A Publication of WTVP

Personal bankruptcy filings have risen dramatically during the past 12 months. As a result of the subprime mortgage crisis and related events plaguing Wall Street, large and small employers are actively taking steps to ensure they don’t hire or retain employees likely to contribute to the next financial crisis. But seemingly prudent employment decisions present dangers greater than the risks employers seek to avoid.

Case in point. Your key financial officer, check writer or money handler seeks protection from bankruptcy court. The Peoria Journal Star reports your employee’s bankruptcy filing. Board members express concerns to senior management. Your CEO fears a public relations nightmare. What lawful actions are available to your organization?

The answer finds its genesis in a little-known anti-discrimination provision of the Bankruptcy Code, which provides:

No private employer may terminate the employment of, or discriminate with respect to employment against, an individual who is or has been a debtor under this title, a debtor or bankrupt under the Bankruptcy Act, or an individual associated with [i.e. a spouse or parent of] such debtor or bankrupt, solely because such debtor or bankrupt—

  1. is or has been a debtor under this title or a debtor or bankrupt under the Bankruptcy Act;
  2. has been insolvent before the commencement of a case under this title or during the case but before the grant or denial of a discharge; or
  3. has not paid a debt that is dischargeable in a case under this title or that was discharged under the Bankruptcy Act. (11 U.S.C. §525(b))

Few court decisions have addressed the subtle nuances of this section of the Bankruptcy Code. Those courts note that the financially troubled employee maintains access to methods of stealing from the employer. Taking these concerns into consideration, these cases attempt to satisfy legitimate employee concerns without running afoul of this obscure section of the Bankruptcy Code.

The section of the Code most debated provides that the employer cannot discriminate “solely because such debtor or bankrupt…[engaged in protected activity].” In Laracuente v. The Chase Manhattan Bank, the employee claimed her employer violated Section 525(b) for terminating her employment 18 months after she filed for bankruptcy. The employer showed that the employee previously made loans to her family members and to employees of her husband’s bakery in violation of credit policies and practices.

The bank argued that the interpretation of Section 525(b) should be limited to the plain language of the statute. Under this approach, given the employee’s improper loan practices, the bank clearly did not terminate her employment solely because of her bankruptcy filing. Applying the plain meaning of the statute, the court ruled that because the employer established that its decision was not solely because of the bankruptcy, it prevailed.

Similarly, in the In re Hopkins case, a bank terminated a valued employee after it discovered she sought protection of the bankruptcy court. The bank claimed she voluntarily resigned, but the court determined that the bank terminated her employment. In analyzing Section 525(b), the court applied the narrow interpretation of the law and found that if the bank could show that it discharged the employee for any reason in addition to her bankruptcy, the bank would win.

However, the bank failed to prove that the employee was anything but a very valuable and competent employee. It omitted any reference to prior problems or other inadequacies concerning her employment. Instead, the bank claimed that the employee, who worked in a small-town bank, would weaken its public perception and the public’s trust in the bank. The court summarily rejected this argument, claiming that such a position would automatically act as an immediate defense for any such case and would render the relevant section of the Bankruptcy Code useless. The court found that the bank had violated the Code because it could not establish a reason, other than the employee’s bankruptcy, to justify her termination.

Bankruptcy issues sometimes arise in the context of failure-to-hire cases. In Pastore v. Medford Savings Bank, the employee applied for a position at a bank. After a successful interview, the bank refused to hire her because a background check revealed that several years earlier she had filed bankruptcy. The applicant sued, alleging that Section 525(b) of the Code should apply to her case because the bank was discriminating against her due to her prior filing. The court rejected the claim, finding that the clear language of the statute did not apply to a failure-to-hire case.

Other cases involve involuntary transfer of employees to backroom assignments. In Hicks v. First National Bank of Harrison, after the employer discovered the employee had filed for bankruptcy, the plaintiff transferred the employee from a teller position to a backroom bookkeeping position in order to avoid regular contact with customers. The employer claimed that it wanted to protect the employee from the embarrassment of conducting transactions with customers who were aware of her financial difficulties and avoid harm to customer relations arising from a bankrupt employee serving as a teller.

After hearing testimony from the teller that she was not embarrassed to continue her teller responsibilities, the court rejected the first argument. Likewise, the court rejected the reputational harm argument because the bank failed to produce evidence of any damage to its public perception, and because such an argument would be an automatic defense for any such claim. The final issue addressed by the court concerned whether the bank discriminated against the employee by moving her to a backroom position, even though she suffered no wage loss. The court ruled in favor of the employee, finding that the bank unlawfully transferred the employee because her job duties were affected, even without any out-of-pocket losses.

Still other cases address the mere threat of bankruptcy filing. In In re Majewski, a hospital employee failed to pay a significant medical expense. He advised management of his intention to file for bankruptcy. Before he actually filed, however, his employer discharged him. He sued the hospital, claiming violation of the Bankruptcy Code. In defense, the hospital claimed that the Code only applies to an employee who has actually filed for bankruptcy, while the employee merely threatened to file. In deciding the case, the court reviewed other anti-retaliation statutes, such as the Fair Labor Standards Act, which protects employees who tell their employers that they intend to file, but are discharged before they seek court protection.

In such statutory contexts, the court reasoned that the government desires to encourage employees to report unlawful behavior. Courts, however, do not desire to encourage employees to file for bankruptcy. Additionally, the formal act of filing for bankruptcy creates significant obligations absent in the other statutes, such as triggering an automatic stay of actions against the debtor, the creation of an estate and the appointment of a trustee. Hence, the court refused to expand the Code and again adhered to its plain language which states that it protects only a person who “is or has been” a debtor in bankruptcy, not merely one who intends to file. Therefore, the hospital prevailed.

In conclusion, courts narrowly interpret the Bankruptcy Code and protect only those employees who establish that their termination was solely because of their bankrupt status. You can discharge an employee after initiating bankruptcy, provided you are not ending the employment only because of the bankruptcy filing. Moreover, based on the case law to date, an employer can refuse to hire an employee because of the employee’s past bankrupt status. Transferring a bankrupt employee to another position solely for filing bankruptcy, even if no adverse economic consequences result, likely violates the Code. Finally, the Code only protects an employee who formally seeks the protection of the Bankruptcy Code. As this area of the law constantly evolves, contact your employment attorney before terminating an employee who files for bankruptcy or threatens to do so. iBi