Appeals Court Advances the Status of Severance Pay
In my prior posting, I noted that there is a hierarchy to what happens in the distribution of a bankrupt’s assets. In other words, certain claims get precedence over others. One such class of “senior claims” are so-called “priority creditor claims.” These include the claims of employees, up to a maximum of $11,725 per person, for wages, salary, and the like, earned within 180 days before the bankruptcy begins.
This class also includes employee severance payments but, until recently, it was unclear whether severance claims were entitled to any meaningful priority in the distribution of debtor assets. Recently, the first appellate federal opinion on the issue, Matson v. Alarcon, 651 F. 3d 404 (4th Cir. 2011), held that agreed severance pay is entirely “earned” upon the termination of employment, thus firmly elevating severance pay to full priority status in bankruptcy distributions.
The debtor in Matson was once the country’s third largest title insurance company. It had an established severance payment policy, by which employees terminated without cause were entitled to a certain number of weeks of salary, based upon their length of service. In the six months leading to the company’s bankruptcy, more than 100 employees became eligible for such payments. The debtor’s fiduciaries asserted in the bankruptcy that these ex-employees had “earned” their severance compensation over the entire course of employment, since the rights accrued based upon length of service. Therefore, the fiduciaries claimed, only modest amounts were “earned” within the requisite 180 days before bankruptcy. The Bankruptcy Court rejected this, holding that the severance pay for each employee was “earned” in its entirety at the moment of termination. The case was taken on a direct appeal to the 4th Circuit Court of Appeals.
The appeals court felt that the key event was the decision to terminate the employees, which occurred within the 180 day window. The court thus held that the severance pay was earned in its entirety upon termination. It therefore found that the employees were each entitled to priority status for up to $11,725.
Hopefully, this will settle the issue and accord necessary protection to displaced employees. At the least, it will serve the salutary purpose of encouraging employees to remain with a distressed company, while it attempts to reorganize, since they will get a “leg up” should the company fold without paying them in full.