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Supreme Court Ruling Shows No Priority for Workers' Comp Claims

By Myron A. Bloom

Just over a year ago, we reported on a case from the 4th U.S. Circuit Court of Appeals that addressed the issue of whether a claim for unpaid pre-petition workers’ compensation premiums is entitled to priority under section 507(a)(5) of the Bankruptcy Code. The case, Howard Delivery Service Inc. v. Zurich American Insurance Company, was as interesting for the majority’s reasoning as it was for the holding.

The holding was that the claim was entitled to priority status. The reasoning was less clear — two judges, both resorting to dictionary definitions, held that the language of the statute was unambiguous, though they disagreed as to its “plain meaning”; the third judge found the statute to be ambiguous and ultimately concluded that priority status was intended.

This result exacerbated a split among the circuits. The 6th, 8th and 10th circuits had earlier held that such a claim was not entitled to priority status; the 4th Circuit, in Howard, sided with the 9th Circuit in concluding that such a claim was entitled to such status.

The U.S. Supreme Court, in order to resolve this split among the circuits, granted certiorari in Howard, and last week the court, in a 6-3 decision, ruled that a claim for unpaid pre-petition workers’ compensation premiums is not entitled to priority status.

Section 507(a)(5) of the Bankruptcy Code provides priority status for “allowed unsecured claims for contributions to an employee benefit plan.” Justice Ruth Bader Ginsburg, writing for the majority, noted that this provision was added to the law during the comprehensive rewriting of bankruptcy legislation in 1978 to provide a priority for fringe benefits which were not given priority under the then-existing Bankruptcy Act: “Beyond genuine debate, the main office of Section 507(a)(5) is to capture portions of employee compensation for services rendered not covered by Section 507(a)(4) [wages, salaries or commissions, including vacation, severance and sick leave pay].”

The inclusion of this new subsection was, in the majority’s view, to cover those benefits that complement or serve as a substitute for regular pay. The problem, as noted by the majority, was that nowhere in the Bankruptcy Code was the term “employee benefit plan” defined. The claimant, the party obviously pushing for treatment of its claim as a priority claim, urged the court to look to other law, namely, the Employee Retirement Income Security Act (ERISA), whose broad definition of “employee benefit plan” could, at least arguably, encompass the kind of claim at issue here.

The majority was not persuaded to do so. One reason is that even under ERISA, it is unclear that such a plan is an employee benefit plan, since ERISA specifically exempts from its coverage a plan maintained solely for the purpose of complying with a workers’ compensation law. Instead, stated the majority, it would follow earlier Supreme Court precedent which states that “‘[h]ere and there in the Bankruptcy Code, Congress has included specific directions that establish the significance for bankruptcy law of a term used elsewhere in a federal statute.’” What this suggests, stated the majority, is that because Congress does not refer to ERISA in section 507(a)(5), the court should not do so here.

Having rejected the claimant’s suggestion that the court “borrow” from ERISA, the majority looked to the essential character of a workers’ compensation program. Such a program, unlike a pension, life, health or disability plan, modifies or substitutes for common law tort liability to which an employer would be otherwise exposed for work-related accidents. As such, a workers’ compensation plan does provide something for employees, but it also removes from employers the risk of judgments generated by tort litigation. Thus, workers’ compensation regimes were in the main established by state legislatures because employers anticipated significant benefits from having such programs. By contrast, other programs that workers’ groups sought to have made mandatory, such as health insurance, were not.

Another feature of a workers’ compensation program, unlike a traditional employee benefit plan, is that such plans typically insure the employee (or his/her survivors or dependents) only, whereas a workers’ compensation program is, like a fire or theft insurance policy, designed to insure the employer — it covers the employer’s liability to pay an employee in the event of a tort. And to further distinguish a workers’ compensation regime from a more typical health, life or pension plan, which is generally a bargained-for fringe benefit, states (with few exceptions) require employers to provide such coverage. In fact, unlike other plans, in many states employers who fail to provide workers’ compensation insurance are liable for penalties or worse, including criminal liability. In other words, such coverage, unlike health or pension coverage, is not voluntary. This, though not determinative, is a factor in assessing whether the unpaid premiums were ever entitled to be accorded priority status.

The claimant argued to the court that affording priority status to such claims will give workers’ compensation carriers incentive to continue coverage of a failing business, thus promoting the rehabilitation of the enterprise. The majority did not find this argument persuasive. It noted that an assumption that priority equals incentive is itself questionable: “It may be doubted whether the projected incentive would outweigh competing financial pressure to pull the plug as swiftly on an insolvent policyholder, and thereby contain potential losses.”

The majority also noted that even under an expired policy, an insurer’s obligation to pay for injuries sustained while the policy is in effect, it can extend out over many years (in cases of serious injury). Finally, since there is no guarantee that a bankruptcy case will yield in all cases payments even on priority claims, the tendency of an insurer smelling bankruptcy will be to “pull the plug anyway,” priority or no priority.

In the end, stated the majority, the decision to afford priority treatment to a pre-petition claim should involve balancing the clarity (or lack thereof) of a particular provision against the overarching congressional bankruptcy policy of equality of treatment. As every claim given priority status diminishes the “pot” available for less fortunate creditors, giving priority to those who are not clearly entitled to it is inconsistent with Congressional policy and in fact dilutes the value of the priority for those creditors Congress intended to prefer. It would in this case put claims by insurance companies for unpaid premiums on a par with unpaid pension and health benefit plans. To do so in the absence of explicit language would be improper.

The dissent was authored by Justice Anthony Kennedy. It began its analysis by noting that the majority did not seem to disagree that the premiums at issue were “contributions” that arose from services rendered. The fact that these contributions are not voluntary does not mean that they are not contributions. (For this proposition, the dissent looked to a dictionary definition, though unlike the 4th Circuit, the dissent referred to an alternate definition.) In fact, statutes and case law often refer to “mandatory contributions.” And the premiums are made on account of services — they are predicated on employees’ performing services for an employer. They are in fact no different from a health insurance plan, where payment goes to a third party (an insurer) predicated on services performed by an employee for an employer.

Still, the question remains, is a workers’ compensation regime an employee benefit plan? The answer, stated the dissenters, is yes. Employees who are beneficiaries of such a program give up the right to sue in tort, but the payments to those with work-related injuries under a workers’ compensation plan do not require the claimant to prove fault, or be subject to various defenses, such as contributory negligence, assumption of the risk, and the like. Thus, rather than primarily benefiting the employer, workers’ compensation plans, on the whole, are a benefit to employees. The fact that such plans also benefit employers, stated the dissent, should not detract from the fact that they benefit employees, just as health insurance programs, for example, which are clearly employee-benefit plans, may also benefit employers in the form of tax breaks, the ability to pay lower wages, or good will.

The majority’s other bases for distinguishing this kind of plan from other plans, stated the dissent, are similarly unpersuasive. This plan, just like any other plan, is in fact a wage substitute; premium payments are in fact reflected in the wage scale. The mandatory nature of the contribution does not change the nature of the contribution, as the benefit is “real and significant” whether the contribution is voluntary or mandatory. The existence of a state fund to pay benefits in the event that employers (wrongfully) fail to provide insurance is has little relevance, since it is unlikely that a state-created fallback health plan would render that benefit not entitled to priority status.

Finally, utilizing the ERISA definition, which in the dissent’s view lends “considerable support” for a finding that contributions are entitled to priority status, is helpful, as the phrase “employee benefit plan” is more a term of art than a generic phrase, and the fact that ERISA exempts these plans from coverage does not mean they should be excluded from the definition of an employee benefit plan. Indeed, the fact that these plans were excluded from ERISA’s coverage gives additional evidence that Congress recognized that they were included in the broad definition of an employee benefit plan.

The Supreme Court has thus resolved the split among the circuits. Of equal importance, it would seem that our earlier guidance — keeping a copy of a dictionary next to the Bankruptcy Code in trying to divine the meaning of a statute — still holds true.

This article is reprinted with the permission from the June 23, 2006 issue of The Legal Intelligencer.  Copyright 2006 ALM Properties, Inc.  Further duplication without permission is prohibited.  All rights reserved.