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Salvaging Severance Pay After a Company Files for Bankruptcy

In today's uncertain economy, companies are filing for Chapter 11 bankruptcy protection everyday. As such, those currently employed by, or contemplating employment with, a struggling company would be wise to consider the following question: how will the severance pay provisions in your employment contract be treated in the event you are terminated before or after your employer files for Chapter 11 bankruptcy protection?

The short answer is you will likely have to sit in line with every other general, unsecured creditor-meaning, if you collect anything, it will be a nominal amount. The answer will also largely depend, however, on whether the severance agreement was entered into pre-petition or post-petition. In any event, with proper planning, and savvy negotiating, you may be able to salvage your severance pay in the event your company goes under.

Your first inclination might be that the parent company of the bankrupt subsidiary you work[ed] for will be liable for your severance pay-not so fast. A parent corporation is generally not liable for the contractual obligations of its subsidiary-even if the subsidiary is wholly owned. Starner v. Guardian Industries (2001), 143 Ohio App.3d 461, 468. So, unless you have the foresight to negotiate the parent corporation's conditional liability in the event of the subsidiary's bankruptcy, your sole remedy will be to file a claim in the bankruptcy proceedings and wait in line with everyone else.

To that end, it is important to realize that not all unsecured claims receive equal priority in a Chapter 11. Section 507(a) of the United States Bankruptcy Code establishes nine categories of claims that receive payment priority and must be paid before any other unsecured claims. One of these categories, one that your severance pay can potentially receive priority under, is defined in Section 503(b) as an "administrative expense."

Generally, however, in order for a contract for severance pay to qualify for "administrative expense" priority, the claimant must prove that the company's severance payment obligation arose after it filed for bankruptcy (post-petition), rather than arising prior to the petition (pre-petition). See, e.g., In re White Motor Corp., 831 F.2d 106, 110 (6th Cir. 1987). In other words, the court will draw a line between: (1) severance pay negotiated pre-petition to induce an employee to forego other employment opportunities to join the company; and, (2) post-petition severance pay negotiated to induce an employee to remain with the already struggling, bankrupt company. Id. In the latter scenario, courts will generally grant the severance pay "administrative expense" priority because it is deemed to benefit the preservation of the estate. Id.

So, what does all this actually mean? It depends on which of the two following scenarios you find yourself in. The first scenario involves a pre-petition agreement for severance coupled with a pre-petition termination. Because the severance was negotiated pre-petition, it will not be granted any priority should the company file Chapter 11. Therefore, if you anticipate any potential that the company will file for Chapter 11 prior to fully performing its payment obligations, you must negotiate the following provisions: (1) a lump sum payment due upon termination-as opposed to an extended payment schedule; or, (2) conditional liability of the parent company in the event the subsidiary files for Chapter 11 protection. A proactive employee will push for inclusion of these provisions at the very outset of their initial employment contract-as opposed to trying to convince the employer to include these provisions in a subsequent Separation Agreement.

The second scenario also involves a pre-petition employment contract containing a payment provision, but here the employee agrees to stay on with the company, post-petition, while it re-structures the Chapter 11. In this scenario, before agreeing to stay on with the distressed company, you must have the company re-confirm or re-negotiate your severance arrangement after it files for Chapter 11. This way, if you are terminated after the filing, your severance will be given priority in the bankruptcy proceedings. Although not always the case, the company may agree to this re-confirmation or re-negotiation as inducement for your agreement to stay on with the troubled company, rather than jumping ship.

Whether you are contemplating going to work for a distressed company and are negotiating the terms of your employment contract, or you find yourself in one of the situations discussed above, the attorneys at Mowery Youell & Galeano, Ltd. can assist you in formulating a plan to improve you chances of salvaging your right to your severance pay in the event the company files for Chapter 11 bankruptcy protection.

By: Jeffrey P. Nagle

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