Priority for Unpaid Workers' Comp Premiums

The issue in Howard Delivery Serv., Inc. v. Zurich American Ins. Co., 126 S. Ct. 2105 (2006), decided on June 15, 2006, was whether unpaid premiums due under a workers' compensation insurance policy constitute 'contributions to an employee benefit plan' so as to entitle the claimholder to priority treatment under ' 507
(a)(5). Resolving a split among the circuit courts, the Supreme Court ruled that such premiums do not fall within the scope of ' 507(a)(5). The Supreme Court's ruling in Howard Delivery provides insight into not only the Court's view of the priority provisions at issue, but also its approach to the interpretation of all provisions of the Bankruptcy Code.

Background

On Jan. 30, 2002, Howard Delivery Service, Inc. (Howard) filed its Chapter 11 bankruptcy petition in the U.S. Bankruptcy Court for the Northern District of West Virginia. Howard operated as an over-the-road-freight carrier to the Midwest and mid-Atlantic regions. The company employed hundreds of truck drivers, mechanics, freight handlers, management and general administrative personnel. At the time it filed for bankruptcy, Howard owed Zurich American Insurance Company (Zurich) $410,215 in insurance premiums for the workers' compensation coverage that Howard was required to carry in each of the dozen or so states in which it operated. In an amended proof of claim, Zurich asserted that these unpaid premiums qualified as contributions to an employee benefit plan entitled to priority under ' 507(a)(5). If entitled to priority, Zurich would share pro rata with other priority creditors, including various health, welfare and pension plans, in the net proceeds from the sale of Howard's assets pursuant to a Chapter 11 plan of liquidation. If Zurich was not entitled to priority, the parties stipulated that Zurich would receive nothing.

The Bankruptcy Court denied priority status to Zurich's claim, as did the District Court. Each court concluded that the unpaid insurance premiums did not constitute bargained-for benefits paid in lieu of wages, and thus were not contributions to an 'employee benefit plan' as that undefined term was used in the Bankruptcy Code. Each court relied on decisions of the Sixth (In re Birmingham-Nashville Express, Inc., 224 F.3d 511, 517), Eighth (In re HLM Corp., 62 F.3d 224, 226-227) and Tenth (In re Southern Star Foods, Inc., 144 F.3d 712, 717) Circuits that had reached the same conclusion, and rejected the contrary ruling of the Ninth Circuit (Employers Ins. of Wausau v. Plaid Pantries, Inc., 10 F.3d 605, 607) that had ruled consistent with the position taken by Zurich.

The Fourth Circuit reversed 2 to 1 in a per curium opinion, with no agreement among the judges as to the rationale for the decision. 403 F.3d 228 (4th Cir. 2005). Judge Robert King concluded that ' 507(a)(5) was unambiguous on its face and that workers' compensation insurance premiums fell within the plain meaning of 'contributions' to an 'employee benefit plan,' as each of those terms was defined in the dictionary. While agreeing with the ultimate outcome, Judge Dennis Shedd found that the statute was ambiguous, thus inviting a review of the legislative history leading to the addition of ' 507(a)(5) to the hierarchy of priorities. Based upon his review of the legislative history, he concluded that Congress intended the term 'employee benefit plan' to be taken from the definition contained in ERISA. This includes workers' compensation plans within the definition of em-ployee benefit plans, but then carves them out of the scope of ERISA. Finally, Judge Paul V. Niemeyer dissented, finding that workers' compensation insurance premiums were not within the plain meaning of 'contributions to an employee benefit plan' and that the legislative history did not support such a reading of the priority statute.

The Supreme Court Decision

The split among the circuit courts, and among the judges of the Fourth Circuit who ruled to overturn the Bankruptcy Court and District Court decisions in favor of Howard, was ultimately resolved by the Supreme Court in a split decision authored by Justice Ginsburg, with a dissent authored by Justice Kennedy. Echoing the somewhat unusual alliances among the circuits on the issue presented in Howard Delivery (the Fourth and Ninth Circuits versus the Sixth, Eighth and Tenth), Justice Ginsburg's opinion was joined by Justices Roberts, Stevens, Scalia, Thomas and Breyer, whereas Justice Kennedy's dissenting opinion was joined by Justices Souter and Alito.

Other Statutes Not Controlling

In its brief and throughout its oral argument, Zurich forcefully asserted that the definition of the term 'employee benefit plan' should be controlled by ERISA, which includes workers' compensation plans within its definition of this term. In further support of its position, Zurich pointed to the Congressional hearings that preceded enactment of the Bankruptcy Reform Act of 1978, which added the provisions of ' 507(a)(5). In the course of these hearings, several witnesses had urged Congress not to draft ' 507(a)(5) too narrowly, making references to the expanding universe of benefits provided employees under the recently-passed ERISA statute.

The majority rejected Zurich's argument and cautioned that borrowing definitions from other statutes absent express direction from Congress was fraught with peril, particularly when these other statutes were 'designed without bankruptcy in mind.' Citing to the Court's earlier holding in United States v. Reorganized CF&I Fabricators of Utah, Inc., 518 U.S. 213, 219 (1996), where it had been noted 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 the federal statutes,' the majority in Howard Delivery concluded that '[n]o such directions are contained in '507(a)(5), and we have no warrant to write them into the text.'

The first lesson of Howard Delivery is simply this: Do not look beyond the Bankruptcy Code for the meaning of its provisions unless the Code expressly points you elsewhere.

Plain Meaning, Bankruptcy Style

In the eyes of Justice Kennedy and the other dissenting justices, the plain meaning of the term 'employee benefit plan' includes workers' compensation. However, in reaching a contrary conclusion, Justice Ginsburg and the majority of the Court adopt a somewhat customized version of the plain meaning doctrine for use in connection with the Bankruptcy Code. This bankruptcy-specific version of the plain meaning rule looks beyond common usage and dictionary definitions of the words contained in the statute; in fact, the majority opinion contains no references to the various dictionary definitions relied upon by Judge King in opinion below. Instead, the majority takes a broad view of the overriding principles of the Bankruptcy Code and applies the rules of statutory construction so as to comport with these general principles.

As Justice Ginsburg explains, 'We are guided in reaching our decision by the equal distribution objective underlying the Bankruptcy Code, and the corollary principle that provisions allowing preferences must be tightly construed.' As the majority duly notes, every claim granted priority status reduces the funds available to general unsecured creditors and may diminish the recovery of other claimants qualifying for equal or lesser priorities. In the case of Howard Delivery, it was clear that granting priority to Zurich's claim would substantially dilute the claims of various health, welfare and pension plans that were undeniably entitled to priority under ' 507(a)(5), but which would not be paid in amount due to the debtor's limited assets.

When subjected to the litmus test of these fundamental principles of bankruptcy law, Zurich's plain meaning argument did not survive. As Justice Ginsburg concludes at the end of the majority opinion, any doubt concerning whether workers' compensation falls with the plain meaning of the term 'employee benefit plan' '

is best resolved in accord with the Bankruptcy Code's equal distribution aim. We therefore reject the expanded interpretation Zurich invites. Unless and until Congress otherwise directs, we hold that carriers' claims for unpaid workers' compensation premiums remain outside the priority allowed by ' 507(a)(5).

Thus, the second lesson of Howard Delivery: Bankruptcy is unique and the plain meaning of the Bankruptcy Code must be determined in light of the fundamental principles upon which the Code is based.

The Essential Character of Workers' Compensation

Beyond the issues of plain meaning and statutory interpretation, the Court in Howard Delivery still faced the question issue of whether workers' compensation plans, be they statutorily mandated or voluntarily provided, were 'employee benefit plans.'

The Court decided this ultimate issue by evaluating the 'essential character' of workers' compensation regimes. It noted that, unlike pension plans and life, health and disability insurance plans that were designed to supplement or substitute for employee wages, workers' compensation programs 'have a dominant employer-oriented thrust: They modify, or substitute for, the common-law tort liability to which employers were exposed for work-related accidents.' Thus, workers' compensation regimes offer something to both employees ' the right to receive benefits on a no-fault basis, and to employers ' the freedom from large tort judgments and the attendant litigation costs.

By contrast, no such trade-off or sharing of benefits exists with respect to the fringe benefit plans that Congress sought to protect when it enacted ' 507(a)(5) in response to the Supreme Court's holdings in Embassy Restaurant and Joint Industry Board. Unlike workers' compensation insurance which, consistent with fire, theft, and other forms of insurance, benefits the employer by shielding it from liability, employer-sponsored pension plans, and group health or life insurance plans typically insure, and thereby benefit, only the employee or his survivor. These latter plans constitute the type of fringe benefits that the legislative history surrounding ' 507(a)(5) specifically addressed ' 'health insurance programs, life insurance plans, pension funds, and all other forms of employee compensation that [are] not in the form of wages.'

Balancing these various factors, the Court found that 'although the question is close,' workers' compensation was not compensation for the employee, but rather a substitute for the tort liability of the employer:

In sum, we find it far from clear that an employer's liability to provide workers' compensation coverage fits the ' 507(a)(5) category 'contributions to an employee benefit plan'arising from services rendered.' Weighing against such categorization, workers' compensation does not compensate employees for work performed, but instead, for on-the-job injuries incurred; workers' compensation regimes substitute not for wage payments, but for tort liability.

One can therefore summarize the third and final lesson of Howard Delivery as follows: When deciding what type of claims are entitled to priority under the Bankruptcy Code, the Court will look at all relevant aspects of the claim to ascertain its essential character and is likely to construe the priority in light of its legislative history.

In the end, '507(a)(5) proved not to be the alchemist's stone that the insurance industry had hoped for. Whether this will change in the future is now up to Congress.

Lawrence A. Katz is a partner in the Virginia and Washington, DC, offices of Venable LLP. He focuses on bankruptcy, financial restructurings and commercial litigation and has extensive experience in debtor and creditors' rights issues. Katz was counsel of record for the co-petitioner Creditors Committee before the U.S. Supreme Court in the Howard Delivery case and was the author of the petition for certiorari and the briefs submitted by Howard Delivery and the Committee.

Priorities are the alchemist's stone of the Bankruptcy Code ' they have the power to turn worthless claims into pots of gold. Without priority status, unsecured claims typically receive little or no distributions from the bankruptcy estate. When these claims fall within one of the statutory priorities of ' 507(a)of the Bankruptcy Code, however, they often lead to significant distributions ' sometimes even payment in full. What often separates the 'haves' from the 'have-nots' in the bankruptcy arena is the ability to fit one's claim into the finite list of priorities set forth in ' 507(a).

Section 507(a)(4) of the Bankruptcy Code affords priority treatment to claims for 'wages, salaries, or commissions, including vacation, severance, and sick leave earned by an individual' earned within 90 days of the earlier of the petition date or the cessation of the debtor's business. In two earlier decisions of the U.S. Supreme Court, United States v. Embassy Restaurant, Inc. , 359 U.S. 29 (1959), and Joint Industry Bd. of Elec. Industry v. United States , 391 U.S. 224 (1968), health and welfare plans were held not to be 'wages' and thus not entitled to priority treatment under ' 507(a)(4). In response to these decisions, Congress added ' 507(a)(5) to the list of priorities when it amended the Bankruptcy Act in 1978. This new provision was intended to extend priority treatment to other forms of employee compensation not covered by ' 507(a)(4), while establishing a combined monetary cap on the claims that could receive such priority (pursuant to BAPCPA, what were previously ” 507(a)(3) and (a)(4) of the Bankruptcy Code were numbered 507(a)(4) and (a)(5) and the combined cap on the priorities was increased to $10,000 per employee). The new provision covered 'contributions to an employee benefit plan'arising from services rendered within 180 days before the date of the filing of the petition or the date of the cessation of the debtor's business, whichever occurs first ' '

The Case

The issue in Howard Delivery Serv., Inc. v. Zurich American Ins. Co. , 126 S. Ct. 2105 (2006), decided on June 15, 2006, was whether unpaid premiums due under a workers' compensation insurance policy constitute 'contributions to an employee benefit plan' so as to entitle the claimholder to priority treatment under ' 507
(a)(5). Resolving a split among the circuit courts, the Supreme Court ruled that such premiums do not fall within the scope of ' 507(a)(5). The Supreme Court's ruling in Howard Delivery provides insight into not only the Court's view of the priority provisions at issue, but also its approach to the interpretation of all provisions of the Bankruptcy Code.

Background

On Jan. 30, 2002, Howard Delivery Service, Inc. (Howard) filed its Chapter 11 bankruptcy petition in the U.S. Bankruptcy Court for the Northern District of West Virginia. Howard operated as an over-the-road-freight carrier to the Midwest and mid-Atlantic regions. The company employed hundreds of truck drivers, mechanics, freight handlers, management and general administrative personnel. At the time it filed for bankruptcy, Howard owed Zurich American Insurance Company (Zurich) $410,215 in insurance premiums for the workers' compensation coverage that Howard was required to carry in each of the dozen or so states in which it operated. In an amended proof of claim, Zurich asserted that these unpaid premiums qualified as contributions to an employee benefit plan entitled to priority under ' 507(a)(5). If entitled to priority, Zurich would share pro rata with other priority creditors, including various health, welfare and pension plans, in the net proceeds from the sale of Howard's assets pursuant to a Chapter 11 plan of liquidation. If Zurich was not entitled to priority, the parties stipulated that Zurich would receive nothing.

The Bankruptcy Court denied priority status to Zurich's claim, as did the District Court. Each court concluded that the unpaid insurance premiums did not constitute bargained-for benefits paid in lieu of wages, and thus were not contributions to an 'employee benefit plan' as that undefined term was used in the Bankruptcy Code. Each court relied on decisions of the Sixth ( In re Birmingham-Nashville Express, Inc. , 224 F.3d 511, 517), Eighth ( In re HLM Corp. , 62 F.3d 224, 226-227) and Tenth ( In re Southern Star Foods, Inc. , 144 F.3d 712, 717) Circuits that had reached the same conclusion, and rejected the contrary ruling of the Ninth Circuit ( Employers Ins. of Wausau v. Plaid Pantries, Inc. , 10 F.3d 605, 607) that had ruled consistent with the position taken by Zurich.

The Fourth Circuit reversed 2 to 1 in a per curium opinion, with no agreement among the judges as to the rationale for the decision. 403 F.3d 228 (4th Cir. 2005). Judge Robert King concluded that ' 507(a)(5) was unambiguous on its face and that workers' compensation insurance premiums fell within the plain meaning of 'contributions' to an 'employee benefit plan,' as each of those terms was defined in the dictionary. While agreeing with the ultimate outcome, Judge Dennis Shedd found that the statute was ambiguous, thus inviting a review of the legislative history leading to the addition of ' 507(a)(5) to the hierarchy of priorities. Based upon his review of the legislative history, he concluded that Congress intended the term 'employee benefit plan' to be taken from the definition contained in ERISA. This includes workers' compensation plans within the definition of em-ployee benefit plans, but then carves them out of the scope of ERISA. Finally, Judge Paul V. Niemeyer dissented, finding that workers' compensation insurance premiums were not within the plain meaning of 'contributions to an employee benefit plan' and that the legislative history did not support such a reading of the priority statute.

The Supreme Court Decision

The split among the circuit courts, and among the judges of the Fourth Circuit who ruled to overturn the Bankruptcy Court and District Court decisions in favor of Howard, was ultimately resolved by the Supreme Court in a split decision authored by Justice Ginsburg, with a dissent authored by Justice Kennedy. Echoing the somewhat unusual alliances among the circuits on the issue presented in Howard Delivery (the Fourth and Ninth Circuits versus the Sixth, Eighth and Tenth), Justice Ginsburg's opinion was joined by Justices Roberts, Stevens, Scalia, Thomas and Breyer, whereas Justice Kennedy's dissenting opinion was joined by Justices Souter and Alito.

Other Statutes Not Controlling

In its brief and throughout its oral argument, Zurich forcefully asserted that the definition of the term 'employee benefit plan' should be controlled by ERISA, which includes workers' compensation plans within its definition of this term. In further support of its position, Zurich pointed to the Congressional hearings that preceded enactment of the Bankruptcy Reform Act of 1978, which added the provisions of ' 507(a)(5). In the course of these hearings, several witnesses had urged Congress not to draft ' 507(a)(5) too narrowly, making references to the expanding universe of benefits provided employees under the recently-passed ERISA statute.

The majority rejected Zurich's argument and cautioned that borrowing definitions from other statutes absent express direction from Congress was fraught with peril, particularly when these other statutes were 'designed without bankruptcy in mind.' Citing to the Court's earlier holding in United States v. Reorganized CF&I Fabricators of Utah, Inc. , 518 U.S. 213, 219 (1996), where it had been noted 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 the federal statutes,' the majority in Howard Delivery concluded that '[n]o such directions are contained in '507(a)(5), and we have no warrant to write them into the text.'

The first lesson of Howard Delivery is simply this: Do not look beyond the Bankruptcy Code for the meaning of its provisions unless the Code expressly points you elsewhere.

Plain Meaning, Bankruptcy Style

In the eyes of Justice Kennedy and the other dissenting justices, the plain meaning of the term 'employee benefit plan' includes workers' compensation. However, in reaching a contrary conclusion, Justice Ginsburg and the majority of the Court adopt a somewhat customized version of the plain meaning doctrine for use in connection with the Bankruptcy Code. This bankruptcy-specific version of the plain meaning rule looks beyond common usage and dictionary definitions of the words contained in the statute; in fact, the majority opinion contains no references to the various dictionary definitions relied upon by Judge King in opinion below. Instead, the majority takes a broad view of the overriding principles of the Bankruptcy Code and applies the rules of statutory construction so as to comport with these general principles.

As Justice Ginsburg explains, 'We are guided in reaching our decision by the equal distribution objective underlying the Bankruptcy Code, and the corollary principle that provisions allowing preferences must be tightly construed.' As the majority duly notes, every claim granted priority status reduces the funds available to general unsecured creditors and may diminish the recovery of other claimants qualifying for equal or lesser priorities. In the case of Howard Delivery, it was clear that granting priority to Zurich's claim would substantially dilute the claims of various health, welfare and pension plans that were undeniably entitled to priority under ' 507(a)(5), but which would not be paid in amount due to the debtor's limited assets.

When subjected to the litmus test of these fundamental principles of bankruptcy law, Zurich's plain meaning argument did not survive. As Justice Ginsburg concludes at the end of the majority opinion, any doubt concerning whether workers' compensation falls with the plain meaning of the term 'employee benefit plan' '

is best resolved in accord with the Bankruptcy Code's equal distribution aim. We therefore reject the expanded interpretation Zurich invites. Unless and until Congress otherwise directs, we hold that carriers' claims for unpaid workers' compensation premiums remain outside the priority allowed by ' 507(a)(5).

Thus, the second lesson of Howard Delivery: Bankruptcy is unique and the plain meaning of the Bankruptcy Code must be determined in light of the fundamental principles upon which the Code is based.

The Essential Character of Workers' Compensation

Beyond the issues of plain meaning and statutory interpretation, the Court in Howard Delivery still faced the question issue of whether workers' compensation plans, be they statutorily mandated or voluntarily provided, were 'employee benefit plans.'

The Court decided this ultimate issue by evaluating the 'essential character' of workers' compensation regimes. It noted that, unlike pension plans and life, health and disability insurance plans that were designed to supplement or substitute for employee wages, workers' compensation programs 'have a dominant employer-oriented thrust: They modify, or substitute for, the common-law tort liability to which employers were exposed for work-related accidents.' Thus, workers' compensation regimes offer something to both employees ' the right to receive benefits on a no-fault basis, and to employers ' the freedom from large tort judgments and the attendant litigation costs.

By contrast, no such trade-off or sharing of benefits exists with respect to the fringe benefit plans that Congress sought to protect when it enacted ' 507(a)(5) in response to the Supreme Court's holdings in Embassy Restaurant and Joint Industry Board. Unlike workers' compensation insurance which, consistent with fire, theft, and other forms of insurance, benefits the employer by shielding it from liability, employer-sponsored pension plans, and group health or life insurance plans typically insure, and thereby benefit, only the employee or his survivor. These latter plans constitute the type of fringe benefits that the legislative history surrounding ' 507(a)(5) specifically addressed ' 'health insurance programs, life insurance plans, pension funds, and all other forms of employee compensation that [are] not in the form of wages.'

Balancing these various factors, the Court found that 'although the question is close,' workers' compensation was not compensation for the employee, but rather a substitute for the tort liability of the employer:

In sum, we find it far from clear that an employer's liability to provide workers' compensation coverage fits the ' 507(a)(5) category 'contributions to an employee benefit plan'arising from services rendered.' Weighing against such categorization, workers' compensation does not compensate employees for work performed, but instead, for on-the-job injuries incurred; workers' compensation regimes substitute not for wage payments, but for tort liability.

One can therefore summarize the third and final lesson of Howard Delivery as follows: When deciding what type of claims are entitled to priority under the Bankruptcy Code, the Court will look at all relevant aspects of the claim to ascertain its essential character and is likely to construe the priority in light of its legislative history.

In the end, '507(a)(5) proved not to be the alchemist's stone that the insurance industry had hoped for. Whether this will change in the future is now up to Congress.

Lawrence A. Katz is a partner in the Virginia and Washington, DC, offices of Venable LLP. He focuses on bankruptcy, financial restructurings and commercial litigation and has extensive experience in debtor and creditors' rights issues. Katz was counsel of record for the co-petitioner Creditors Committee before the U.S. Supreme Court in the Howard Delivery case and was the author of the petition for certiorari and the briefs submitted by Howard Delivery and the Committee.