On June 15, 2006, the U.S. Supreme Court issued its opinion in Howard Delivery Service Inc. v. Zurich American Insurance Co., 574 U.S. ___, resolving a split among the circuit courts of appeals concerning whether pre-petition claims for unpaid premiums for a workers' compensation liability policy are entitled to priority status. In a 6-3 decision, the court held that such premiums are not "contributions to an employee benefit plan" and therefore are not entitled to priority status.

Under the Bankruptcy Code, when an employer files for bankruptcy, unpaid pre-petition "wages, salaries or commissions," up to $10,000 per employee, are entitled to priority over most other pre-petition unsecured claims. 11 U.S.C. § 507(a)(5). Prior to an amendment to the Bankruptcy Code in 1978, the courts held that "wages, salaries and commissions" did not include fringe benefits, such as contributions to a union welfare plan or an employees' annuity plan, and therefore denied priority status to unpaid contributions to such plans.

In response, Congress amended the Bankruptcy Code to provide for priority status to contributions to "employee benefit plans," limited to the amount that the employees' unpaid wage claims were less than the maximum amount granted priority wage status, on an aggregate basis. As a result, certain "wage substitutes," such as health and life insurance plans and pension funds, have been accorded priority of payment in an employers' bankruptcy case.

The Bankruptcy Code, however, does not define the term "employee benefit plans." In the Howard Delivery case, the workers' compensation insurer urged the Supreme Court to decide that premiums for workers' compensation insurance constitute contributions to an "employee benefit plan" accorded priority status. The Supreme Court refused to extend priority protection to workers' compensation premiums. The court instead ruled that the Bankruptcy Code's objective of equal distribution to similarly situated creditors, which requires that priority provisions be construed narrowly, compelled the conclusion that workers' compensation insurance policies are not employee benefit plans.

The court was persuaded that workers' compensation premiums do not compensate employees for work performed because they "have a dominant employer-oriented thrust." Slip Op. at p. 10. The workers' compensation regime provides a benefit to both sides — employees are assured of fixed payments for on-the-job injuries and employers are free from the risk of large judgments and heavy costs generated by litigation. This means that workers' compensation policies were not a "fringe benefit" that Congress wanted to protect when it expanded priority protection to employee benefit plans.

The court rejected the insurer's argument that the meaning of "employee benefit plan" in the Bankruptcy Code should be guided by the interpretation of that same term as used in ERISA. Because Congress did not specifically direct that ERISA should be used to clarify Section 507(a)(5), and ERISA's definition of "employee benefit plan" was subject to multiple interpretations, the court ruled that ERISA's definition did not establish the meaning of "employee benefit plan" for purposes of the Bankruptcy Code.

By ruling that unpaid premiums for workers' compensation are not entitled to priority payment, the Supreme Court narrowly construed the Bankruptcy Code's priority scheme, in order to uphold the Bankruptcy Code's goal of equality of distribution to creditors. Workers' compensation insurers, therefore, will be treated similarly with all other unsecured creditors, and will no longer be able to argue that they should be entitled to the preferred status granted to certain programs that benefit employees. As a result, workers' compensation premiums may increase to compensate for the new "risk."