Constitutional Court Decides Employee Wages Get Priority over Secured Creditors in Bankruptcy / Liquidation

Continuing the ongoing series of judicial reviews against the Labor Law,¹ the Constitutional Court rendered Decision No. 67/PUU-XI/2013 on September 11, 2014, with the result that payment of wages now receives top priority during bankruptcy or liquidation of an employer—even over satisfaction of secured creditors.

The Decision revises Labor Law provisions that initially stipulated that wages and other employee rights are “prioritized” over “other payables” when a company is bankrupted or liquidated. The applicants for judicial review argued that Article 95(4) of the Labor Law failed to provide sufficient detail about what “other payables” are preceded by payment of wages and other employee rights. In its Decision, the Constitutional Court declared that Article 95(4) shall now be read as follows:

The payment of outstanding wages of workers/laborers shall take precedence over all other types of creditors, including secured creditors’ claims and claims of states’ rights, auction houses and public institutions established by the Government, whereas the payment of other rights of workers/laborers shall take precedence over all claims, including claims of states’ rights, auction house, and public institutions established by the Government, except for claims by secured creditors.

In amending the provision, the Constitutional Court reasoned that employee wages and rights are part of the rights to life and livelihood, as contained in Article 28A of the 1945 Constitution, which cannot be reduced under any circumstance. Despite the constitutional basis for protecting employees’ livelihoods, the Decision poses serious implications for secured creditors.

♦ Types of Creditors

Ordered based on priority, there are three types of creditors:
1. Secured creditors (kreditur separatis);
2. Preferential creditors (kreditur preferen); and
3. Concurrent creditors (kreditur konkuren).

Secured Creditors
Secured creditors are those holding security over movable or immovable assets, such as pledge, hypothec, mortgage, fiducia, and warehouse receipt. In bankruptcy and liquidation, secured creditors may immediately execute the collateral and receive repayment of their loans prior to other creditors.

Preferential Creditors
Preferential creditors are those given the right by law to precede other creditors. Examples of preferential creditors include those with the following receivables:
1. Court fees;
2. Lease payments for immovable property;
3. Unpaid movable property; and
4. Insurance policy holders in the bankruptcy of a general loss or life insurance company.

Concurrent Creditors
Concurrent creditors are those not classified as either secured or preferential creditors. As such, concurrent creditors receive the lowest priority in bankruptcy and liquidation.

♦  Debts to the Government

The rights of the Government in bankruptcy and liquidation are set out under the General Taxation Law, which requires outstanding tax payments of the entity to be paid prior to liquidating the assets and settling with preferential and concurrent creditors. As such, outstanding tax payments are disposed after secured creditors are satisfied, but take precedence over preferential and concurrent creditors.

♦  Implementation Unclear

The most significant issue raised by the Decision is the impact on the status of secured creditors that are now subordinated to employee wage claims, as the source of wage payments may in some cases require the sale of secured assets. Prior to the Decision, wages and other employee rights were classified under preferential creditors, as affirmed under the ICC. As a consequence of the Decision, employee wages are now prioritized over all other creditors, including secured lenders and the Government, whereas other employee rights are positioned after secured creditors.

“Other employee rights” was not defined by the Constitutional Court, but we infer that such rights cover severance, unclaimed annual leave, compensation for housing allowance, medical and health care costs, and other compensation stipulated in the Labor Law, company regulation, collective labor agreement (if applicable) and individual work agreements

Another critical issue is the clash between the new definition provided in the Decision and the provisions of the Bankruptcy Law. As the Decision prioritizes wages over every other debt, will secured creditors be required to wait for the bankrupted company to pay the wages of their employees, or even obtain approval from the court or the receiver, before executing their securities? Under the Bankruptcy Law, secured creditors are given the right to execute their collateral (as though the debtor was never declared bankrupt) during the first 90 days after the bankruptcy decision. Will this right now be sidelined by the obligation to prioritize the wages of employees? The Constitutional Court did not address any of these issues in the Decision.

The Ministry of Manpower and Transmigration subsequently issued Circular Letter No. SE.7/MEN/IX/2014, announcing the Decision to the regional governments, but the letter offered no guidance on how to interpret or implement the Decision.

We will continue to seek confirmation regarding the implementation of the Decision. If there are inquiries regarding the impact of the Decision on a particular legal matter, we will gladly facilitate and discuss them with you.

Legal Basis
The legal bases used in this article are as follows:
1. Indonesian Civil Code (“ICC”)
2. Indonesian Trade Code (“ITC”)
3. Law No. 6 of 1983 on General Tax Provisions and Procedures, as lastly amended by Law No. 16 of 2009 (“General Taxation Law”)
4. Law No. 2 of 1992 on Insurance Companies (“Insurance Law”)
5. Law No. 4 of 1996 on Mortgage on Land and Property Affixed on Land (“Mortgage Law”)
6. Law No. 42 of 1999 on Fiducia Security (“Fiducia Law”)
7. Law No. 13 of 2003 on Labor Affairs (“Labor Law”), as amended
8. Law No. 37 of 2004 on Bankruptcy and Suspension of Debt Payments (“Bankruptcy Law”)
9. Law No. 9 of 2006 on Warehouse Receipt Systems, as amended by Law No. 9 of 2011 (“Warehouse Receipt Law”)
10. Law No. 17 of 2008 on Shipping (“Shipping Law”)
11. Law No. 1 of 2009 on Aviation (“Aviation Law”)

Jakarta, October 13, 2014

1 Previous judicial reviews of the Labor Law include: 1) Constitutional Court Decision No. 27/PUU -IX/2011, dated January 17, 2012, 2) Constitutional Court Decision No. 100/PUU -X/2012, dated September 19, 2013, 3) Constitutional Court Decision No. 115/PUU-VII/2009, dated November 10, 2010, 4) Constitutional Court Decision No. 37/PUU-IX/2011, dated September 19, 2011, 4) Constitutional Court Decision No. 012/PUU -I/2003, dated October 28, 2004, 5) Constitutional Court Decision No. 19/PUU-IX/2011, dated June 20, 2012, and 6) Constitutional Court Decision No. 58/PUU-IX/2011, dated July 16, 2012.