Employee Screening.jpgEmployers commonly ask if it is legally permissible to use a job applicant’s prior bankruptcy filing in making hiring decisions. A recent court opinion out of the Third Circuit (the federal circuit that covers Pennsylvania, Delaware, New Jersey) answers this question in favor of employers. But for employers in Michigan and outside of the jurisdiction of the Third Circuit, the answer is not so clear cut and there are also important limitations to using bankruptcy in hiring and firing decisions.

First for background purposes, under the Bankruptcy Code, 11 USC § 525(b), a private employer cannot “terminate the employment of, or discriminate with respect to employment against, an individual who is or has been a debtor under … the Bankruptcy Act …”

The Third Circuit Court of Appeals, however, determined that despite the preceding statute, private employers may refuse to hire an applicant based upon a prior bankruptcy filing. Specifically, in Rea v. Federated Investors (3d Cir. Pa. 2010), the plaintiff, Dean Rea, appeared to have a job offer contingent upon a third-party background check. Rea, however, was later informed that the company refused to hire him because of his 2002 bankruptcy.

Takeaway for Employers

With respect to using an applicant’s prior bankruptcy filing, there are a number of legal and business decisions employers should consider:

  • First, under 11 U.S.C. § 525(b), employers cannot discharge a current employee “solely” because that employee filed for bankruptcy.
  • Second, the Rea decision is not binding on courts outside of the Third Circuit. Michigan employers are within the jurisdiction of the Sixth Circuit Court of Appeals and a review of the case law did not reveal any decisions addressing the issue of whether private employers may refuse to hire a job applicant who has previously filed for bankruptcy.
  • Third, it is important to consider that filing bankruptcy or related credit problems may be completely unrelated to an applicant’s decision making or integrity. For example, Katherine Shinn, a bankruptcy attorney explained that it is not uncommon for an individual to file for bankruptcy due to a catastrophic medical event, long term unemployment following a mass layoff, or other reasons unrelated to whether an individual is employable. In this regard, consider individual bankruptcy filings in the United States (both Chapter 7 and Chapter 13) increased from 797,783 in 2007 to 1,383,644 in 2009. This staggering increase certainly correlates to the equally significant job losses the U.S. experienced for that time-period.  
  • Fourth, and building upon the preceding, a default rule to exclude consideration of job applicants based solely upon a prior bankruptcy filing may not make business sense in the long run. Take for example that Abraham Lincoln, Walt Disney, and (the original Detroit import) Mr. Henry Ford all declared bankruptcy before achieving well-known success. No company would want to see in their rear-view mirror job applicants of this calibre passed up simply because of a rigidly applied bankruptcy exclusion rule.     

Certainly these are exceptional examples. But it can also be said that the increased bankruptcy filings have – in large part – occurred under exceptional circumstances. For these reasons, a more strategic course for employers is to continue to permissibly screen applicants to identify the best qualified candidates. As Steve Williams of Ecto HR explains “in conducting background checks for our clients we make it a point to give as a complete picture of a candidate as possible, including the circumstances of the bankruptcy filing.” With this information, Mr. Williams notes that “employers are then able to make informed decisions as to a prospective hire.” 

An important note about using third-party service providers to conduct background checks: Bankruptcy filings are often uncovered when an employer conducts a background check on a job applicant. For any employer using a third party service provider to obtain background reports on a job applicant, the Federal Fair Credit Reporting Act will come into play. This statute imposes a number of obligations on employers obtaining background reports (referred to as “consumer reports” under the statute). Such obligations include obtaining advance authorization from an applicant to conduct a background check and mailing an “adverse action” notice if a job applicant is rejected due, in whole or in part, to derogatory information contained in the background report. 

Failing to comply with this statute may expose the employer to civil and criminal liability in addition to punitive damages. It is, therefore, critical for employers to understand the requirements of this statute as well as their their third-party service providers actually conducting applicant background checks.