Payroll Obligations During Liquidity Crunch Crisis—Implications and Responses

On Friday, March 10, 2023, regulators shut down Silicon Valley Bank (“SVB”) and seized its deposits, resulting in the second largest U.S. banking failure since the 2008 financial crisis. Specifically, SVB was closed by the California Department of Financial Protection and Innovation, and the Federal Deposit Insurance Corporation (the “FDIC”) was named receiver. Since the FDIC insures deposits of up to $250,000, that amount was immediately available; however, the fact that deposits above and beyond the $250,000 limit were not immediately available alarmed many. After a weekend of chaos as many businesses scrambled for a solution to the illiquid funds, on Sunday, March 12, 2023, in a joint release among the Department of Treasury, Board of Governors of the Federal Reserve System and the FDIC, Treasury Secretary Janet Yellen instructed the FDIC to guarantee SVB customers access to all deposits, including the uninsured funds. The release further stated that New York-based Signature Bank was closed by its chartering authority and that its customers would also receive access to all deposits, including the uninsured funds. While this may have provided relief to many, it is important to keep in mind the lesson and best practices in the event of such a liquidity crunch.

Lesson from the SVB and Signature Bank Fallout

There are countless implications to a company being stripped of its operating capital. Employers find themselves in need of tackling numerous action items. The top priority, however, should be considerations and contingency planning for potentially missing the upcoming payroll cycle before the legal liability resulting from belated or unpaid wages grows to unmanageable levels. When it comes to electing which financial obligations to satisfy for employers that find themselves suddenly cash strapped, making payroll in a timely manner must be made the priority.

Failure to timely make payroll will result in significant liability to employers due to the robust statutory protection provided by federal and state law. Under the Fair Labor Standards Act (“FLSA”), an employer has the basic obligation of paying its employees for all hours worked and maintaining accurate and complete records reflecting hours worked and wages paid. While the FLSA does not impose a pay frequency requirement, most states maintain statutory requirements governing pay frequency and impose penalties for related violations. In California, for example, employers are subject to penalties for failing to meet the pay frequency requirements under California Labor Code §204, which requires non-exempt employees to be paid semi-monthly on paydays designated in advance. Pay frequency infractions can lead to imposition of statutory penalties of $100 (first offense) or $200 (subsequent offense) for each violation and potentially liquidated damages of 25% of the late paid wages. Such violations can also serve as the predicate for claims under California’s Private Attorney General Act under which employees can assert claims on their own and on behalf of similarly situated employees and the State of California. 

The New York Labor Law § 191 also imposes a pay frequency requirement to pay non-exempt clerical workers at least semi-monthly. There is a proliferation of class actions in New York against employers for failing to comply with the pay frequency requirements. In these lawsuits, employees are seeking to recover liquidated damages available under New York Labor Law, which amount to 100% of the late paid wages. It is also worth noting that wage obligations are generally not dischargeable, even if companies become bankrupt. Some states, including New York, also impose criminal liability for egregious violations of wage and hour laws.

Consequences from the fall-out from the recent cyberattack on an outside payroll provider management system that prevented many companies from meeting their payroll obligations should further caution employers to prioritize their payroll obligations. The cyberattack resulted in numerous class and collective action lawsuits against the affected companies for violations of the Fair Labor Standards Act and various state laws.  A common claim in these lawsuits alleges that the companies failed to implement a system to timely pay wages to non-exempt employees until issues related to the cyberattack were resolved. Another claim contends that the companies’ failure to adopt functional back-up plans for processing payroll resulted in inaccurate payments to employees.

Mitigating Potential Liability

Employers should embark on a good faith effort to mitigate against any potential liability resulting from delayed payment of wages or impacts on employee benefits in another crisis event such as a pandemic, banking crisis or cyber attack. We recommend that employers consider taking the following steps:

• Keep your employees informed as to the status of the payroll. Making a good faith effort in this regard may offset claims that any belated payment of wages was the result of bad faith or willful violation of applicable federal and state law. Further, any goodwill that employers can maintain with their employees may soften any enthusiasm that impacted employees may have to file wage claims against them.  For unionized workforce, employers must consider their obligations under the relevant collective bargaining agreements and engage with the unions before taking any action that impacts the terms and conditions of employment.
• Great caution is required. Be careful in considering prioritization of payment of certain employees over others. Employers must avoid unlawfully discriminating against any group of employees, including  those who are part of one or more legally protected classifications.
• Carefully navigate steps taken to change pay dates and pay periods. Employers seeking to amend their pay date(s) or corresponding pay period(s) must do so in accordance within the requirements of applicable state law. Certain states, including California and New York, require advance notice to affected non-exempt employees before any change can take effect. Further, the changes must still comply with the frequency of pay requirements set forth in applicable state law. Employers located in states with wage notice and/or wage statement (paystub) requirements must also make corresponding changes to their employees’ wage notices and statements. 
• Maintain Time Records. Remain diligent in complying with record-keeping and time-reporting requirements under federal and state law, particularly with respect to non-exempt employees.
• Layoffs, Termination and Furlough of Employees. Employers that find themselves unable to pay employees may contemplate layoff, termination or furlough of employees. A furlough is discharge or termination of employment, especially temporarily, resulting from economic conditions or lack of work. Best practice: employers must carefully communicate such adverse employment action to affected employees and avoid making promises of reinstatement if the employers are unsure if and when reinstatement can occur. Employers that plan to terminate a group of employees, whether temporary or permanent, must also consider the need to comply with the notice and other requirements under the Worker Adjustment and Retraining Notification (“WARN”) Act or applicable state-level mini-WARN Acts.
  

  Furloughing employees may not provide an immediate cash flow relief for cash strapped employers. Employers seeking to furlough employees should be cognizant of the fact that any wages due may become immediately due during or immediately after the last day of work for the furloughed employees. For example, under California Labor Code § 201, employees’ final paychecks must be paid on the dates of separation from employment. 

  In selecting employees subject to furlough, employers should also carefully engage in the selection process to avoid engaging in unlawful discrimination. Employers should also consider whether they will provide post-furlough employee benefits, such as health care continuation other than merely offering COBRA.

• Employee Benefits. Employers and individuals responsible for administering both health and welfare and retirement plans are considered “fiduciaries” under ERISA, meaning that they have special legal obligations to ensure plan compliance. The most pressing issues to address are:
  
  • Review any health and welfare contracts, policies or service agreements to understand the timing of premium payment cycles and remittance of employee salary deferrals to FSAs and HSAs, and reach out to the insurer/administrator regarding possible delays in making the premium payments or remitting deferrals.
  • Employers should also review the Company’s 401(k) plan to determine the impact of delayed payroll on the timing of salary deferral and/or employer contributions to the plan.
  • In addition to 401(k)s, employers should review all of their qualified retirements plans to determine if the plan holds any funds directly or indirectly invested in the bank where funds may be frozen or if the plan or trust accounts are held at or serviced by such bank. 
• Deferred Compensation subject to 409A. If an employer maintains a deferred compensation program subject to Code Section 409A, the employer should closely review whether the executive has incurred a “separation from service” and whether any distributions are triggered (or if anticipated deferrals can be stopped).
• Tax Obligations. Employers should also review their federal and state employment tax obligations with legal counsel and with the payroll administrator. Federal and state tax laws impose strict payment deadlines, and late deposits will trigger various penalties.

Crowell is available to discuss and address how to best position your company to mitigate liability in the event of crisis.