).1 At the time, it was predicted that the back-pay priority might “create substantial administrative claims ... burying other priority and unsecured claims beneath a sizeable ‘post-petition’ debt and, indeed, threatening administrative insolvency in many cases.”2 In the two decades that have since passed, however, there have been virtually no published opinions awarding a back-pay priority administrative-expense claim.3

The reason for this absence of back-pay priority awards arises from the provision’s peculiar nature and wording — an obscurity that is magnified by the absence of any meaningful legislative history.4 First, the provision runs afoul the seminal requirements for an administrative expense (a transaction with the post-petition debtor that provides a benefit to the bankruptcy estate) by directing that courts not take into account “the time of the occurrence of the unlawful conduct on which such award is based ... or to whether any services were rendered.”5

This initial barrier was surpassed in 2010. As declared by the court in In re Philadelphia Newspapers LLC:6 “[G]iven that there is no legislative history upon which to base a conclusion that Congress did not mean what it said, the provision must be applied in accordance with its language.”7 Thus, Collier on Bankruptcy now recognizes that under the back-pay priority, “[i]t does not matter when the conduct on which the award is based began or whether any services were rendered.”8

However, the language of § 503(b)(1)(A)(ii) remains self-contradictory, as it requires both that the “back pay [be] attributable to any period of time occurring after commencement of the case” but “without regard to the time of the occurrence of unlawful conduct on which such award is based.”9 This seeming inconsistency has been viewed by various courts as “confusing on its face.”10 U.S. v. Cleveland Indians Baseball Co.,11 the seminal U.S. Supreme Court opinion on the tax treatment of back pay, provides the answer to this “attributable to” puzzle.

In Cleveland Indians, the Court ruled that for income tax purposes under the Federal Insurance Contributions Act and Federal Unemployment Tax Act, back pay should be “attributed to” the year in which it is paid rather than the year in which it is earned.12 This tax treatment of back pay continues today.13

The choice to use the “attributable to” phrase in § 503(b)(1)(A)(ii), and the fact that both Cleveland Indians and the back-pay priority both distinguish the time period that back pay is earned from how back pay is treated, cannot be accidental. It is a “settled rule that a statute must, if possible, be construed in such a fashion that every word has some operative effect.”14 A “statute should be construed so that effect is given to all its provisions, so that no part will be inoperative or superfluous, void or insignificant.”15 Thus, the paradox in the wording in § 503(b)(1)(A)(ii) is resolved by Cleveland Indians.

In the only circuit court opinion that addresses the back-pay priority, Financial Oversight and Management Board of Puerto Rico,16 the First Circuit recognized that the meaning of “attributable to” was at the heart of the back-pay-priority debate.17 It rejected the claimants’ request for an administrative expense, because the claimants’ only argument was that the “attributable to” requirement was satisfied by the fact that the wages remained unpaid in the post-petition period, a theory that the First Circuit described as “making little practical sense.”18 In a footnote, the First Circuit recognized that the back-pay priority could be satisfied under a different set of facts. The example that it provided referred to “claims based on situations where the debtor committed a violation of law before the petition date that resulted in the deprivation of wages after the petition date. This would include cases in which a wrongful discharge pre-petition resulted in the deprivation of wages that would have been paid post-petition.”19 Thus, the First Circuit reasoned that the back pay would be “constructively earned” in the post-petition period, thereby satisfying the “attributed to” requirement.20

Similarly, the “attributable to” mandate could be satisfied by a back-pay judgment under the WARN Act.21 Under the WARN Act, damages are calculated by counting a maximum of 60 days forward from the date of the mass layoff resulting in the WARN Act violation.22 Thus, a violation may occur pre-petition, but the “attributable to” requirement would be satisfied in situations in which the 60-day period included a “period of time occurring after the commencement of the case.”23 Arguably, without relying on any statutory provision that identifies the timing of a payment, the back-pay priority also could be satisfied if a back-pay order provided that payment of a judgment be made within 30 days of the date of the order and a bankruptcy petition was filed before the 30 days had expired.

In the throes of a contentious bankruptcy case, major players may contend that a sizeable, administrative back-pay wage claim is simply unmanageable. However, Congress foresaw that problems could arise from an onerous back-pay administrative-expense claim by limiting the application of the back-pay priority to situations in which “the operation of this clause will not substantially increase the probability of layoff or termination of current employees, or of nonpayment of domestic-support obligations.”24 It is notable that no other Bankruptcy Code provision imposes such a self-correcting limitation on its operation. The Supreme Court has directed that once Congress has struck a balance in the operation of a statute, it is not within a court’s discretion to alter that balance because it believes that balance needs mending.25

Future litigation will define how the back-pay priority is effectuated, including new bases for linking pre-petition back-pay judgments to the post-petition period in order to satisfy the “attributable to” requirement. What is critical for now is that Cleveland Indians provides guidance on how a pre-petition breach can be “attributable to” the post-petition period.

Leonard Gerson is based in New York and was lead counsel for the respondent in Tennessee Student Assistance Corp. v. Hood, 541 U.S. 440 (2004).