S. 2820 Would Increase Wage Priority and Recover Unjust Compensation

A bill introduced by Senator Carnahan (D-Missouri) and co-sponsored by Senators Kennedy (D-Massachusetts) and Leahy (D-Vermont) on July 30, 2002, would increase the dollar amounts for the section 507(a)(3 & 4) wage and employee benefits priorities to $13,500 from the current cost of living adjusted amount of $4,650. This is the same change proposed by the pending Employee Abuse Prevention Act of 2002 (S. 2798 and H.R. 5221) that was introduced by Senator Durbin and Rep. Delahunt. The current limit has come under attack recently in such high profile cases as Enron and Worldcom. In Enron, the bankruptcy court approved priority wage payments that exceeded the current $4,650 limit and a similar motion is pending in the Worldcom case.

In addition to increasing the wage and employee benefits priority, the bill would also amend the section 547 preference provision to permit recovery of transfers of "compensation" made within 90 days before bankruptcy to present or former employees, officers, or directors. In order to be recoverable, such compensation must be shown to be either "out of the ordinary course of business" or "unjust enrichment." Although this provision would be added to the preference section, it would not technically be a preference since the section would permit recovery of compensation even if the debtor was solvent and even if there was no pre-existing debt owed to the employee, officer, or director. Although the Durbin-Delahunt bill also would allow recovery of excessive compensation, its provisions are substantially different from the provisions of S. 2820.

Since the term "compensation" limits the class of transfers that can be recovered under S. 2820 and since that term is not defined, it is not clear whether this provision would apply to transactions such as sweetheart loans to executives and the forgiveness of such loans that have recently drawn scrutiny.

Similarly, it is unclear how the avoidance standards would apply. The non-ordinary course test, if applied strictly, might result in the avoidance of payments made to rank and file employees, such as the non-ordinary course payment of all earned but unpaid wages on the eve of bankruptcy. It might also result in the avoidance of completely proper compensation arrangements merely because the debtor's financial condition required it to resort to unusual compensation schemes as its condition worsened.

It is unclear whether the alternative "unjust enrichment" standard is meant to incorporate the common law contract doctrine of unjust enrichment or to provide wide discretion to bankruptcy judges to avoid compensation deemed excessive. If it merely allows recovery of compensation in cases where the compensation was excessive, it adds little to the section 548 power to avoid constructively fraudulent transfers where the debtor received less that a reasonably equivalent value. Unlike section 548, the amendment would allow recovery even if the debtor was solvent and might allow recovery where excessive compensation was paid pursuant to a contract entered into before the one-year look-back period under section 548.

The bill has been referred to the Committee on the Judiciary.

Prof. G. Ray Warner, ABI Resident Scholar, Professor of Law at the University of Missouri-Kansas City.