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we are a small business (C Corp). recently an ex-employee filed

a complaint citing we didn't...
we are a small business (C Corp). recently an ex-employee filed a complaint citing we didn't pay overtime, which in fact unforunately we found out he was right 'cos we were paying all of the by salary instead of hourly. (we are in the process of correcting this mistake, and we never knew before) Mediator just presented proposal of paying the plaintiff $70 to get it settled. However, we talked to a bk attorney that we can file ch11 and set up a 363 deal. Basically, we set up a new company to buy out our own old company. At the end of the day, the old company won't have anything valuable left for plaintiff or any other current/former employees' potential wage/labor claim. What I want to ask is is this really to protect us from this plaintiff (they will file lawsuit as soon as we decline the settlement offer) as well as any potential claims since we currently have about 40 employees that can potentiallly sue us for overtime pay. Is there any risk of doing so? Will BK court approve the deal since although the company is not making money, we are not deep in debt to the point of bankruptcy. So is there a chance for court to not approve the deal citing that we are filing bk just to ditch lawsuits? And with 363 deals, will owners of company be liable for anything?
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10/17/2013
socrateaser
socrateaser, Attorney
Category: Bankruptcy Law
Satisfied Customers: 39,498
Experience: Attorney and Real Estate Broker -- Retired
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What I want to ask is is this really to protect us from this plaintiff (they will file lawsuit as soon as we decline the settlement offer) as well as any potential claims since we currently have about 40 employees that can potentially sue us for overtime pay?

A: A "363 deal," is a Chapter 11 reorganization under which the debtor corporation sells its assets "free and clear" of any creditor's interest in such property. Bankr. Code 363(f). A creditor can object to such a sale on grounds that the creditor's sale will cause the " "virtual destruction of the plaintiff's remedies" against the debtor, because the sales price is "grossly inadequate" and "unconscionable." See Myers v. US, 297 BR 774, 786 (USDC SD CA 4/10/2003).

The upside of the bankruptcy filing, is that the average employee doesn't have the money to pursue a corporation in Chapter 11, because the legal expenses to hire a competent creditor's bankruptcy attorney are overwhelming, especially when the employee is not currently employed.

The downside of the bankruptcy is: the corporation could pay out $25,000 or more in legal expenses; if the creditor/employee objects to the asset sale, and the court agrees, then the sale may be denied; even if the sale succeeds, the debtor corporation will receive revenue from the sale, and that may be enough to pay some portion of the employee's claim (at least $12,475 in unpaid prepetition wages have priority in bankruptcy, so the employee is almost certain to receive that much, no matter what).

I could go on, but this is not necessarily a risk-free transaction. If I were in your shoes, and there is a real risk of being sued by 40 or more employees for nonpayment of wages, then I might consider Chapter 11 as a means of reorganizing and trying to make a settlement offer with all of the employees for a release of further liability after payment of a lesser amount, and then only consider a Section 363(f) sale as a last resort, if no settlement can be reached. And, I might try to get that settlement, before filing bankruptcy. You have a legitimate risk here that could drive you into bankruptcy, given that 40 X $70K is $2.8 million in unpaid wages. Jumping into the bankruptcy may not save you money, but if you could settle on $12,475 per employee, that would be $499,000. You may not be able to pay that either. If you cannot, then the true recourse here may be to file Chapter 7, liquidate the business and just start over from scratch.

Is there any risk of doing so?

A: See above.

Will BK court approve the deal since although the company is not making money, we are not deep in debt to the point of bankruptcy.

A: The bankruptcy court will approve the sale if no one objects. If someone does object, then the court will have to consider whether or not the sale is intended to avoid successor liability, and whether or not the sale will result in the creditor-employees losing any possibility of recovering their unpaid wages from the original corporation.

So is there a chance for court to not approve the deal citing that we are filing bk just to ditch lawsuits?

A: The risk depends heavily on whether or not the employee(s) object to the asset sale in bankruptcy. See above.

And with 363 deals, will owners of company be liable for anything?

A: Depends on whether or not Uncle Sam (IRS) gets involved. It's possible that the failure to remit payroll taxes to the IRS can trigger the 100% federal Trust Fund Recovery Penalty (TFRP). IRC § 6672. This penalty attaches to any person who is responsible for the failure to remit (i.e., persons who had legal authority to withhold and remit federal payroll tax to the U.S. Department of Treasury). And, the penalty is not dischargable in bankruptcy.

In order for IRS to get interested, an employee must file a formal complaint with the IRS. Most employees are not particularly interested in anything other than getting paid damages for the unpaid wages. But, if someone does complain, and the IRS gets involved, then at some point, the responsible corporate officer(s) (e.g., CFO, CEO, controller -- anyone with signing authority over payroll matters), could get burned, regardless of the bankruptcy and regardless of the corporate structure.

The best possible outcome here would be some sort of settlement and release from further liability on the wage claim. But, if the employee(s) is/are uncooperative, Chapter 7/11 bankruptcy may be the only option(s).

Please let me know if my answer is helpful, or if I can provide further clarification or assistance.

And, thanks for using justanswer.com!

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Customer reply replied 4 years ago

Thank you for your response. It was a great answer. If you don't mind, I have further questions:


 


Since we found that we had been paying wrongly our employees in a salary without itemized OT hours on their stubs (BTW, their salary was fully enough to cover them with at least min wage plus overtime, so we didn't intentionally not pay OT), we have changed our system to reflect itemized hours. Is it true that employees can over claim the $12K in unpaid wages earned within the only last 180 days before filing bankruptcy? If so, the plaintiff employee has already left our company for 4 months, so we don't have much left from the 180 days, plus we are talking only 8 hours unpaid OT per week averaging about $12/hr. For the current employees, we have already changed our system so the clock is also ticking.


 


Given that we are a small business with gross only $2.5M, in you opinion, logically would the counsel of the plaintiff employee even bother to pursue a ch 11 company with not much return? You mentioned max $12K. Is that all they would get if they pursue us during ch 11 or are they entitled to any damages or fees or penalties. (Right now, they are asking for unpaid wages and all kinds of liquidated damages and penalties)


 


We don't really want to disclose to our current employees to this unpaid OT hours issue. Telling to get a lesser settlement with them is like inviting lawsuits, right? Then why not just jump to 363 sale without offering settlement? Our goal is the protect ourselves with the least disruptions with current employees as well as front sales. The less people know about this, the better.


 


 


Can you explain on payroll tax liability? We haven't not paid payroll tax. Are you talking about the payroll tax attached to the unpaid OT wages? These money don't go to the employees at all, right? Just to IRS?


 


With the 363 sale, what are tax consequences on the original owners of the old, bankrupted, company?


 

Is it true that employees can over claim the $12K in unpaid wages earned within the only last 180 days before filing bankruptcy?

A: The 180 day limit is as to the 4th position priority. Bankr. Code 507(a)(4). The employee still has an unsecured claim for the remainder of any unpaid wages, but he/she must stand in the same line as all of the other unsecured creditors. So, the risk calculation is whether or not the assets left in the corporation after sale is enough to satisfy the employee claims, and then the unsecured creditor claims, which will still include any balance owed for unpaid overtime. My thumbnail calculation for 40 employees, not considering the 180 day priority is a settlement of $4,937.13 per employee (197,485.71), not including attorney's fees and costs of suit to the prevailing party. Federal law permits the employees to recover liquidated (double) damages for unpaid overtime. 29 U.S.C. 216(b).

If so, the plaintiff employee has already left our company for 4 months, so we don't have much left from the 180 days, plus we are talking only 8 hours unpaid OT per week averaging about $12/hr. For the current employees, we have already changed our system so the clock is also ticking.

A: The premise is incorrect. The employees have a priority claim for $12,475, plus a no-priority claim for any amounts that do not fall within the scope of the priority. So, even though the claim amount is likely to be less than the priority limit, the employees will still be your unsecured creditors after the asset sale. In sum, unless you conduct a "fire sale," and get away with it, the employees are going to get paid some of what they are owed, if you choice bankruptcy as the way to mitigate this debt.

Given that we are a small business with gross only $2.5M, in you opinion, logically would the counsel of the plaintiff employee even bother to pursue a ch 11 company with not much return? You mentioned max $12K. Is that all they would get if they pursue us during ch 11 or are they entitled to any damages or fees or penalties. (Right now, they are asking for unpaid wages and all kinds of liquidated damages and penalties)


A: First issue is whether or not plaintiff's counsel is a member of the federal district court bar. If not, then counsel can't represent the employee in bankruptcy court -- so counsel would have to associate with another attorney (which means sharing legal fees, and attorneys don't like doing that), or withdraw from the case. Assuming counsel follows you into bankruptcy court (I would, if it were my case), then you can probably expect that counsel will carefully scrutinize your asset sale.

 

I think my original answer is still valid here. I would consider putting together a settlement package for all of the employees, and then try to get them to accept a payment plan. If you were to spread the settlement over 12 months, it would probably work out to about $2.50 per hour per employee.

 

Not cheap, but if you can negotiate the settlement down below what could be obtained in court, you may be able to reduce the bite to something you can swallow.

 

We don't really want to disclose to our current employees to this unpaid OT hours issue. Telling to get a lesser settlement with them is like inviting lawsuits, right? Then why not just jump to 363 sale without offering settlement? Our goal is the protect ourselves with the least disruptions with current employees as well as front sales. The less people know about this, the better.

A: The only way to keep the issue with the current employee confidential is to enter into a confidential settlement agreement. If you cannot settle, then, were I opposing counsel, I would be considering filing a class action against you on behalf of all of the employees, and then you really will have a reason to file for bankruptcy.

If you really believe that you can keep a lid on this matter, then you may want to seriously consider trying to counter the employee's current offer, and try to get a confidential settlement. Otherwise, I see this as potentially exploding -- after which, Chapter 7 will probably be the only option.

Can you explain on payroll tax liability? We haven't not paid payroll tax. Are you talking about the payroll tax attached to the unpaid OT wages? These money don't go to the employees at all, right? Just to IRS?

 

A: Each employee is entitled to wages for hours worked. Each payroll check must have withholding for FICA, FUTA, Medicaid, SDI, unemployment, etc. If an employer is found liable for unpaid wages, and the settlement characterizes the payment as such, then tax withholding must be made on the unpaid wages. If you go bankrupt and you don't pay the unpaid wages, then you will also not pay the withholding, and that means that IRS has a claim for the remitted withholding.

 

If the corporation dissolves, the IRS can come looking for that withholding in the form of a penalty, equal to the amount not withheld, from any person who had the authority as a corporate officer or other responsible person, to withhold, but who failed to do so.

 

With the 363 sale, what are tax consequences on the original owners of the old, bankrupted, company?

A: Owners aren't liable for unpaid corporate income tax. They are potentially liable for unpaid employee payroll withholding (TFRP). Also, personal liability can attach for any unpaid unemployment insurance contributions -- and for unpaid sales or use tax.

Hope this helps.
socrateaser
socrateaser, Attorney
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Experience: Attorney and Real Estate Broker -- Retired
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Customer reply replied 4 years ago

We have on the table a $70K mediation proposal that we need to respond by tomorrow. Whatp happens if we accept and still go to Ch11 BK vs. we simply decline the settlement deal. Would you take the hit of $70K up front if it was you or woud you go the BK route.

What happens if we accept and still go to Ch11 BK vs. we simply decline the settlement deal?

A: If you accept, and then file bankruptcy, then the settlement is executory/incomplete and you have the right to either assume or reject the settlement in bankruptcy. If you assume, then the contract moves forward without modification. If you reject, then that is a breach of the contract, and the creditor/employee has an unsecured claim under the contract, the same as any other creditor. In other words, everyone is "back to square one."

Would you take the hit of $70K up front if it was you or would you go the BK route?

A: I think that the critical issue here is whether or not the "news" will get out to the other employees (it may already be disclosed, and the employees are simply waiting to see what happens with the settlement offer). If the other employees discover that they have rights to money, then your settlement will not prevent your bankruptcy, which will make the settlement a waste of time and money.

In sum, my position would be that unless I can get a comprehensive settlement from all of the employees, then I would be filing Chapter 7, and starting my business again from scratch, after the dust settles.

Hope this helps.
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