Contributed by Elisa Lemmer
Those of us who live in South Florida are familiar with a saying that goes something along these lines, “The farther south you go, the further north you get.” The saying may be true in many respects, especially considering that many South Florida residents are New York “transplants,” but the adage didn’t appear to hold true in the recent decision by the United States Bankruptcy Court for the Middle District of Florida, Robb & Stucky Limited, LLLP, which held that severance payments to a terminated CEO were not entitled to administrative expense status in the employer’s bankruptcy. The bankruptcy court showed just how different the North and South can be, dismissing the Second Circuit’s conclusion on the issue as the minority view. Or did it?
In Robb & Stucky, the debtor had entered into a prepetition employment contract with its CEO. Just three weeks after the debtor filed for bankruptcy protection, it terminated the CEO and rejected the employment contract. The CEO filed an application for payment of administrative expense in which he sought nearly $1.3 million in severance payments under his employment contract, arguing that, because he was terminated postpetition, his claim was entitled to administrative priority. Objecting to the CEO’s request, the debtor contended that its rejection of the employment contract constituted a prepetition breach.
In reaching its decision, the court first examined when the CEO’s right to payment arose. Although the CEO contended that his right to payment arose when he was terminated (i.e., postpetition), the court concluded that his right to payment, albeit contingent, arose when he executed his employment contract, two years before the debtor sought bankruptcy protection. The court cited to other courts’ decisions concluding that severance claims based on prepetition employment agreements were not entitled to administrative priority even when the employees were terminated postpetition. The court acknowledged that, in 1967, the Second Circuit held, in Straus-Duparquet, Inc. v. Local No. 3 Int. Bro of Elec. Wkrs. that where employment was terminated as an incident of administration of the debtor’s estate, the related severance pay claims could be paid as administrative expenses of the estate. The bankruptcy court, however, dismissed the Second Circuit decision as espousing a minority view of the issue and cited to courts in the First, Fifth and Tenth circuits taking the contrary position.
To buttress its conclusions, the court then analyzed the CEO’s request under section 503(c)(2) of the Bankruptcy Code, which was added to the Bankruptcy Code in 2005. Section 503(c)(2) prohibits severance payments to a debtor’s insiders unless the payment is part of a program that is generally applicable to all of the debtor’s full-time employees and does not exceed 10 times the mean severance pay given to non-management employees during the calendar year in which the payment is made. Because the severance claims arose under the CEO’s employment contract, the bankruptcy court concluded that it did not arise under a “program,” and the severance payments, therefore, were not entitled to administrative expense status under section 503(c)(2) of the Bankruptcy Code.
Perhaps pouring salt on the CEO’s wounds, the court noted that administrative expense payments require a benefit to the debtor’s estate. It observed that an agreement for a sale of the debtor’s assets had been executed prepetition, the CEO had not contributed to the debtor’s reorganization efforts, and the debtor’s new chief restructuring officer (who ostensibly replaced the CEO) had been “in place” prepetition. Ultimately, the bankruptcy court disallowed the CEO’s request for treatment of his severance payments as an administrative expense of the debtor’s estate.
Would the CEO have fared differently if the debtor’s case were pending in the Second Circuit or before a court that followed Straus-Duparquet? Well…maybe. Although the Second Circuit held in Straus-Duparquet that severance payments are not earned from day to day and do not accrue, but, instead, are payable upon termination (and thus are potentially payable as postpetition administrative expenses), many courts in the Second Circuit have since chipped away at its holding. For example, some have carefully examined the “severance” claims asserted under an employment contract to determine whether they contain the characteristics of the term “severance” as the Second Circuit had previously defined it in Straus-Duparquet. In doing so, these courts have concluded that Straus –Duparquet applied only to “severance” and that the payments at issue in the cases before them were properly considered “damages” (not severance), rendering Straus-Duparquet inapplicable. The Robb & Stucky court, by contrast, never questioned (probably because it did not need to do so) the nature of the damages owed to the former CEO under his employment contract. The court accepted the characterization of the damages as “severance” payments and, in fact, went on to analyze whether they were payable under section 503(c)(2) of the Bankruptcy Code, which explicitly governs “severance” payments. Characterizing the payments as “severance” increases the likelihood that all or a portion of the CEO’s claim could be treated as an administrative expense claim by a court that followed Straus-Duparquet.
One might argue that even if the debtor’s case had been pending in a court that followed Straus-Duparquet, and the court characterized the requested payments as “severance payments,” the CEO’s request for administrative treatment, ultimately, would have been rejected pursuant to section 503(c)(2), just like it was in Robb & Stucky. After all, the Robb & Stucky court did consider, hypothetically, whether the CEO’s severance claims could have been entitled to administrative expense priority under section 503(c)(2) and concluded that they were ineligible, in any event, because they arose under an employment agreement and thus not within a “program” applicable to all full-time employees. This view, however, is not universal. At least one other court to consider this, In re Forum Health, has concluded that employment agreements, coupled with other company policies, collectively could constitute a “program” as used in section 503(c)(2). Thus, the fact that a severance payment arises under an employment agreement might not – in and of itself – be a barrier to administrative expense treatment. Courts in the Second Circuit, however, have not yet considered this specific issue, so it is possible that they could deem an employment agreement to be part of a “program” and ultimately allow administrative expense treatment. In sum, the treatment of severance payments is not uniform across bankruptcy courts, and an insider with an employment agreement who is terminated postpetition may have an uphill battle to fight if he or she seeks administrative expense treatment from a court that does not follow Straus-Duparquet.
Interestingly, in rendering its decision, the Robb & Stucky court (Tampa Division) acknowledged, but rejected, a contrary result reached nearly 25 years earlier by the Bankruptcy Court for the Southern District of Florida (Miami Division) in In re Miami General Hospital, Inc., which followed Straus-Duparquet. In re Miami General Hospital, Inc. is the only reported decision in the Southern District of Florida to have analyzed Straus-Duparquet. So, as it stands now, while the Tampa court has rejected the New York court’s decision, the Miami court continues to back it – proving (not discrediting) the adage that you have to travel farther south to get further north.