As we face a potential banking crisis after the collapse of the Silicon Valley and Signature Banks, this seems like an opportune time to address the potential ramifications of a company’s inability to meet its payroll obligations. Missing payroll has multiple ramifications under both state and federal law, and impacts both employment and employee benefits laws and regulations including, but not limited to, the Fair Labor Standards Act (FLSA), ERISA and other similar state and local laws and regulations.
Each employment situation is different, and how employee benefits are structured (such as whether benefits are self-funded or fully insured) vary from employer to employer. Further, employment laws and requirements vary from state to state. Therefore, it is important to work with counsel when navigating these difficult situations.
Fair Labor Standards Act
Under the FSLA, covered, non-exempt employees are required to be paid for hours worked, at a rate at least the applicable minimum wage for under 40 hours of work, as well as for any overtime (at a rate 1.5 times their regular wage) for hours exceeding 40 per week. Further, all covered, non-exempt employees are required to be paid for all hours in which they are on duty, at a prescribed place of work, or “suffered and permitted” to work for the employer. Exempt employees must be compensated their applicable salary for any and all work performed for the employer (even if it is only one hour) in a given week.
Therefore, an employer cannot simply skip payroll or fail to pay employees for hours worked (non-exempt) or any performance of work for the employer (exempt employees) during a given workweek. Failure to comply with the FLSA may result in lawsuits from employees, civil monetary penalties issued by the Department of Labor and/or state agencies, criminal fines or imprisonment (for willful violations).
Moreover, many states have their own wage and hour laws, including wage-theft laws, with which employers must comply. While these laws vary from state to state, some states, such as California, have stringent requirements associated with payroll frequency and timing, and require specific information to be reported on wage statements. Failure to follow these requirements may result in both civil and criminal penalties and lawsuits.
It’s also important to remember that if the company intends to lay employees off until it can secure new or additional funding, it must comply with any final pay requirements under applicable state law.
Under the Internal Revenue Code, employers are required to deposit and report wages, tips and other compensation paid to employees. Employment taxes taken from the employee’s pay include federal income tax, Social Security or Medicare taxes and other applicable state income tax or other taxes. Additionally, the employer must pay any applicable federal unemployment taxes (“FUTA”), as well as any other applicable state unemployment tax or other taxes.
News outlets have recently interviewed business owners and CEOs who have used their own personal funds to cover employee pay due to unavailability of funds in some failed banking institutions. In these situations, the CEO or business owners must ensure that any payments to employees from personal funds or other sources are processed through an applicable payroll vendor to ensure that all applicable taxes are withheld from employee pay and that the employer pays its FUTA taxes attributable to employee pay. Further, working through a payroll vendor will ensure the employer is meeting wage statement requirements under applicable law. Failure to withhold and/or pay applicable employment-related taxes may result in significant penalties for employers.
Employee Benefits Implications
Depending on the facts of the situation, an employer’s failure to make payroll may violate ERISA’s exclusive benefits requirements, fiduciary obligations, plan asset and prohibited transaction rules. This may be especially applicable for funded plans (i.e., those with a trust). Moreover, employers with funded plans must consider any requirements under the trust agreement or risk violating the terms of the trust.
For self-funded plans where claims are paid from the company’s general assets, the employer has a fiduciary obligation to cover any valid/covered, outstanding claims under the plan that were incurred at a time when employees’ premiums were remitted to the plan. Failure to pay claims for benefits to which the employee was entitled breaches the plan’s fiduciary obligations.
Additionally, the employer has notice requirements with regard to coverage under the plan. If the employer is unable to make payroll and will not be able to meet its obligations to carriers and/or third-party administrators, particularly for an extended period, the employer will need to notify the carrier/third-party administrator (TPA) and plan participants, and terminate the plan. Any notice to participants should ideally be delivered before the decision to terminate the plan but not later than 60 days after the decision to terminate the plan.
Aside from legal ramifications from failing to make payroll, the employer’s biggest hurdle will be its goodwill with employees. It is important to notify and set expectations for employees, though no matter how well the employer communicates the issues, the employer should expect some level of employee relations fallout from this unfortunate situation.
While this piece focuses on ramifications under federal law and employee health and welfare benefits rules, an employer may be required to comply with additional notice requirements under state law, and there may be other state wage and hour laws an employer violates if it does not meet payroll obligations. Moreover, there are notice and other ERISA-related requirements that may apply to the employer’s retirement benefits, depending on the facts and circumstances. Accordingly, it is important for employers facing a potential payroll shortfall to reach out to experienced employment and employee benefits counsel for guidance.
About the Author.
This whitepaper was prepared for Alera Group by Barrow Weatherhead Lent LLP, a national law firm with recognized experts on ERISA and the Affordable Care Act.
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