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In a recent decision in the VeraSun bankruptcy cases, the U.S.
Bankruptcy Court for the District of Delaware held that
"change in control" agreements between former executives
and the debtors are "employment contracts" under section
502(b)(7) of the Bankruptcy Code. Accordingly, the Court determined
that the former executives' claims asserted under the
agreements were appropriately capped by the claims-allowance scheme
set forth in section 502. In re VeraSun Energy Corp., et al., 2012
Bankr. LEXIS 1262 (Bankr. D. Del. Mar. 26, 2012).
Change in Control Agreements
Due to the uncertainty caused by corporate mergers, and the
increased likelihood that executives of merging firms may seek
employment elsewhere, "change in control" agreements or
"CIC Agreements" were conceived to ensure that key
executives continue their employment until a merger is either
completed or abandoned. CIC Agreements typically provide that if a
particular executive is terminated without cause within a specified
time period after the closing of a merger, certain benefits will
become due. In VeraSun, the CIC Agreements at issue involved
compensation packages featuring, upon termination, a cash payment
equal to a multiple of the executive's base salary and bonus,
continued medical benefits, payment for unused vacation, vesting of
any unvested equity, and a guarantee that once the merger occurred,
the debtor could not change the executive's position, duties,
compensation, benefits, or work location.
The VeraSun Decision
VeraSun filed for bankruptcy protection in October 2008. Shortly
thereafter, VeraSun terminated various CIC Agreements, and the
executives that were parties to these agreements subsequently
asserted claims for amounts owing thereunder. The debtors objected
to the claim amounts, arguing that the CIC Agreements were
"employment contracts", and because Bankruptcy Code
section 502(b)(7) caps claims for "damages resulting from the
termination of an employment contract" at one year's
salary and fringe benefits (plus any earned but unpaid
compensation), the executives' claims should be capped
accordingly.
In determining whether the 502(b)(7) cap applied, the Court
first considered whether the CIC Agreements modified the
executives' employment contracts and thus constitute
"employment contracts" under section 502(b)(7), or are
stand-alone agreements outside the ambit of 502(b)(7). Because the
employment contracts and the CIC Agreements both relate to
employment compensation, the CIC Agreements modified the
executives' employment relationship, and the CIC Agreements
could not be interpreted without reference to the employment
contracts, the Court held that each CIC Agreement formed a single
contract with its associated employment contract. Accordingly, the
Court determined that the CIC Agreements are "employment
contracts", as that term is used in section 502(b)(7).
The Court then considered whether the executives' claims
under the CIC Agreements were "for damages resulting from the
termination of an employment contract", thus justifying the
application of the 502(b)(7) cap. The Court focused on the fact
that the CIC Agreements explicitly define the compensation to be
awarded as "severance benefits", which are routinely
capped under section 502(b)(7), and contain language nearly
identical to severance agreements that have been subject to the cap
in numerous prior bankruptcy cases. Further, the Court noted that
Congress enacted 502(b)(7) to counter self-serving actions by a
debtor's executives, such as the approval of generous severance
packages.
The court explained that section 502(b)(7) of the Bankruptcy
Code is necessary to offset the "distinct advantage"
executives enjoy "over other unsecured creditors, including
other employees, who cannot easily adjust their claims to the
company's assets". Accordingly, based on the plain
language of the CIC Agreements and the important policy
considerations underlying section 502(b)(7), the Court determined
that the 502(b)(7) cap applied to the CIC Agreements.
Conclusion
In VeraSun, the Court applies a common sense approach to the
executives' CIC Agreements that comports with prior case law
and the plain language of the Bankruptcy Code. Although the Court
is mindful of a debtor's need to retain key employees during
uncertain periods, such as during a merger or a bankruptcy,
Congress has made clear that executive claims are to be reviewed
carefully and that executive claims arising under employment
contracts, regardless of their form, should generally be subject to
the 502(b)(7) cap.
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