Supreme Court: Workers Comp Premiums Not Priority in Bankruptcy

June 20, 2006

A workers compensation insurer does not have a claim against a bankrupt business for unpaid premiums under bankruptcy law, according to the U.S. Supreme Court in a 6-3 decision that insurers are warning could disrupt the insurance marketplace unless Congress acts to reverse it.

The Supreme Court majority rejected an insurer’s argument that an employer’s liability to carry workers’ compensation coverage fits the employee benefit plan category that would assign it priority in the event of a bankruptcy.

Instead, the high court ruled that workers compensation premiums are more like liability premiums than employee benefit costs and as such do not fall under the section of bankruptcy code (11 U.S.C. section 507(a)(5)), which assigns priorities to unsecured creditors’ claims for unpaid contributions to an employee benefit plan.

“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,” Justice Ruth Bader Ginsburg wrote on behalf of the majority.

In Howard Delivery Service, Inc., et al v. Zurich American Insurance Co., handed down June 15, the high court reversed the Court of Appeals for the Fourth Circuit which had held that payments for workers’ compensation coverage were “contributions to an employee benefit plan … arising from services rendered” and thus subject to the bankruptcy priority provision.

Zurich had urged the court to borrow the broader definition of employee benefit plan contained in the Employee Retirement Income Security Act of 1974 (ERISA): “[A]ny plan, fund, or program [that provides] its participants … , through the purchase of insurance or otherwise, … benefits in the event of sickness, accident, disability, [or] death.”

But the majority noted that federal courts have questioned whether ERISA is appropriately used to fill in blanks in a Bankruptcy Code provision.

The court further noted that workers’ compensation also differs from fringe benefits in that while nearly all states require employers to carry workers’ compensation, they commonly do not mandate employee benefits.

In the case before the court, Howard contracted with Zurich to provide workers’ compensation coverage for its operations in 10 states. After Howard filed a Chapter 11 bankruptcy petition, Zurich filed an unsecured creditor’s claim for some $400,000 in premiums, asserting that they qualified as “contributions to an employee benefit plan” entitled to priority under §507(a)(5).

The Bankruptcy Court denied priority status to the claim, reasoning that because overdue premiums do not qualify as bargained-for benefits furnished in lieu of increased wages, they fall outside §507(a)(5)’s compass. The District Court affirmed, similarly determining that unpaid workers’ compensation premiums do not share the priority provided for unpaid contributions to employee pension and health plans.

But a Fourth Circuit panel reversed without a rationale, which resulted in the case being brought before the Supreme Court.

Justice Ginsburg was joined in her majority opinion by Chief Justice John Roberts and Justices John Paul Stevens, Antonin Scalia, Clarence Thomas and Stephen Breyer. Justice Anthony Kennedy filed a dissenting opinion, in which Justices David Souter and Samuel Alito joined.

Insurer reaction

Insurers said the decision is flat out wrong and could have serious repercussions in the marketplace.

“The court simply got it wrong. The majority’s narrow focus on the priority provisions of the bankruptcy code overlooked that workers’ compensation coverage is mandatory, and the consequences of an employer’s lapse in coverage,” charged Bruce Wood, American Insurance Association assistant general counsel.

Wood also maintained that the decision could undermine the workers’ compensation system and benefits for injured workers.

“This decision means that an employer trying to reorganize its business will no longer be required to pay its workers’ compensation premiums. This result will jeopardize continued coverage, because an insurer now has no legal authority to compel payment of premiums and doubtful incentive to continue coverage,” according to Wood. “Under current law, employers without workers’ compensation coverage – even bankrupt employers – are subject to huge fines, criminal prosecution and business shutdown.”

“At the same time this decision puts worker protections at risk, along with the viability of the employer’s business,” he added.

AIA participated in the case as an amicus in this case.

Employers that self-insure their workers’ compensation coverage will face related problems, Wood also warned. “Even though a self-insured employer is paying an on-going claim for a past injury, after a bankruptcy filing, ongoing medical treatment and cash benefits stop because the lack of explicit priority for workers’ compensation dumps injured workers into the same category as unsecured creditors.”

The industry will likely now press lawmakers to a change the bankruptcy law.

“This is a poorly reasoned decision with an unfortunate policy result. It appears this is a matter for Congress to address,” Wood said.

In its ruling, the Supreme Court said questions over priority status should be decided with the bankruptcy code’s aim of equal distribution in mind. “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” the court noted. “To give priority to a claimant not clearly entitled thereto is not only inconsistent with the policy of equality of distribution; it dilutes the value of the priority for those creditors Congress intended to prefer.”

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