Not Enough Money to Make the Next Payroll? Know the Law Before You Act

Recent disruptions in the financial services sector as well as an economic downturn in certain industries, including high tech, may create an immediate and unanticipated liquidity crisis for impacted employers. When faced with these circumstances, employers may not have enough cash on hand and may consider skipping payroll obligations to conserve cash. Skipping even one payroll, however, can have dire legal consequences for the company and may impose potential personal liability on officers, directors, and even managers, making an already bad situation worse. Before skipping payroll obligations, employers should know the following:

• Almost every state has laws regulating the payment of wages to employees. The laws of the various states where your employees actually perform work for the company will normally govern, not the state where the company is headquartered or incorporated. These state wage payment laws, in addition to the federal Fair Labor Standards Act (FLSA), must be considered before any pay dates are missed.
• Some state wage payment laws have very significant penalties, such as daily fines for each day a worker goes unpaid, triple damages, attorney’s fees, and others. If faced with any of this, employers should always consider alternative sources of cash or deferment of other expenses, rather than missing a payroll. Wages are usually defined to include base compensation, commissions, bonuses, and in some states, vacation/personal time off that has been earned and is due to be paid. Some employers may have flexibility in when they can pay commission and/or bonuses, or other non-hourly or non-base salary compensation, depending on how their commission/bonus plans are drafted. Employers should review their commission/bonus plans carefully with counsel before electing to defer any payments.
• Getting a waiver or consent from an employee agreeing to waive earned wages is almost always a bad idea. Except for exempt employees who have a significant, actual ownership interest in the business (not stock options or unvested equity), employees cannot lawfully waive their right to timely payment of wages — they must be paid in full for all earned wages even if employees agree that they are willing to defer or forego some or all of what they have earned.
• It may be possible to delay a payroll rather than skipping one altogether. Under federal law and in many states, exempt employees can be paid as infrequently as once per month, but deductions generally cannot be made for any week in which an exempt employee has already performed any work. However, the rules differ for non-exempt and hourly paid employees, and some states even mandate weekly payment for certain categories of workers. Again, employers should examine these issues with counsel to determine whether and for which employees they can delay payroll.
• In many cases, employers can unilaterally, prospectively reduce compensation rates provided the reduction does not take an employee’s regular rate of pay below applicable minimum wage or applicable salary threshold limits — except where prohibited by state law or otherwise by contract. In other words, if an employer needs to reduce payroll by a certain amount to ensure liquidity for the next payroll cycle, they may be able to notify employees that, for example, starting March 16, employees’ compensation rate will be reduced by 20% (or some other amount) until further notice, provided such reduction does not result in a sub-minimum wage rate or salary threshold requirement under the FLSA or applicable state law (if higher than federal law). Keep in mind that many state wage payment laws require specific forms of written notice regarding any changes to rates or timing of pay.
• If compensation is deferred to a later tax year, be sure to be mindful of Internal Revenue Code Section 409A, which does provide some relief when making payments would jeopardize the company’s ability to continue as a going concern (a facts and circumstances test). In addition, if more than 20 percent of your total plan participants were laid off in a particular year, your 401(k) plan may have experienced a partial plan termination and all affected employees must be fully vested in their account balances.
• If layoffs are necessary, employers should consult counsel immediately to determine whether there are any federal or state Work Adjustment and Retraining Act of 1988 (WARN) implications. In most states (but not all) and under federal law, if WARN is triggered, employers must give 60 days’ advance notice of the termination event unless certain exceptions apply (i.e., unforeseeable business consequences, which would be expected to include unexpected bank failures and the like). Exceptions are very limited in application so consultation with counsel is highly encouraged if layoffs are required. There also state and local “Mini-WARN Acts” that must be considered.

Employers facing a liquidity crisis have options, and with some planning and forethought can avoid lawsuits and investigations from federal and state labor regulators.

Please reach out to members of the Bank Receivership Task Force or to your Foley relationship partner if we can provide assistance.