Restructuring

Contributed by Elizabeth Hendee
In a recent decision out of the Bankruptcy Court for the Southern District of New York, In re DeWitt Rehabilitation and Nursing Center, Inc., Judge Gropper held that payments made by a debtor that constitute contributions to a third party’s employee benefit plan were not entitled to priority under section 507(a)(5) of the Bankruptcy Code.  Only contributions made to the debtor’s employee benefit plan fall within this priority.
DeWitt, a for-profit nursing center located in New York City, filed for bankruptcy protection in January, 2011.  For over a decade prior to its bankruptcy filing, DeWitt had contracted with United Staffing Registry, Inc. to provide temporary employees in the nursing center.  Pursuant to the contract, DeWitt was responsible for certain employee-related payments, including wages and withholding taxes.  United filed a proof of claim in DeWitt’s bankruptcy case based on this contract for almost $2 million, asserting that a portion of its claim, approximately $150,000, was entitled to priority status under section 507(a)(5) of the Bankruptcy Code because this part of the claim constituted “contributions to an employee benefit plan.”  DeWitt objected to the priority portion of United’s claim.
Section 507(a)(5) of the Bankruptcy Code grants priority status to “allowed unsecured claims for contributions to an employee benefit plan” subject to certain time and dollar restrictions.  United asserted that the relevant portion of its claim was attributable to payments it made for the benefit of DeWitt’s temporary employees to Medicare, social security, unemployment, and other insurance programs during the relevant time period and, thus, was entitled to priority status under section 507(a)(5).
DeWitt, and the Court, disagreed.  The Court looked to the Supreme Court’s decision in Howard Delivery Service, Inc. v. Zurich American Insurance Co., for guidance.  In Howard Delivery Service, the Supreme Court noted that section 507(a)(5) of the Bankruptcy Code was intended to complement section 507(a)(4) of the Code, which grants priority status to certain claims for compensation, by capturing portions of employee compensation not covered by section 507(a)(4).  Priority is warranted in these situations because the debtor’s individual employees are benefited by the priority.  Lower courts have agreed, holding that the purpose of the section 507(a)(5) priority is to protect a debtor’s employees.  According to the Bankruptcy Court, no court has held that either of these subsections is intended to protect persons who are not individuals.
Because United was not an individual and application of the section 507(a)(5) priority in this instance would not protect DeWitt’s employees, the Court sustained DeWitt’s objection to the priority portion of United’s claim and reclassified the entire claim as a general unsecured claim.  According to the Court, a different result would “expand section 507(a)(5) far beyond its intent.”  The policy concerns that section 507(a)(5) seeks to address were not at issue in this case because United’s employees had already received their benefits from United, and the Debtor’s direct employees were not covered by the relevant employee benefit plans.
The DeWitt decision shows that, at least in the Southern District of New York, the section 507(a)(5) priority must be construed narrowly.  Holding otherwise would stifle the “rehabilitation” of debtors like DeWitt.