The recent closure of Silicon Valley Bank (the “SVB Closure”) has created liquidity issues for many employers, which in turn may impact their ability to, among other things, timely pay employees and operate their compensation and benefit programs. This alert discusses key employee-related considerations for employers that may arise in the wake of the SVB Closure and related disruptions in the employers’ access to liquidity. We note that as a consequence of the liquidity crises produced by the SVB Closure, federal and state labor (or similar) agencies may eventually provide employers with some level of relief from their obligations under applicable federal and state labor law through the issuance of emergency or similar orders. However, as of the date of publication, there is no indication that these agencies will provide employers with any immediate relief.
Immediate Steps to Consider
- Communicate immediately with employees regarding potential delays in payroll timing and provide prompt updates on changes. Transparency is the key to maintaining trust within the employer’s workforce during challenging times. If switching payroll to another financial institution, ensure compliance with wage rules that prevent changes to employees’ elected methods of payment without consent. Employers must be mindful to accurately withhold applicable taxes and other authorized deductions from wages (and to timely remit these amounts to the applicable tax authorities).
- To the extent the employer cannot timely make payroll, consider furloughing or terminating employees. Allowing employees to work when the employer cannot timely make payroll will result in violations of federal and state wage laws, and potential personal liability to officers and directors and large shareholders of the employer, under those laws.
- Review health and welfare benefit plans, contracts and arrangements to determine whether missed or late payments by the employer to third-party providers may cause a lapse in benefits/insurance coverage for employees (or otherwise impact coverage). Consider contacting benefit plan administrators to discuss potential impact. To the extent employee health and welfare coverage may be impacted by liquidity issues, develop a plan to communicate the potential impact to employees.
- Review plan documents regarding timing of deposits for employee elective deferrals and matching contributions. Coordinate with the plan administrator to determine the proper course of action, if any, to deal with any timing delays.
- Note that if matching and profit-sharing contributions are required for compliance with the “safe harbor” provisions of the Internal Revenue Code (the “Code”) (which provisions generally excuse employers from certain annual compliance tests), midyear suspension or reduction of the contributions can typically only be accomplished if (a) the plan sponsor shows that it is operating at an economic loss for the plan year under the applicable provisions of the Code or (b) the annual notice relating to the plan that was distributed before the beginning of the plan year stated that matching contributions might be suspended or reduced during the plan year and that the suspension or reduction would not be effective until at least 30 days after all eligible employees are provided with a supplemental notice regarding that action. In both instances, the Code dictates the content and timing of notices relating to the adjustment. Employers making these adjustments will also need to consider alternative methods for assuring compliance with the Code’s additional testing requirements.
- Review individual employment agreements and offer letters to determine whether missed payments may give rise to “Good Reason” resignation rights, which may in turn trigger severance or termination obligations.
- Audit incentive compensation programs and award agreements to determine whether any incentive awards have upcoming settlement dates that require cash payments. If so, the employer will need to determine whether timely settlement is possible and, if not, whether delayed payment creates any issues from a Code Section 409A (“Section 409A”) or other perspective. Note that there are certain exceptions from Section 409A penalties/compliance for late payments due to unforeseeable circumstances.
- Check whether there are outstanding severance or related payments that will become due in the near future.
- Certain states, such as California, Texas, Florida and New York, require employers to be covered by a workers’ compensation insurance policy, unless the employer is eligible under applicable state rules to be self-insured. Any employer covered by a policy should determine when premium payments are due and assess the potential that a premium payment may be missed. To the extent a premium payment may be missed, the policy documents should be reviewed to determine when the coverage may be cancelled by the insurance carrier. If the policy grants the insurance carrier liberal ability to cancel the policy upon missed payments, the employer should reach out to the insurance carrier to arrange for waivers of the payment requirement.
Payroll/Wage Payment Considerations
Fair Labor Standards Act
Many employers impacted by the SVB Closure are faced with difficulties in timely making payroll. Most employers are covered by the Fair Labor Standards Act (“FLSA”), which governs federal wage and hour standards. Covered employers have several obligations under the FLSA, including ensuring nonexempt employees are paid (a) minimum wage for all hours worked and (b) overtime for all hours worked in excess of 40 hours in any workweek. There is no explicit deadline in the FLSA itself with respect to the payment of wages. Nevertheless, the U.S. Department of Labor’s (the “DOL”) position is that FLSA-mandated sums earned for a workweek generally must be paid on the regular payday for the pay period in which the workweek ends. There is not a currently available waiver or exemption for noncompliance resulting from a bank closure.
An employer that repeatedly or willfully violates the minimum wage or overtime pay requirements of FLSA is subject to a civil penalty of up to $1,100 for each violation. For any violation (including isolated or inadvertent violations), the employer is liable to the employee for the amount of unpaid wages and overtime pay, if any, plus an equal additional amount paid as liquidated damages. There is no requirement that the affected employee show harm beyond the late payment (e.g., that such affected employee was unable to pay rent or similar adverse consequences on account of the late payment). Instead, all that is necessary is for the employee to show that the payment was owed and that it was not paid. Furthermore, paying the amounts as soon as the employer can does not cure the violation.
There are several methods that FLSA provides for recovering unpaid minimum and overtime wages, which are: (a) The Wage and Hour Division of the DOL may supervise payment of back wages, (b) the Secretary of Labor may bring suit for back wages and an equal amount as liquidated damages, (c) an employee may file a private suit for back pay and an equal amount as liquidated damages, plus attorneys’ fees and court costs, and (d) the Secretary of Labor may obtain an injunction to restrain any person from violating the FLSA, including the unlawful failure to provide proper minimum wage and overtime pay.
In addition to potential penalties for compliance failures under FLSA, employers may also face penalties in connection with the failure to timely remit the employer portion of taxes, which includes federal income tax, Social Security and Medicare taxes and Federal Unemployment Tax. Generally, employers must send employment tax deposits to the IRS on a monthly or semi-weekly schedule (and in some instances more rapidly). There are penalties for untimely, incorrect or improperly paid employment taxes, imposed based on the number of days such taxes are overdue. Furthermore, employee earnings that are withheld by employers for the benefit of taxing authorities—so called “trust fund taxes”—also must be timely remitted to the IRS, and the failure to do so can give rise to personal liability of officers, directors and other persons or entities responsible for the collection and accounting for those taxes.
FLSA also imposes personal liability on officers and directors for wage and overtime violations under certain circumstances. An “employer” for purposes of the FLSA includes “any person acting directly or indirectly in the interest of an employer in relation to an employee.” Courts have interpreted this to include persons who exercise significant operational control over corporate affairs, irrespective of whether persons were directly responsible for the violations. In determining whether to impose personal liability on an officer or director, courts will consider, among other things, whether the person (a) has the power to hire and fire employees, (b) supervises and controls employee work schedules or conditions of employment, (c) determines the rate and method of compensation or (d) maintains employment records.
State Wage Laws
In addition to complying with wage payment obligations under FLSA, employers must also comply with applicable state wage laws or risk additional fines and penalties. Unlike FLSA, many states impose specific intervals for paying employees (e.g., weekly, bi-weekly, etc.), which may vary depending on an employee’s role or function or the industry in which they work. For example, under New York law, absent an exemption, manual workers are required to be paid weekly and sales commission employees are required to be paid at least monthly. Penalties for failing to comply with state wage laws vary by state and can include liquidated damages and attorneys’ fees. In certain states, such as California, New York and Texas, officers, directors and, in certain cases large shareholders, may be held personally liable for violations of applicable state wage laws. See the Appendix to this alert for a brief summary of select state wage laws.
Health Plan Modification and Termination Considerations
Absent contractual requirements, employers offer health benefits on a voluntary basis. Although the Affordable Care Act imposes penalties on covered employers for not providing coverage, federal law does not require employers to offer health coverage to their employees, nor does it generally prevent employers from cutting or reducing benefits. However, employers considering modifying or terminating health plan coverage for their employees may have to take certain steps (such as providing advance notice). For example, under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), employers are required to provide 60-days’ notice of any “material modification” (which is not defined by ERISA, and ultimately is a court determination should there be related litigation) to sponsored health-plans. Before reducing or terminating health plan coverage for employees, employers should contact their benefit plan administrators to confirm whether there are any restrictions for reducing or terminating health benefit coverage for employees and any notice requirements in connection with such reduction or termination.
Finally, if health benefit plans are terminated in their entirety and therefore no longer exist, there would be no opportunity for employees to seek continuation coverage under the Consolidated Omnibus Budget Reconciliation Act of 1985 (“COBRA”).
In connection with similar liquidity crises, employers have considered employee furloughs as an alternative to layoffs until they can resolve their liquidity issues. Furloughs generally refer to a mandatory, but temporary, cessation from work without pay, with the expectation that the impacted workforce would return to work with the employer in the future. The following discusses key considerations for employers contemplating furloughs.
Health Benefits and COBRA
Employers that sponsor group health plans should consider whether a furlough would allow employees to continue to participate in employer-provided health benefit plans as “active” participants without requiring participants to elect benefits under COBRA. The determination will depend on the terms of the applicable plan and the underlying insurance policies. In particular, it is important to consider how eligibility is defined in the plan document. The definition often focuses on whether employees are continuing to receive pay or perform services. If any plan amendments are required in order to provide active coverage rather than continuation coverage under COBRA, and if it is possible under the circumstances to adopt such amendments, employers must ensure they properly document the changes, including updating the summary plan description.
If furloughed employees do not qualify for active coverage, employers that employed at least 20 employees (whether full or part time) on more than half of its typical business days in a year must provide furloughed employees with notice of their right to elect COBRA coverage. Failure to timely provide a COBRA notice to terminated employees can subject employers to significant penalties. COBRA requires that continuation coverage for covered employees and their eligible beneficiaries extend for 18 months from the date of a “qualifying event” (extensions are mandatory in certain states; e.g., up to an additional 18 months (or 36 in total) of coverage is required for health insurance policies subject to New York law after such event).
Whether furloughed employees receive healthcare coverage through continued active participation or as a result of electing COBRA, employers may want to consider subsidizing the cost of healthcare premiums for some period of time, if liquidity becomes available to the employer.
Qualified Defined Contribution Retirement Plans
A furloughed employee generally will be considered an active participant in a retirement plan and will not be considered to have experienced a “severance of employment.” As such, the employee would not qualify to take a termination distribution from the retirement plan. Further, furloughed employees would not be counted toward any partial plan termination assessment. Furloughed employees who are considered active participants may, subject to applicable plan terms, receive plan loans (or have existing loans remain outstanding) or in-service distributions.
The determination of whether a furloughed employee has experienced a “severance of employment” is based on facts and circumstances, and may change during the furlough, particularly if the employer no longer expects the employee to return to work or if the employer ceases operations. Changes to an employee’s annual salary due to the furlough can impact the employee’s 401(k) contribution levels and employer matching and profit-sharing contribution calculations. Furloughed employees should be notified of these effects and of how they can alter their deferral elections due to the expected change in their income.
Employers should review their equity plans to determine whether a furlough would be treated as a termination of employment. This determination is likely to fall to the plan administrator, which may be the board, a committee of the board, or an officer in the case of grants beyond the C-suite, and the plan document may provide the administrator with significant and binding discretion to construe its terms. In the event that it is determined that the furlough is a termination of employment, awards will be treated in accordance with the termination provisions of the plan or award agreement. However, typically, equity plans or the related award agreements provide for awards to remain outstanding and for continued vesting during an approved leave of absence (in some cases through an express leave of absence provision). It is also possible that a plan will provide that vesting be tolled during certain leaves of absence. Plan administrators should review plan provisions, including whether the plan documents limit the duration of an approved leave of absence to a set period (such as 90 days). If the existing plan terms are not in line with employer expectations, or the needs of the employer, the employer may wish to consider whether to amend awards to reach the desired outcome (and the accounting consequences of any change).
Employers should remain aware that changing circumstances may impact this assessment mid-furlough and separately assess whether the furlough has resulted in a “separation from service” under Section 409A, which is discussed further below, or, in the case of incentive stock options (“ISOs”), a termination of employment under the regulations governing ISOs.
Employers should consider whether an employee furlough results in a “separation from service” under its non-qualified deferred compensation plans covered by Section 409A. Under Section 409A, an employee furlough is not a “separation from service” so long as it qualifies as a “bona fide” leave of absence. A “bona fide” leave of absence is one where there is a reasonable expectation that the employee will return to perform services for the employer, and where either: (a) the leave is less than six months or (b) the leave of absence exceeds six months but the employee has either a contractual or a statutory right to reemployment. If the leave exceeds six months and the individual does not have a contractual right to reemployment, the employment relationship would be deemed terminated on the first date following the six-month period.
Employers should also carefully review and assess the impact of furloughs on employee participation in, and elections made under other benefit plans, including flexible spending accounts. A furlough may be considered a qualifying event triggering an employee’s ability to make mid-year election changes under a flexible spending account. Employers should notify furloughed employees of the impact of the furlough on the plans in which they participate and of their ability to make changes in plan elections such as transit benefits and employee stock purchase plans.
Labor Law and Contract Considerations
Employers considering furloughing employees must consider and comply with applicable federal, state and local wage and labor laws, as well as any individual contracts and employer policies.
The FLSA and similar state wage and hour laws require among other things, an employer to compensate employees for any work performed. As such, employers should take steps when furloughing employees to ensure that furloughed employees do not perform any work on behalf of the employer during the furlough period. These steps may include preventing employees from receiving or accessing their work emails, preventing access to employer facilities and ensuring that employees who are still actively working and may try to contact furloughed employees are made aware that they should not contact furloughed employees concerning work-related matters.
Further, when determining which employees to furlough, it is important for employers to use objectively defined and non-discriminatory categories of employees, to mitigate arguments of disparate impact and retaliation.
Prior to placing any employees on furlough, employers should review all contracts and policies covering such employees, including employment contracts, employee handbooks and, with respect to unionized employees, collective bargaining agreements. These documents may contain specific terms regarding furloughs and employers should ensure that any employee furlough complies with the terms of its policies and agreements. Further, contracts may contain guarantees of annual compensation or terms of employment, and a furlough may give rise to a contract breach or trigger a right for the employee to terminate the employment relationship for “good reason.” Employers should also assess confidentiality and restrictive covenant agreements, and how the employer intends to interpret and enforce these provisions, keeping in mind that furloughed employees remain common-law employees.
Under the federal Worker Adjustment and Retraining Notification Act of 1988 (“WARN Act”), employers with 100 or more employees are required to provide 60 days’ advance written notice to terminated employees in the event of a “plant closing” or “mass layoff.”
Under the federal WARN Act, notice obligations are not triggered if employees will be furloughed for fewer than six months. However, a furlough that exceeds six months or a reduction of hours by 50% for six months or more will constitute an “employment loss” and trigger WARN’s notice obligations. An employer implementing a furlough on account of the SVB Closure may believe that the furlough is short-term, but if conditions persist longer than expected, WARN requirements may apply.
The WARN Act does include an exception to the standard notice requirement for extensions of furloughs beyond six months resulting from business circumstances that were “not reasonably foreseeable” at the time of the original furlough event. To determine if the business circumstances were “not reasonably foreseeable,” “[t]he employer must exercise such commercially reasonable business judgment as would a similarly situated employer in predicting the demands of its particular market. The employer is not required, however, to accurately predict general economic conditions that also may affect demand for its products or services.” In this case, the employer must provide notice “when it becomes reasonably foreseeable that the extension is required.” The employer bears the burden of proving that it appropriately relied on this exemption. If this exemption is not met, an extension of a furlough beyond six months may result in the original furlough event being treated as the event for which advanced notice was required, retroactively triggering the violation.
Several states that have adopted “mini-WARN” laws have similar exceptions for unforeseeable business circumstances to the WARN Act, such as New York. Employers should review the applicable local, state and federal notice requirements before furloughing any employees.
The effect of the SVB Closure is still evolving and impacted employers need to act swiftly to ensure compliance with applicable federal and state wage laws. Employers should also immediately communicate to employees any potential delayed timing for wage payments and potential impact on the employer’s compensation and benefit plans, and work with their third-party benefit providers to anticipate potential issues in maintaining and operating their benefit plans. We are closely monitoring developments related to the SVB Closure and will continue to update this alert as new developments unfold.
Appendix – Summary of Select State Wage Laws