Hunton Employment & Labor Perspectives

Businesses need to have written protocols in place to deal with bankruptcy filings by their employees and independent contractors, or they risk serious sanctions and, potentially, punitive damages for violations of the bankruptcy laws. Consider two examples.

First, the employer receives a notice that an employee working on commission has filed for Chapter 7 bankruptcy relief. The notice is placed in the employee’s personnel file and forgotten. One week later, the employer issues a check to the employee for commissions earned prior to the bankruptcy filing. The employer has unwittingly violated the Bankruptcy Code. Commissions earned by an employee prior to filing for bankruptcy generally belong to the employee’s Chapter 7 trustee, not the employee. Two weeks later, after the employee has been terminated, the employer receives a letter from the trustee, demanding that the employer send the trustee another check for the pre-bankruptcy commission. The employer must comply – and likely has no effective recourse against the former employee.

Second, another employee working on commission files for bankruptcy shortly after incurring a debt to the employer – for return of a commission advance, or for training or other costs covered by the employer. The employer again fails to notify accounting of the bankruptcy after receiving a notice. Two weeks later, the employee’s pre-bankruptcy debt to the company is deducted from the employee’s next paycheck. The employer has just knowingly violated the automatic bankruptcy stay by taking an action to collect a pre-bankruptcy debt from post-bankruptcy earnings. The employer eventually receives from the bankruptcy court an order to show cause why it should not be held in contempt, sanctioned, and assessed punitive damages.

To avoid these and other bankruptcy issues, businesses should consult with bankruptcy counsel to develop and implement a written policy for handling employee and contractor bankruptcy issues. A process should be developed whereby notices relating to bankruptcy cases are channeled to a designated member of the legal or accounting team trained to immediately take action to ensure payments are correctly routed and stay violations are avoided. We also recommend that businesses have bankruptcy counsel review employee and contractor agreements to ensure that provisions are included to address potential collection and bankruptcy issues, including those discussed above as well as claims for fraudulent or preferential transfers, filing of bankruptcy claims, and treatment of confidential information of the business in the bankruptcy context.