An executive’s right to severance payments isn’t always written in stone, even if his employer agrees to provide them.  In this post, we described how one exec lost his severance pay after the Federal Reserve decided that his employer, a bank, was in a “troubled condition” at the time.

A recent decision from the U.S. Bankruptcy Appellate Panel of the Tenth Circuit, In re Adam Aircraft Industries, Inc., illustrates another scenario in which an executive’s golden parachute can collapse around him.  Joseph Walker was the president of Adam Aircraft, an airplane designer and manufacturer.  He was terminated in February 2007, and was allowed to resign, after which he negotiated a healthy severance package.  Over the next year, Adam Aircraft paid him $250,000 in severance, $100,002 to repurchase his stock, and $105,704 as a refund on a deposit he had made on a plane. 

Perhaps the most important lesson of the decision for employees is that when there is even a remote possibility of a bankruptcy down the line, an employee is better off to take early severance pay rather than deferring payments for later.  As Walker’s case shows, whether an employee can keep a severance payment or must pay it to an aggressive trustee can depend solely on when the payment was made.

In February 2008, Adam Aircraft filed for Chapter 7 bankruptcy, and the bankruptcy court appointed a trustee to collect its property and liquidate its assets.  A trustee’s powers in a bankruptcy include the ability to “avoid” transactions by the debtor that would result in an unfair distribution of corporate assets.  In the Adam Aircraft case, the trustee sought to avoid – or in this case, claw back – all of Walker’s severance payments.

The trustee was successful, but only in part.  The court allowed the trustee to avoid the $62,500 that Walker had been paid within 90 days of the date that Adam Aircraft filed for bankruptcy, under the doctrine that allows a trustee to avoid such transfers as “preferential” and unfair to other creditors.  Thus, Walker was required to pay back that money. 

As to the remaining payments, which were made more than 90 days in advance of filing, the trustee had a higher burden.  In order to establish that those payments were “preferential transfers,” it had to show that Walker qualified as an “insider” at the time the payments were made.  However, because Walker had made a “clean break” with Adam Aircraft upon his resignation, he was not a director or officer who would qualify as a “per se insider.”  Further, his relationship with Adam Aircraft did not show that he was any other kind of insider.  He was not close to management; he negotiated his severance package at arm’s-length and did not receive everything he asked for; and he resigned without locking up his severance package.  

In addition to arguing insider status, the trustee claimed that Adam Aircraft was insolvent when it entered into the severance agreements with Walker, and that it didn’t get adequate value for its transfers.  These arguments also failed.  Thus, Walker was allowed to keep most of the payments made to him.