Guest Article

From Mandated Health Benefits--The COBRA Guide, published by Thompson Publishing Group, Inc.

Employer May Have To Treat COBRA Qualified Beneficiaries as Unsecured Creditors in Bankruptcy Proceeding

Summary: An employer that went bankrupt after an asset sale may have to treat COBRA qualified beneficiaries as unsecured creditors with priority status.

April 4, 2001 - An employer that went bankrupt after an asset sale may have to treat two aggrieved COBRA qualified beneficiaries as unsecured creditors with priority status, a federal bankruptcy court in Florida ruled, if it can be verified that they were: (1) eligible for, and covered under, the employer's plan during the asset sale; and (2) offered and provided COBRA continuation coverage up until a few months before the bankruptcy petition was filed.

In the case, In Re A.B.C. Fabrics of Tampa, Inc., 2001 WL 261785 (Bankr. M.D. Fla., Feb. 8, 2001), the COBRA qualified beneficiaries petitioned the court for priority creditor status after the employer failed to pay more than $37,240 in medical claims.

Facts of the Case

Greg Rayburn was the chief executive officer (CEO) of Silas Creek Retail, Inc. In October 1997, Carolina Sales, Inc. (apparently, part of A.B.C. Fabrics of Tampa, Inc.) purchased substantially all of Silas Creek's assets.

The asset purchase agreement noted that Carolina Sales would not assume certain obligations, including any liabilities or obligations for COBRA coverage and various benefits such as medical, health and disability coverage. However, an assumption agreement provided that Carolina Sales would assume certain obligations, including certain medical/health claims that occurred before the agreement date.

The sale of Silas Creek's assets became effective Nov. 1, 1997. Rayburn remained as CEO during the sale's transition period. He alleged that during November 1997, he and his wife received health benefits through a group health plan offered by Carolina Sales, and that he "was being treated as an employee of ABC Fabrics for the purpose of these benefits."

Rayburn's employment terminated on Nov. 30, 1997. He allegedly was offered, and elected, COBRA coverage, and paid the applicable COBRA premiums. Rayburn and his family incurred more than $37,240 in medical expenses from September 1997 through November 1998. However, none of their medical claims were paid.

In June 1999, A.B.C. Fabrics filed for Chapter 11 bankruptcy, and continued to operate its business at least until that date. Generally under the bankruptcy code, creditors can assert claims against the bankrupt entity. However, certain unsecured creditors have a higher priority than others in bankruptcy cases. Fourth on the list of priority claims are certain unsecured claims for contributions to an employee benefit plan.

The Rayburns argued that they had priority status as unsecured creditors because of the $37,240 in medical claims that A.B.C. Fabrics failed to pay. However, the company countered that no priority claim existed because, among other things:

1. Rayburn was the CEO of Silas Creek until he resigned on Nov. 30, 1997, and never was an A.B.C. Fabrics' employee, officer or director; and
2. any benefits Rayburn had were not provided under the Carolina Sales plan, rather, they were contracted for under the asset purchase and assumption agreements.

The court noted that the priority status for employee benefit plan contributions benefits employees of a bankrupt employer by giving priority status to promised fringe benefits that they did not receive before the bankruptcy filing.

In determining the Rayburns' priority status, the court found that future proceedings were necessary because:

1. enough questions were raised by both parties regarding a determination of whether the Rayburns were actually covered by the plan; and
2. based upon COBRA provisions, the Rayburns might be entitled to priority status if coverage was extended to Rayburn in November 1997, Rayburn was notified of his COBRA rights upon his employment termination and Rayburn elected COBRA coverage.

Therefore, if A.B.C. Fabrics determined that Rayburn satisfied the plan's eligibility requirements as an employee, it could not now find that he was not an employee under the bankruptcy code. If Rayburn was deemed an employee eligible for plan benefits, then the contributions that A.B.C. Fabrics may owe to the plan should have whatever status the bankruptcy code provides for such contributions.

Implications

This case represents one of probably many other COBRA cases likely to arise in this uncertain economic environment. In many cases, employers may go bankrupt or out of business. If they are otherwise subject to COBRA requirements, qualified beneficiaries will be in the middle of COBRA coverage periods and paying their premiums on a regular basis without any knowledge of the employer's economic condition. In those cases, qualified beneficiaries are likely to bring claims for recoupment of their medical expenses or COBRA premiums. Employers and plan administrators should keep an eye out for these cases. Particularly at risk are third-party administrators, which typically collect and remit premiums.

A more detailed version of this article will appear in the May 2001 supplement to Mandated Health Benefits-The COBRA Guide, ©Thompson Publishing Group, Inc., 2001. All rights reserved

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