Fall 2010 • Issue 38, page 18

Priority of Unpaid Wages for Former Employees of the entity in Receivership

By Davidson, Peter*

Q: I was getting ready to wrap up a case recently when I got a call from a former employee of the entity in receivership who said his brother-in-law, a lawyer, told him that his claim for unpaid wages should be paid on a priority basis. I looked at the sections of the Code of Civil Procedure dealing with receiverships, Sections 564-570, and the Rules of Court and did not see anything about wage priorities. Is the former employee correct?

A: Yes. There are a number of statutes that affect receiverships that are not readily apparent. C.C.P. §1204, concerning labor claims, is one of them. It provides, in part, “When any assignment…is made for the benefit of creditors… or results from any proceeding in insolvency or receivership…or when any property is turned over to the creditors…or to a receiver or trustee for the benefit of creditors, the following claims have priority in the following order:

  1. …$4,300.00 for each individual or corporation…earned within 90 days before the assignment…the commencement of the court proceeding or the date of the cessation of the debtor’s business, whichever first occurs of the following:

    1. Wages, salaries or commissions, including vacation, severance and sick leave earned by an individual;…

  2. …contributions to employee benefit plans arising from services rendered within 180 days before the assignment…[or receivership]…”

The statute has two other interesting provisions, which I would wager are not generally followed by receivers. Subsection (c) provides: “The above claims shall be paid…before the claim of any other creditor…and shall be paid as soon as the money with which to pay same becomes available.” Subsection (d) goes on to provide: “This section is binding upon all courts of this state and in all receivership actions the court shall order the receiver to promptly pay out of the first receipts and earnings of the receivership, after paying current operating expenses, such preferred labor claims.”

The legislature has made it clear that receivers and assignees should not wait until the end of the case to pay these labor claims. The statute directs receivers, in two different sections, to pay these claims as soon as possible.

There are two issues that do arise under the statute. First, the statute directs that the labor claims be paid “promptly out of the first receipts and earnings” but then goes on to state “after paying current operating expenses”. What does that mean? Second, is the statute applicable in federal receiverships?

As to the first question, a receiver can wait to pay labor claims until he or she has sufficient funds in the estate to pay any “current operating expenses”, which would include fees and costs owed to the receiver and his or her professionals, as well as sufficient funds, if applicable, to run the business or property. When sufficient funds exist, however, the receiver should seek instructions to pay the labor claims (which the statute states “the court shall order”) rather than waiting until the end of the case. This would not be true if the matter were an assignment for the benefit of creditors. There, the wage claims would have priority over the assignee’s fees and expenses, because subsection (d) providing for payment “after paying the current operating expenses”, only applies to receiverships. This is one reason a receivership may be preferable to an assignment.

This interpretation of the statute has been affirmed by the 9th Circuit and California cases. In Division of Labor Enforcement v. Stanley Restaurants, 228 F. 2nd 420 (9th Cir. 1955), the 9th Circuit had previously reversed the district court when it held that labor claims had priority over taxes owed the federal government (another priority to remember that is not apparent in the C.C.P. But note, state taxes do not have a priority because Revenue and Taxation Code §6756 specifically states that §1204 claims have priority).

The district court then held that the assignee’s fees and expenses were senior to the labor claims. The 9th Circuit reversed again, holding that under §1204 the labor claims take precedence in assignments but not in receiverships because the legislature limited the payment of labor claims “after paying current operating expenses” to receivership cases.

As indicated above, subsection (d) only refers to receiverships and does not mention assignments or other insolvency proceedings. The 9th Circuit not only relied on the statutory language, but reasoned that in a receivership “the estate is in the hands of a court appointed and supervised individual acting as an arm of the court. Such is not true of the common law assignee. No matter how salutary the practice of assignments for creditors, it must be conceded that as an individual engaged in private enterprise, the assignee is for practical purposes outside the control and supervision of the court.” It also cited California cases to the same affect including Bank of Visalia v. Dillonwood Lumber Co., 148 Cal. 18 (1905). The assignee in the case argued that such a rule would be fatal to assignments “since the risk of nonpayment of fees and expenses would be immeasurably increased if labor claims be held to be entitled to a priority”. The court rejected this assertion as being overstated but added “but even if not, we find no sufficient ground for holding otherwise.” See also, Meyer v. Bass, 281 F. 2nd 728, 731 (9th Cir. 1960) [“payment of fees and expenses of administration in disregard of the liens of the wage claimants was an improper disbursement by the assignee.” – assignee surcharged for making distribution].

With regard to federal receiverships, while the statute is not binding on federal courts (the statute itself confirms it is only “binding upon all courts of this state”) at least one federal court has indicated it will usually follow it. T. H. Mastin & Co. v. Pickerling Lumber Co., 2 F. Supp 605, 606 (N.D. Cal. 1933) [“it is conceded that federal courts acting in equity receiverships are not absolutely bound to recognize preferences and priorities created by state laws, but it is the practice of this and other jurisdictions to allow such preferences and priorities as seem equitable”.]. It is unlikely, however, that the provision would be followed in government enforcement cases where the goal is to return funds to defrauded investors or consumers because, generally, the money recovered in those cases is held in trust for the defrauded parties. FTC v. Crittenden, 823 F. Supp 699 (C.D. Cal. 1993). To the extent there are sufficient funds in the estate to pay such claims, then the priority would likely apply.

*Peter A. Davidson is a Partner of Ervin Cohen & Jessup LLP a Beverly Hills Law Firm. His practice includes representing Receivers and acting as a Receiver in State and Federal Court.