The Bankruptcy Code’s Puzzling Back Pay Provision

By Peter D. DeChiara

pdechiara@cwsny.com

Posted August 2016

How much judicial confusion can one small section of the Bankruptcy Code create?  Quite a bit, as the Bankruptcy Code’s back pay provision demonstrates.  That provision, 11 U.S.C. § 503(b)(1)(A)(ii), added to the Code as part of a package of 2005 amendments, seeks to define what types of back pay claims enjoy administrative priority status.  But the provision, which one bankruptcy court recently called “confusing on its face,” In re Calumet Photographic, Inc., 2016 WL 3035468, at *3 (Bankr. N.D. Ill. 2016), has proven to be a real head-scratcher for the courts called upon to interpret it.  And its lack of virtually any legislative history only adds to the fog.

Section 503(b) of the Bankruptcy Code, divided into nine separate subparts, defines the various types of creditor claims against a debtor that enjoy administrative status.  That status is important; unlike other bankruptcy claims, administrative expense claims typically receive payment in full.  The first subpart, Section 503(b)(1)(A), confers administrative status on claims arising from “the actual, necessary costs and expenses of preserving the estate.”  Section 503(b)(1)(A) further states that this includes two types of claims:  “wages, salaries, and commissions for services rendered after” the company’s bankruptcy filing, as set out in subsection (i), “and” certain types of back pay claims, as set out in subsection (ii).

Subsection (ii), which is the subject of this blog post, is a mouthful.  It provides administrative status to “wages and benefits awarded pursuant to a judicial proceeding or a proceeding of the National Labor Relations Board as back pay attributable to any period of time occurring after commencement of the case under this title, as a result of a violation of Federal or State law by the debtor, without regard to the time of the occurrence of unlawful conduct on which such award is based or to whether any services were rendered,” so long as the payment of such claims won’t substantially increase the likelihood of layoffs or terminations of the company’s employees.

Some of this language is relatively straightforward.  Since subsection (ii) only applies to claims resulting from an employer’s “violation of Federal or State law,” a court has concluded that claims based on violations of a collective bargaining agreement don’t qualify.  See In re Philadelphia Newspapers, LLC, 433 B.R. 164, 176 (Bankr. E.D. Pa. 2010).   Similarly, since it applies to “wages and benefits,” another court found that claims for attorney’s fees arising from an employment suit don’t qualify either.  See In re Trump Entertainment Resorts, Inc., 2015 WL 1084294, at *3 (Bankr. D. Del. 2015).

But what about the phrase “awarded pursuant to a judicial proceeding”?  Does the judicial proceeding have to be one other than the bankruptcy case in which the claim is asserted?  In First Magnus Financial Corp., 390 B.R. 667, 678 (Bankr. D. Ariz. 2008), aff’d, 403 B.R. 659 (D. Ariz. 2009), the bankruptcy court held that the judicial proceeding must be in a court of general jurisdiction, not the bankruptcy court itself.  That distinction, however, has no basis in the language of the statute.  The better view holds that proceedings in the bankruptcy court, which is after all an arm of the district court, constitute “judicial proceedings” within the meaning of subsection (ii).  See, e.g., In re Truland Group, Inc., 520 B.R. 197, 204 (Bankr. E.D. Va. 2014).

Also, does the term “awarded” mean the proceeding needs to have reached judgment before the back pay claim can be deemed administrative?  One might think that the statute’s use of the past tense suggests an affirmative answer, but, as the bankruptcy court in In re 710 Long Ridge Road Operating Co.,505 B.R. 163, 174-75 (Bankr. D.N.J. 2014), explained — doubtlessly after dipping into a grammar book — the language beginning with “awarded pursuant to …” simply acts as a “past participial phrase” modifying the type of “wages and benefits” covered by the provision.  It says nothing about the timing of the court’s judgment.

How the various phrases in subsection (ii) hang together, and how they relate to other phrases in Section 503(b)(1)(A), has raised even more questions.  The court in First Magnus, 390 B.R. at 677, convinced itself that the word “and” between subsections (i) and (ii) meant that to satisfy subsection (ii), a claim has to also satisfy subsection (i).  That would mean that only back pay claims based on services actually rendered to the company following the bankruptcy filing could enjoy administrative status.  Subsequent cases have convincingly demonstrated that, on the contrary, subsection (ii) provides an additional category of administrative claims, separate from subsection (i).  See, e.g., Truland, 520 B.R. at 202-03; Philadelphia Newspapers, 433 B.R. at 173-74.  Cautioning about a too-literal reading of the word “and,” the bankruptcy court in Philadelphia Newspapers pointed out that Section 503(b) ties together with the word “and” all nine different categories of administrative claims, including such diverse items as taxes, professional fees and the cost of closing a health care business.  No one would suggest that Congress intended that an administrative claim satisfy all nine.

Courts have also puzzled over the meaning of the phrase back pay “attributable to any period of time occurring after” the debtor filed its bankruptcy petition.  The bankruptcy court in In re Powermate Holding Corp., 394 B.R. 765, 774-75 (Bankr. D. Del. 2008), tried to pin that down by holding that back pay is “attributable” to a post-petition period if the claim vests or accrues post-petition.  Other courts have rightly rejected that reading, since the statutory text makes no mention of vesting or accruing.  Indeed, Powermate’s reading conflicts with the language later on in subsection (ii) that administrative status applies “without regard to the time of the occurrence of unlawful conduct on which such award is based.”  See, e.g., Truland, 520 B.R. at 203; Philadelphia Newspapers, 433 B.R. at 174.

Finally, how should courts reconcile the language in subsection (ii) that administrative status may attach “without regard … to whether any services were rendered” with the overarching language in Section 503(b)(1)(A) that defines administrative expenses as those needed for “preserving the estate.”  The bankruptcy court in Calumet recently relied on the latter language in concluding that a back pay claim can only be administrative if the employee performed post-petition service to the bankrupt estate.  See Calumet Photographic, 2016 WL 3035468, at **3-4.  But that reading effectively erases the more specific language in subsection (ii) stating that it doesn’t matter “whether any services were rendered.”  See Philadelphia Newspapers, 433 B.R. at 174-75.  In determining whether a back pay claim qualifies for administrative status, the safe bet is to rely on what the back pay provision says.

Congress’ intent behind Section 503(b)(1)(A)(ii) was good:  to give more back pay claims a leg up in the bankruptcy claims process.  But a bit more clarity in drafting would have helped.