Employee Rights During Bankruptcies

By Yosie Saint-Cyr, editor at HRinfodesk---Canadian Payroll and Employment Law, May 2005

Following the recent Jetsgo collapse, (the airline carrier Jetsgo shut down recently, leaving some 17,000 passengers stranded and about 1,350 employees out of work) many questions have been raised by Human Resources professionals and employers pertaining to the rights of Jetsgo's former employees, and Jetsgo’s obligations toward these employees. This is not the first time these questions have been asked, and it does raise some interesting legal, practical and ethical issues. According to recent statistics that were used to recently amend the Bankruptcy and Insolvency Act, every week in this country there are roughly 200 commercial bankruptcies, 1,000 bankruptcies a month, and roughly 10,000 bankruptcies per year, many of which leave behind employees who are owed back wages, benefits and pension contributions. We can only estimate the total figures, but over $1 billion per year is a figure that has been used.

According to a December 3, 2004 speech in the House of Commons by Brian Masse, an NDP MP for Windsor West, "it is workers who pay the price when workplaces shut down. This is especially true when these shutdowns are triggered by bankruptcy, because not only do the employees lose their jobs and their source of income, they also often lose wages that they have not been paid, and vacation pay, termination pay and severance pay."

This article will try to provide input on how these situations can be planned by organizations and will answer the following questions by providing some legal and practical guidelines.

• What are the ethical procedures and employer obligations involved in communicating to employees pre- and post-bankruptcy?
• How do insolvency and bankruptcy laws protect employees in these cases?
• What are the rights of employees?

What is insolvency and/or bankruptcy?

The Bankruptcy and Insolvency Act (BIA) is an Act for both personal and corporate insolvencies. It offers various alternatives from outright bankruptcy for individuals or corporations to less extreme consumer proposals for individuals and reorganizations for corporations. The various alternatives are meant to reflect the seriousness of the financial problems being experienced by the debtor and to offer a degree of protection to the creditors.

• Insolvency: a company is insolvent if it does not have enough assets to cover its debts, or is unable to pay its debts when they are due. An insolvent employer may have ceased operating because he or she can no longer get credit, or because utilities are cut off or the landlord has locked the business out for not paying rent. Creditors can also ask a Court to declare a debtor insolvent.
• Bankruptcy: a bankruptcy happens when a business voluntarily applies for bankruptcy through the Official Receiver under the federal Bankruptcy and Insolvency Act, or is forced into bankruptcy by creditors asking a court to declare the debtor bankrupt. An employer may not be bankrupt simply because employees were not paid or because the company has closed its doors; proper court documents must be filed in court.

Where no hope remains of restoring an insolvent person or corporation to financial viability, bankruptcy is a means of liquidating the assets for the benefit of the creditors, providing the debtor with a fresh start and getting the assets back to work in a profitable environment. Where restoration is possible, the BIA provides both consumers and corporations of any size with the means to make a proposal to their creditors to restructure their debt. These are commonly known as "consumer proposals" for consumers and "reorganizations" for corporations. Proposals and reorganizations generally result in a greater return to creditors while allowing the individual or business to continue to function and to recover. In both bankruptcies and reorganizations, the BIA provides a structured system and ensures a fairly predictable and consistent outcome.

The benefits of a successful reorganization are profitable continuation of the business and the mainte­nance of jobs. If reorganization is unsuccessful, bankruptcy would usually follow.

What are the ethical procedures and employer obligations involved in communicating to employees pre- and post-bankruptcy?

However, with all the recent high profile cases of fraud and bankruptcy, several industries and the broader business world have been confronted with corporate misconduct, accounting irregularities, bankruptcies, and an erosion of confidence and trust on the part of employees and investors. The tide is changing…there is a call by regulators for organizations to establish a reputation for maintaining the highest standards of business behaviour, conduct and corporate governance. Customers, employees, suppliers, and investors must be able to rely on the organizations integrity.

Governments are focusing on directors and the company’s business operations, including areas of risk exposure (i.e., executive compensation and related party transactions) demanding meaningful and comprehensive reporting from all directors and management levels. There is also a greater focus on directors for the company’s continuous disclosure, including quarterly and annual reporting and press releases; as well as regular review of corporate governance policies, controls and procedures to ensure that they represent best practices and are being complied with. This focus is to build a new sense of commitment to strong corporate values, improved communication and the need for leaders who demonstrate through personal action that they are dedicated to creating an internal environment grounded in trust, openness, and integrity.

An organization that is insolvent and/or files for bankruptcy (whether for protection from creditors under the Bankruptcy and Insolvency Act to either restructure or reorganize) damages their credibility; organizations should work on communications issues surrounding damaged credibility, management transitions, bankruptcies, litigation, regulatory actions, rumour management, earnings shortfalls, restructurings and product liability situations. They should establish a crisis communication policy dealing with damage control and responses, specifically ongoing feedback and communications services designed to preserve or rebuild client/employee credibility once the actual crisis has been contained.

How do insolvency and bankruptcy laws protect employees in these cases?

The BIA provides no special protection for unpaid contributions to pension plans. Priorities are provided under federal and provincial pension legislation, although it is uncertain whether the provincial priorities would be recognized in bankruptcies. Ontario is the only province that provides funded protection for pension claims.

The bankruptcy trustee will pay creditors according to the priorities set out in the Bankruptcy and Insolvency Act. Creditors are prioritized as follows:

• Secured creditors are creditors who have a secured or registered claim for all or part of a debt incurred for a specific purchase (for example, a bank holding a mortgage on a property).
• Preferred creditors are creditors who have received regular payment on bills or debts (for example, employees who have earned wages in the six months prior to the bankruptcy to a maximum of $2,000, utility companies).
• Non-secured creditors are creditors who have extended credit to the company based on a promise to pay (for example, suppliers, credit card companies, employees who have earned wages in excess of the amount described above).

It is possible that, once secured creditors are paid, there may be little or no funds left to pay preferred and non-secured creditors.

The amount of wages having priority over the claims of all other non-secured creditors of an employer was increased from $2,000 to $10,000 (the legislation continues to specify that this does not apply with respect to a distribution made by a trustee under the federal Bankruptcy and Insolvency Act).

In addition, during a bankruptcy, Directors are liable for unpaid wages, unremitted payroll deductions, employment insurance and the Canada Pension Plan premiums and contributions, and for dividends paid or other transactions that do not meet a financial test if the company is insolvent, among others. For all these matters, a due diligence defence is available and would normally be covered by an indemnity from the company or Directors’ and Officers’ liability insurance. Directors are only protected to the extent their actions evidence the exercise of their business judgment.

The keystone of protection for directors therefore remains the ability to demonstrate that each director in fact has taken reasonable steps to exercise his or her business judgment when considering corporate actions; decisions and actions that are made honestly, prudently, in good faith and on reasonable grounds.

The Bankruptcy and Insolvency Act permits a restructuring of an insolvent company with creditor claims; as well, under the Companies' Creditors Arrangement Act -restructuring is possible but for creditor claims in excess of $5 million. An expert hired by the trustee will investigate and report on whether the company is viable in its present form, or could be through reorganization. As a result, employees may have an opportunity (there are no guarantees) to be reinstated in their pre-bankruptcy position.

In order to encourage directors of an insolvent corporation to remain in office and assist the company to reorganize, the Bankruptcy and Insolvency Act was amended in 1997 to allow a stay of proceedings in respect of claims against directors of a company filing a proposal to creditors. The amendment shields the directors against claims that occurred prior to the proposal filings and may include personal liability for the following:

• Canada Revenue Agency - Employee Source Deductions
• Canada Revenue Agency - Goods and Services Tax
• Workers Compensation Board
• Minister of Finance - Provincial Sales Tax

For example, on March 24, 2005, the media indicated that Jetsgo proposed a restructuring plan that will allow business to continue. The plan presents an opportunity for employment to potentially hundreds of individuals and will provide a financial recovery for the company's creditors superior to the result that they would achieve in bankruptcy, as reported. Plans of reorganization require the approval of creditors and the sanction of the court.

What are the rights of employees?

If the employer is bankrupt, the Employment Standards Branch cannot recover wages on behalf of an employee. Employees who are covered under a collective agreement must contact their union for assistance in recovering wages. Please note that a collective agreement does not terminate on bankruptcy. The status of a collective agreement is governed by the Labour Relations Act and is only terminated in specific circumstances set out in the Act. As the court have stated, it follows that a collective agreement can bind a successor employer who takes over the business of the debtor if the labour board so declares. In addition, a collective agreement is a contract between the company and a union, and not its employees.

An employer may not be bankrupt simply because he or she is insolvent or employees were not paid or because the company has closed its doors. Employees must find out for sure if their employer really is bankrupt and obtain the name of the Bankruptcy Trustee.

If the company is not bankrupt, but closed its door because it is insolvent and has not yet asked for protection from creditors under the Bankruptcy and Insolvency Act, the employee must recover unpaid wages with the Employment Standards Branch by filing a complaint. The Employment Standards Branch will then demand that the employer provide payroll records. If the records show the employee is owed money, the Branch will issue a determination and try to collect money on the employee’s behalf.

If the employer is bankrupt, the employees working in a non-unionized workplace or the Union in a unionized workplace will need to file a claim with the bankruptcy trustee. There are time limits for filing so the employee or union should do this as soon as possible. In bankruptcy cases there is no guarantee that they will receive all or part of the wages owed to them. In any case, it usually takes up to six months before employees will see any money.

The employee or Union must file a "proof of claim" with the bankruptcy trustee. They should make a list of all monies owed to them by the employer, including:

• Regular wages (both the dollar amount and hours worked);
• Annual vacation pay;
• Compensation for length of service (termination and/or severance pay); and
• Any other monies owed to them by the employer.

The employees are allowed to sue the directors of the corporation to make up for any shortfall. However the process is tedious. It can take years, and not all the employees involved have a union to advocate for them.

Employees should keep all pay statements and other records that can prove they were an employee and that wages are owed to them.

If they have not received a Record of Employment from their employer to apply for EI benefits, employees should be directed to contact Human Resources and Skills Development Canada (HRSDC). If they did not receive their T-4 Slip, they should contact the Canada Revenue Agency (CRA).

Conclusion

In conclusion, employees and pensioners have limited rights under bankruptcy.

Any employer that has filed for bankruptcy should support the efforts of its employees to receive the wages and benefits, including severance, owed to them. This is not only the right thing, it is good business sense for anyone seeking to restructure a firm successfully and preserve as much of the human capital component of the firm's going concern value.

The significance for directors of the statutory liability for employees' wages is clear. Where an organization becomes insolvent and is unable to satisfy the claims of its employees for wages owed, the directors may be personally obligated to satisfy such claims. Therefore it is extremely important for directors to carefully review the financial statements and all other financial records and related documents of the organization on whose boards they are members.

Several of the Resources used to generate this article can be found at:

• Bankruptcy and Insolvency Act
• Employment Standards Act, 2000, S.O. 2000, c. 41
• Employment Standards and Bankruptcy Fact Sheet (although from Alberta, it’s application is general across jurisdiction)
• Canadian Law Firm - Blakes Means Business Pension Claims Update-Whose Rights Prevail?
• Bankruptcy Law Update (88-16e)
• Changes to the Bankruptcy and Insolvency Act
• Report of the Standing Senate Committee on Banking, Trade and Commerce (PDF Format)

By Yosie Saint-Cyr, Editor at HRinfodesk

Published on HRinfodesk---Canadian Payroll and Employment Law

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