by Betsy Johnson and Aaron Olsen

On July 27, 2009, the U.S. Court of Appeals for the Ninth Circuit held that a corporation's managers can be held personally liable under the Fair Labor Standards Act ("FLSA") for wages that the corporation failed to pay to employees prior to the employer's filing for bankruptcy. This opinion serves as a cautionary reminder of the risks managers potentially face when a corporation files for bankruptcy and has failed to pay its employees for all wages earned prior to the filing.

In Boucher v. Shaw, ---- F. 3d ----, 2009 WL 2217517 (9th Cir. 2009), former employees of the Castaways Hotel, Casino and Bowling Center sued three senior managers for unpaid wages under Nevada state law as well as federal law. The managers moved to dismiss the claims based on, among other grounds, the fact that the hotel had filed for bankruptcy protection. The Ninth Circuit asked the Nevada Supreme Court to address the issue of whether, under state law, the managers could be personally liable as "employers" for the unpaid wages. The Nevada Supreme Court ruled that individual managers are not "employers" under state law. However, the Ninth Circuit ruled against the managers on the federal FLSA claims and allowed the employees' claims to proceed.

Prior Ninth Circuit opinions have given the FLSA's definition of "employer" an "expansive interpretation in order to effectuate the FLSA's broad remedial purposes." Lambert v. Ackerley, 180 F. 3d 997, 1011-12 (9th Cir. 1999) (en banc) (quoting Bonnette v. California Health & Welfare Agency, 704 F. 2d 1465, 1469 (9th Cir. 1983)). Under those opinions, where an individual exercises "control over the nature and structure of the employment relationship" or "economic control" over the relationship, that individual can be held to be an "employer" within the meaning of the FLSA and thus subject to individual liability. Lambert, 180 F. 3d at 1012.

Other circuits follow a similar analysis. For instance, in Chao v. Hotel Oasis, Inc., 493 F. 3d 26, 34 (1st Cir. 2007), the court held the corporation's president was personally liable where he had ultimate control over business's day-to-day operations and was the corporate officer principally in charge of directing employment practices. Likewise, in United States Dep't of Labor v. Cole Enters., Inc., 62 F. 3d 775, 778-79 (6th Cir. 1995), the court found the president and 50 percent owner of the corporation was an "employer" under the FLSA where he ran the business, issued checks, maintained records, determined employment practices and was involved in scheduling hours, payroll and hiring employees. In Donovan v. Grim Hotel Co., 747 F. 2d 966, 971-72 (5th Cir. 1984), a corporate officer with no ownership interest was held to be an "employer" where, among other things, he began and controlled the corporations, held their purse-strings, and guided their policies, and where, "speaking pragmatically, [the corporations] were [his] and functioned for the profit of his family."

In Boucher, the three defendants were the corporation's Chairman and Chief Executive Officer, who was alleged to own 70 percent of its shares; the Chief Financial Officer, who was alleged to have had responsibility for supervision and oversight of the company's cash management; and the manager responsible for handling labor and employment matters, who was alleged to own the remaining 30 percent of the shares. As the issues came before the District Court in the form of a motion to dismiss, all of the plaintiffs' allegations were accepted as true for purposes of deciding the motion. Significantly, for the purposes of the motion to dismiss, none of the defendants challenged their status as employers under the FLSA. Instead, they argued that any authority and duty that they had to pay wages to employees under the FLSA ended when the company entered into Chapter 7 bankruptcy proceedings. The District Court agreed with this argument and granted defendants' motion to dismiss.

The issue before the Ninth Circuit was whether the corporation's bankruptcy filing affected the liability of these individual managers under the FLSA. The managers argued that the automatic stay of claims against the bankrupt provided for under the Bankruptcy Code should apply to FLSA claims made against the executives and not only to the claims asserted against the corporation. The Ninth Circuit disagreed, and explained that the purpose of the automatic stay is to protect only the debtor (i.e., the corporation), by giving it room to breathe and potentially reorganize, and to protect the creditors as a group by ensuring that no single creditor obtains payment on its claims to the detriment of others. There is no such protection for non-debtor parties, such as the managers of the corporation.

The Ninth Circuit noted that since there were no allegations that the corporation was obligated to indemnify the individual managers for legal expenses or a judgment, any liability of the defendants to the employees would not affect the corporation's bankruptcy proceedings. The Court noted, however, that if a finding of liability on the part of the managers were to affect the assets and liabilities of the corporation through indemnification obligations or a directors and officers insurance policy, then the bankruptcy protections might apply to such claims.

This opinion highlights issues that employers and senior management, including substantial shareholders in closely held corporations, ought to consider not only in the context of consideration of a possible filing for bankruptcy protection but in the ordinary course of business as well. For example, addressing such matters as the corporation's obligation to defend and indemnify key members of senior management in the structuring of employment agreements and other such arrangements may allow for the protection of executives from such personal liability notwithstanding a bankruptcy filing.

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