The Bottom Line:

On July 6, 2011, the United States Court of Appeals for the Fourth Circuit in Matson v. Alarcon, 2011 U.S. App. Lexis 13729 (4th Cir. 2011), held that terminated employees “earn” the entirety of their severance compensation on the date the employee becomes entitled to receive his or her compensation under the terms of the governing severance plan.  In doing so, the Fourth Circuit did not require severance pay to be allocated over the time of the employee’s employment and affirmed the bankruptcy court’s order granting severance claims priority treatment for the maximum statutory amount under 11 U.S.C. § 507(a)(4).  

What Happened:

Under the Bankruptcy Code, an employee is entitled to priority treatment of “allowed unsecured claims, but only to the extent of [$11,725] for each individual. . . earned within 180 days before the date of the filing of the petition or the date of the cessation of the debtor’s business . . . for (A) wages, salaries, or commissions, including vacation, severance, and sick leave pay earned by an individual.”  11 U.S.C. § 507(a)(4) (emphasis added).  The question raised in Matson v. Alacrcon was how and when do terminated employees “earn” their severance. 

Factually, LandAmerica Financial Group, Inc. (“LandAmerica”) established a “Severance Benefit Plan” (the “Plan”) to assist employees upon termination.  Under the terms of the Plan, participants were entitled to receive compensation equal to their weekly salary multiplied by a certain number of weeks, based on the employee’s length of employment.  In 2008, LandAmerica terminated 125 employees during the 180-day period prior to filing its bankruptcy petition.  Although all 125 terminated employees were participants of the Plan, LandAmerica did not pay any severance compensation to its former employees.  After LandAmerica filed for bankruptcy, its former employees (“claimants”) filed proofs of claim for severance compensation due under the Plan, requesting priority treatment for the maximum statutory amount pursuant to 11 U.S.C. 507(a)(4).  

The trustee of LandAmerica’s liquidation trust objected.  Although the trustee did not dispute the amount of the claims, the treatment of the claims as a pre-petition priority was disputed.  The trustee “contends that the former employees ‘earned’ their severance compensation over the entire course of their employment and that, therefore, only the portion ‘earned’ within the 180-day period before LandAmerica filed for bankruptcy was entitled to priority.”  The bankruptcy court overruled the trustee’s objections, holding that the claimants’ entire severance claims were entitled to priority treatment subject to the statutory cap.  Upon direct certification to the Fourth Circuit, the Court affirmed. 

In affirming, the Fourth Circuit focused on the statutory construction of section 507(a)(4) to determine how and when a terminated employee “earns” severance.  Because the Bankruptcy Code does not define the words “earn” and “severance pay,” the Court used the plain and ordinary meaning approach to interpret these words, while also analyzing the purpose of severance.  In its analysis, the Fourth Circuit reasoned that termination of employment is the triggering event that allows an employee to receive severance.  As such, an employee is entitled to receive – or “earns” – the severance payment upon his or her actual termination (subject to any other prerequisites under an employer’s severance plan).  Given that the LandAmerica employees were terminated during the 180-day priority period, their claims were entitled to priority treatment up to the statutory maximum under 11. U.S.C. § 507(a)(4) and they were not required to be pro-rated over the course of the employee’s pre-bankruptcy years of service. 

Why the Case is Interesting:

The interpretation of the word “earned” under section 507(a)(4) is an issue of first impression for the Fourth Circuit. Because priority and administrative expense claims must be paid in full, these claims have a direct impact upon an estate’s distribution scheme and cash flow.  Each additional dollar granted priority treatment can affect proceeds available for other creditors further down the priority scheme.  Companies filing in the Fourth Circuit will now need to account for the costs of employees severed during the priority period.  It also stands to reason that employees terminated post-bankruptcy could argue that their entire claim is entitled to administrative expense treatment having been “earned” on the date of termination and would not be subject to the statutory cap in section 507(a)(4), which only applies to pre-petition claims.