Second Circuit Broadly Caps Wage Claims Accelerated Before Bankruptcy

Under the plain language of the statute, Section 502(b)(7) caps an employee’s claim for incentive compensation that was accelerated by termination before bankruptcy, even if the compensation was fully earned before termination, the Second Circuit held.

The creditor was a lobbyist for a health care provider. His contract called for $10 million in incentive compensation if he was successful in obtaining regulations from Medicare and Medicaid that would increase the employer’s revenue. The contract provided that he would receive the incentive payments over five years if he remained employed by the company.

If he were fired without cause, the contract said that the incentive bonuses would be “immediately accelerated and paid in full.” Conversely, the employee would forfeit the incentive bonuses if he resigned or was fired for cause.

The employee earned the entire $10 million in incentive bonuses and was paid $1 million. However, he was fired without cause eight months before the employer’s bankruptcy, leaving $9 million to be paid.

The employee demanded immediate payment of the $9 million and sued when the company didn’t pay. After the employer’s bankruptcy, the employee filed a proof of claim for the $9 million in incentive bonuses.

The debtor objected by contending that the claim was capped by Section 502(b)(7). Bankruptcy Judge Robert D. Drain of White Plains, N.Y., sustained the objection and capped the incentive bonus claim at $4 million under the “plain language” of Section 502(b)(7). The district court affirmed, and so did the Second Circuit in a July 20 opinion by Circuit Judge Dennis Jacobs.

The employee contended that the incentive payments were fully vested before bankruptcy and were therefore akin to retirement benefits that are not capped by Section 502(b)(7). Judge Jacobs disagreed, based on the plain language of the statute.

Section 502(b)(7) applies to “the claim of an employee for damages resulting from termination of an employment contract.” It caps the claim at “the compensation provided by such contract, without acceleration,” for one year following the earlier of (1) the bankruptcy filing date, or (2) the date when the employee was terminated. [Emphasis added.]

Judge Jacobs said that that the cap was principally intended by Congress to cut off so-called golden parachute claims by high-level company executives. Nonetheless, he said the cap “is not necessarily limited to snipping the cords on golden parachutes.” Furthermore, the plain language of the statute means that the cap applies “whether or not [the claim] is characterized as severance.”

Judge Jacobs said the cap “applies broadly to employee claims for ‘damages resulting from the termination of an employment contract,’” except for compensation due without acceleration on the termination date.

The employee-creditor argued that the incentive payments were fully earned before he was terminated, but Judge Jacobs explained that the accomplishments giving rise to the bonuses were “necessary but not sufficient conditions” to require payment. Instead, he said the payments were not due until termination accelerated the due date.

Judge Jacobs said that the “statute’s explicit provisions for ‘acceleration’ subvert the [creditor’s] contention that the timing of the Incentive Bonus payments was ‘irrelevant.’” In other words, he upheld Bankruptcy Judge Drain and capped the payments at one year because the payments were accelerated by the employee’s termination.

Judge Jacobs ended his opinion by explaining the practical significance of the holding. If the claim were not capped, he said that “artful drafting” could evade Section 502(b)(7) by “recasting a golden parachute as an incentive payment for goals easily achieved.”