In the wake of the recent news of bank failures, businesses—and their investors—are rightly concerned about the implications of a missed or delayed payroll.  Let’s look at those implications, and strategies for minimizing risk.

Obligation to Make Payroll

Under federal and most state laws, employers have both timing-of-pay and frequency-of-pay obligations.  Under most of these laws, wages earned in a particular workweek must be paid on the regular pay day for the period in which such workweek ends.  Under some of these laws, payment of certain kinds of wages (e.g., overtime wages) can be delayed until the following regularly scheduled pay day, but only if the wages cannot be computed in time with reasonable diligence.  Here, however, the issue is likely not one of computation—but of availability of funds.

Consequences

Employees who do not receive timely payment of wages can sue, and can seek not only their unpaid wages, but liquidated damages equal to 100% (and in certain states 200%) of the amount of wages not timely paid.  In many jurisdictions, civil penalties and attorneys’ fees are also available to prevailing plaintiffs in wage lawsuits.  Unfortunately, the wage laws do not provide a defense based on lost access to payroll funds.  In addition, while an employer may have rights or claims vis-a-vis their banks or insurers, the employer is the entity with responsibility for compliance with wage and hour laws, and third-party liability won’t absolve the employer of its responsibility to make timely payroll.

Investor and Individual Liability

To what extent can an investor (e.g., a private equity or venture firm) or an individual (e.g., a director or officer) be liable to employees for unpaid or late-paid wages?  The short answer is it depends.  Employees and plaintiffs’ lawyers may pursue different theories of liability depending on the jurisdiction, and most depend on an analysis of multiple considerations.

Federal Law

Under the Fair Labor Standards Act (“FLSA”), an employer is defined as “any person acting directly or indirectly in the interest of an employer in relation to an employee.” It’s possible for more than one entity or individual to be an “employer” of the same individuals under the FLSA, and all such “employers” are jointly and severally liable for wages—meaning any of them can be sued for the full amount of unpaid wages.  To determine whether an individual or third party is an “employer” for purposes of FLSA liability, most courts apply a version of the “economic reality” test that considers whether the individual or third party (1) had the power to hire and fire the employees, (2) supervised and controlled employee work schedules or conditions of employment, (3) determined the rate and method of payment, and/or (4) maintained employment records.  None of the factors individually is dispositive, and the inquiry is fact specific.

The FLSA’s definition of a “person” includes an individual, partnership, association, corporation, business trust, legal representative, or any organized group of persons.  As such, a corporation, partnership, or limited liability company could be held liable for unpaid or delayed wages if it otherwise qualified as an “employer” under the FLSA.

While individual officers and directors can (depending on the facts) be deemed “employers” under the FLSA, many courts have held that individuals who are not directly involved in employment decisions and/or who do not have economic control over employees are not liable under the FLSA.  By contrast, courts have found that individual defendants who are directly involved in employment decisions and/or who have economic control over the at-issue employees may be liable as “employers.”

State Liability

As with all wage and hour issues, state laws may require a different analysis of individual or third-party liability.  For example, under the Wage Orders of California’s Industrial Welfare Commission, an individual or third party may be deemed an employer—or joint employer—if they “directly or indirectly, or through an agent or any other person, employs or exercises control over the wages, hours, or working conditions of any person.”  For a discussion on the consequences of a missed payroll under California law, see our blog here.

Separate and apart from whether individuals and third-parties can be held directly liable for wages as employers or joint employers, some states have statutes that allow employees to seek relief against shareholders.  For example, under Section 630 of New York’s Business Corporations Law, the top ten shareholders of a corporation (determined based on the fair value of their respective beneficial interests) are jointly and severally liable for amounts owed in respect of unpaid services performed in New York, including:

  • wages;
  • vacation, holiday, and severance pay;
  • employer contributions to or payments of insurance or welfare benefits;
  • employer contributions to pension or annuity funds; and
  • other amounts due and payable for services rendered by the employee.

Because liability is joint and several, employees can elect to recover from only one, a few or all of the top ten shareholders, though shareholders that pay more than their pro rata share are entitled to contribution from the other shareholders.

Under the New York law, to seek relief from the top ten shareholders, plaintiffs must:

  • first give written notice to the applicable shareholder(s) that they intend to hold such shareholder(s) liable within 180 days of the termination of the services performed in New York (or, if within such time period the employee demands an inspection of the corporation’s records to determine the top ten shareholders, within 60 days of being granted such inspection);
  • seek to recover the amounts owed from the corporation and obtain a judgment against the corporation that remains unsatisfied prior to commencing an action against the shareholder(s); and
  • commence such action within 90 days after the judgment against the corporation is unsatisfied.

The requirement that the employee first obtain a judgment against the corporation is of particular importance because it has the effect of limiting the potential for shareholder liability to situations in which the corporation is insolvent or bankrupt.  In all other contexts, the corporation should generally be able to satisfy the claim directly without the need to shift the liability to its shareholders.  Similar relief is available against the ten members of a limited liability company with the largest percentage ownership interest, under Section 609 of New York’s Limited Liability Company Law.

California also has unique laws that could implicate a company’s directors and officers.  For example, under Section 558.1 of the California Labor Code, an “owner, director, officer, or managing agent” of an employer may be held personally liable for violating or causing a violation of any provision of the Labor Code relating to minimum wages or hours and days of work in any Wage Order of the Industrial Welfare Commission.  California courts have held that the key inquiry for liability under Section 558.1 is whether the individual had “personal involvement” in violating a labor statute or causing the violation.  In 2021, the Court of Appeal held that a company’s owner was not liable because her involvement in the operation and management of the business was “extremely limited” and “she did not participate in the day-to-day operational/management decisions of the company.”

Employee Benefits Considerations

Missed payroll can impact employee benefit plans.  First, employee contributions (e.g., to health or 401(k) plans) will need to resume when payroll resumes.  Employees can miss out on 401(k) and similar deferral opportunities if payroll does not resume by year-end.  Second, employers that are unable to make matching or other employer contributions should consider whether the plan can be amended to cut off the employer’s obligation.  Third, employers should contact their insurers to ensure there are no gaps in coverage.  If employers are resorting to manual adjustments to payroll or moving to new providers, they should confirm that employee contribution elections are implemented correctly.  If any employees’ benefit elections are missed, employers should discuss with counsel the available options to correct the error.

Avoiding Section 409A Issues

If pay is delayed beyond March 15, 2024, employers can be exposed to adverse tax consequences under Section 409A of the Internal Revenue Code.  To avoid this tax, the employer will need to make payment as soon as practicable and establish either (a) that it was “administratively impracticable” to make the payment earlier and the impracticability was unforeseeable, or (b) that earlier payment would jeopardize the employer’s ability to continue as a going concern.

Practical Considerations

Employers that no longer have access to their payroll accounts should, of course, be actively seeking alternative sources of funds to make payroll (e.g., from cash reserves in other accounts, credit lines, etc.).

As with so many other workplace issues, early and open communication with impacted employees—combined with frequent updates as to the status of remediation efforts—is a key strategy that can help to create and maintain trust and minimize the risk of legal claims.  Employers that have lost access to their payroll accounts and will miss a payroll as a consequence should immediately notify employees of the development and the plan to make payroll on the next possible date.  In that communication, the employer should designate a contact person or team to field questions from employees, and that contact person/team should respond to all employee inquiries in real time.  Employers should send regular updates to impacted employees (e.g., every 24 hours) as to when they expect to make payroll.  Assuring employees that they will be paid notwithstanding the circumstances—and keeping them well-informed as to timing—should help alleviate what is likely the primary concern in most workers’ minds, particularly for those who rely on a predictable payroll to meet their financial obligations.

As with all wage and hour and benefits issues, state law may require a different or more nuanced approach.  Employers with multi-state operations must consider both federal and state law in devising a strategy to address a missed payroll.

Proskauer’s Wage and Hour Group is comprised of seasoned litigators who regularly advise the world’s leading companies to help them avoid, minimize, and manage exposure to wage and hour-related risk.  Subscribe to our wage and hour blog to stay current on the latest developments.

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Photo of Katrina McCann Katrina McCann

Katrina E. McCann is a senior counsel in the Tax Department and a member of the Employee Benefits & Executive Compensation Group.

Katrina advises a diverse group of clients on a broad spectrum of employee benefits matters, including:

  • counseling clients with respect to

Katrina E. McCann is a senior counsel in the Tax Department and a member of the Employee Benefits & Executive Compensation Group.

Katrina advises a diverse group of clients on a broad spectrum of employee benefits matters, including:

  • counseling clients with respect to the design, drafting, implementation and ongoing qualification of their qualified plans in both the single and multi-employer context, including profit sharing, money purchase, 401(k), ESOP, and defined benefit plans;
  • providing counsel on the establishment, administration and continued legal compliance of health & welfare plans and programs;
  • advising tax-exempt organizations regarding their 403(b) plans and 457 arrangements;
  • creating and advising on non-qualified plans, including deferred compensation and supplemental employee retirement plans;
  • providing technical and practical advice on compliance with ERISA, the Internal Revenue Code, the Affordable Care Act, COBRA, HIPAA, and other laws affecting employee benefit plans, as well as issues concerning plan administration, qualification requirements, correction of plan document failures, fiduciary issues and prohibited transaction issues;
  • routinely working with clients and their service providers, advising on the RFP process, reviewing provider arrangements and collaborating to develop effective and compliant disclosures, government reporting forms and participant communications;
  • analyzing the employee benefits and executive compensation issues in connection with corporate transactions, advising on withdrawal liability matters and structuring benefit plans following a transaction and providing counsel with respect to all aspects of benefit plan mergers; and
  • advising both employers and senior executives in connection with various executive compensation matters, including the negotiation and drafting of equity plans and awards, employment agreements, severance agreements and other compensation arrangements.

Katrina is a member and former co-chair of Proskauer Women’s Alliance Steering Committee and serves on the Firm’s Reproductive Rights Steering Committee. She is also a Board member of Playwrights Horizons, an off-Broadway theater dedicated to the development of contemporary American playwrights and the production of innovative new work, and a Board member of the Axe-Houghton Foundation.

Prior to joining Proskauer, Katrina served as Special Assistant to the Mayor’s Office of Pension and Investments and was Special Assistant Corporation Counsel, Pensions Division, New York City Law Department. While in law school, Katrina was the Robert M. LaFollette/Keenan Peck Legal Fellow, serving in the offices of Senator Herb Kohl & the United States Senate Committee on the Judiciary.

Photo of Allan Bloom Allan Bloom

Allan Bloom is the co-chair of Proskauer’s Labor & Employment Law Department and a nationally recognized litigator and advisor who represents employers, business owners, and management in a broad range of employment and labor law matters. As a litigator, Allan has successfully defended…

Allan Bloom is the co-chair of Proskauer’s Labor & Employment Law Department and a nationally recognized litigator and advisor who represents employers, business owners, and management in a broad range of employment and labor law matters. As a litigator, Allan has successfully defended many of the world’s leading companies against claims for unpaid wages, employment discrimination, breach of contract and wrongful discharge, both at the trial and appellate court levels as well as in arbitration, before government agencies, and in private negotiations. He has secured complete defense verdicts for clients in front of juries, as well as injunctions to protect clients’ confidential information and assets.

As the leader of Proskauer’s Wage and Hour Practice Group, Allan has been a strategic partner to a number of Fortune 500 companies to help them avoid, minimize and manage exposure to wage and hour-related risk. Allan’s views on wage and hour issues have been featured in The New York Times, Reuters, Bloomberg and Fortune, among other leading publications. His class-action defense work for clients has saved billions of dollars in potential damages.

Allan is regularly called on to advise operating companies, management companies, fund sponsors, boards of directors and senior leadership on highly sensitive matters including executive and key person transitions, internal investigations and strategic workforce planning. He has particular expertise in the financial services industry, where he has litigated, arbitrated, and mediated disputes for more than 20 years.

A prolific author and speaker, Allan was the Editor of the New York State Bar Association’s Labor and Employment Law Journal from 2012 to 2017. He has served as an author, editor and contributor to a number of leading treatises in the field of employment law, including ADR in Employment Law (ABA/Bloomberg BNA), Employment Discrimination Law (ABA/Bloomberg BNA), Cutting Edge Advances in Resolving Workplace Disputes (Cornell University/CPR), The Employment Law Review (Law Business Research, U.S. Chapter Author), and The Complete Compliance and Ethics Manual (SCCE).

Allan has served as longtime pro bono counsel to Lincoln Center for the Performing Arts and The Public Theater, among other nonprofit organizations.  He is a past Vice Chair of Repair the World, a nonprofit organization that mobilizes volunteers and their communities to take action to pursue a just world, and a past recipient of the Lawyers Alliance Cornerstone Award for extraordinary contributions through pro bono legal services.

Allan is a Fellow of the College of Labor and Employment Lawyers and has been recognized as a leading practitioner by Chambers since 2011.

Photo of Philippe A. Lebel Philippe A. Lebel

Philippe (Phil) A. Lebel represents employers in all aspects of employment litigation, including wage and hour, wrongful termination, discrimination, harassment, retaliation, defamation, trade secrets, and breach of contract litigation, in both the single-plaintiff and class- and/or representative-action context, at both the trial and…

Philippe (Phil) A. Lebel represents employers in all aspects of employment litigation, including wage and hour, wrongful termination, discrimination, harassment, retaliation, defamation, trade secrets, and breach of contract litigation, in both the single-plaintiff and class- and/or representative-action context, at both the trial and appellate level, and before administrative agencies.

In addition to his litigation work, Phil regularly advises clients regarding compliance with federal, state and local employment laws, and assists a variety of companies and financial firms in evaluating labor and employment issues in connection with corporate transactions. Phil also has experience assisting employers with sensitive employee investigations and trainings.  Phil also represents employers in connection with labor law matters, such as labor arbitrations and proceedings before the National Labor Relations Board.

Phil has assisted clients in a wide array of sectors including in the biotech, education, entertainment, financial services, fitness, healthcare, high-tech, legal services, manufacturing, media, professional services, sports, and staffing industries, among others.

Phil regularly speaks on emerging issues for employers and has been published or quoted in Law360, the Daily JournalThe Hollywood ReporterBusiness Insurance, and SHRM.org regarding a variety of labor and employment law topics.

During college, Phil worked on political campaigns in Atlanta, Georgia and Birmingham, Alabama, and was an intern with the National Gay and Lesbian Task Force and the Gay and Lesbian Victory Fund. Phil is a former member of the Board of Directors of the AIDS Legal Referral Panel.

Photo of David Gobel David Gobel

David R Gobel is an associate in the Labor Department and a member of the Employment Litigation & Counseling Group.

David Gobel earned his J.D at USC Gould School of Law, where he was a Senior Citations Editor of the USC Journal of

David R Gobel is an associate in the Labor Department and a member of the Employment Litigation & Counseling Group.

David Gobel earned his J.D at USC Gould School of Law, where he was a Senior Citations Editor of the USC Journal of Interdisciplinary Law, and part of the executive committee of USC’s Music Law Society. Prior to law school, David worked as a research executive for a marketing research firm in New York.

Photo of Jennifer McGrew Jennifer McGrew

Jennifer McGrew is a law clerk in the Labor Department and a member of the Labor General Group. Jennifer earned a J.D. from Duke University School of Law, where she was a member of the Black Law Students Association, Womxn of Color Collective…

Jennifer McGrew is a law clerk in the Labor Department and a member of the Labor General Group. Jennifer earned a J.D. from Duke University School of Law, where she was a member of the Black Law Students Association, Womxn of Color Collective, and First-Generation Professionals. While at Duke, Jennifer worked as a Faculty Research Assistant focusing on discrimination in the workplace.

Prior to law school, Jennifer earned a M.Ed. from Boston College and is currently completing her Ph.D.