Evidencing increasing scrutiny over the reach of the federal government’s power by the courts, a recent ruling in a Virginia case involving the Troubled Asset Relief Program (TARP) has upheld the rights of individuals as preserved by the United States Constitution, according to Charles M. Sims and John “Jack” M. Robb III, Richmond-based partners in national law firm LeClairRyan.

On April 30, Fourth Judicial Circuit of Virginia Judge Charles E. Poston (Ret.) ruled that former Shore Bank President Scott C. Harvard was unjustly deprived of his severance package due to the retroactive application of a provision of the TARP program. LeClairRyan represents Harvard.

“Judge Poston’s opinion in Harvard v. Shore Bank, et al sends a strong message about Constitutional limits of the federal government, and what happens when the federal government oversteps Constitutional boundaries,” said Sims, who chairs LeClairRyan’s Business Litigation Practice and focuses on officers’ and directors’ liability, professional malpractice, ERISA claims, complex commercial disputes and other matters. “It is rare for a court to find that a federal agency has exceeded its powers, particularly one as powerful as the Treasury Department. But this case of first impression turned on important Fifth Amendment principles regarding improper taking of an individual’s contractural rights without just compensation.” 

The case arose from an employment contract dispute between Harvard and his employer Shore Bank and its parent company Hampton Roads Bankshares Inc. (HRB). Under the terms of a January 2008 employment contract entered into when HRB acquired Shore Bank, Harvard—who also served as executive president of operations for HRB in Delaware, Maryland and Virginia—could terminate his employment with Shore Bank within six months of a transaction involving a “change in control” of HRB. Under the contract, upon such termination Harvard would be entitled to a severance payment equal to 2.99 times his base salary, as well as certain health and insurance benefits.

“The Treasury Department became an investor in the bank under TARP, and the severance contract complied with the initial TARP restrictions under the Emergency Economic Stabilization Act of 2008 that was passed in the wake of the financial crisis,” notes Robb, a member of the firm’s Banking Industry team, who focuses on commercial disputes and complex litigation. “The initial TARP restrictions, passed in October 2008, prohibited any bank that received TARP funds from paying severance payments to senior executive officers only if the payment exceeded an amount equal to three-times the executive’s salary.” 

On December 31, 2008, HRB completed its merger with Gateway Financial Services, which met the definition of a change in control transaction under Harvard’s contract due to the significant ownership interest the Gateway shareholders retained in the combined company. That event gave Harvard the contractual right to leave the bank within six months—which he did in June 2009— and to collect his severance pay.

But in the meantime, Congress and the Treasury Department changed the rules, retroactively. Treasury advised the bank that the American Recovery and Reinvestment Act (ARRA) of 2009 modified TARP to prohibit any severance payments, regardless of the amount, to a senior executive. Based on the Treasury’s advice, HRB and the bank refused to pay the contracted severance to Harvard.

“In his decision, Judge Poston noted that all of the parties, including Treasury, had taken affirmative steps acknowledging that they were subject to Treasury regulations issued prior to or on the December 31, 2008 closing date, when the bank received the TARP funds,” observed Sims. “The judge further noted that ‘None of those agreements acknowledge that they would be subject to future regulations,’ such as the AARA of 2009. Additionally, the terms of the TARP agreement with the bank indicated that the government was acting as an investor not as a regulator, which strengthened the argument that retroactive control of the CEO’s pay was outside of the scope of the government’s agreement with Shore Bank and HRB.” 

The outcome of the case should be comforting to individuals who believe the government is overstepping its boundaries, Sims added. “In recent months, in cases focusing on such matters as the Affordable Care Act, courts have increasingly demonstrated their willingness to examine the government’s exercise of its power and to rein it in, if such exercise oversteps Constitutional boundaries. Judge Poston’s decision is an excellent example of the courts’ important role in our system of government founded upon principles of checks and balances,” he concluded.

Read the full opinion.