Matson v. Alarcon, No. 10-2352, 2011 WL 2624437 (4th Cir. July 6, 2011)  

CASE SNAPSHOT

The severance plan at issue here provided payment based on a terminated employee’s length of service. Within 180 days prior to its bankruptcy filing, the debtor terminated several employees who qualified for compensation under the plan, yet these employees did not receive any severance compensation. In the bankruptcy case, the terminated employees asserted priority claims for the entirety of the severance compensation owed to them. The bankruptcy trustee objected, contending that each employee “earned” severance compensation daily during the employee’s tenure, so that only the pro rata portion of the severance “earned” before the employees’ termination and within the 180 days before the employer’s bankruptcy filing was entitled to priority treatment under section 507(a)(4) of the Bankruptcy Code. In a case of first impression in the Fourth Circuit, the Court of Appeals concluded that employees “earned” severance compensation in full on the day they first became qualified for the severance, not daily throughout the term of their employment. Therefore, the court held that the employees’ claims were entitled to priority treatment, subject only to the statutory cap provided in section 507(a)(4).  

FACTUAL BACKGROUND

In 2004, LandAmerica Financial Group, Inc., established a “Severance Benefits Plan,” the purpose of which was to assist employees upon their termination from LandAmerica. Employees became eligible to participate in the plan when: (1) they were terminated without cause; (2) they signed a severance agreement and release; and (3) certain other exempting circumstances were not present. Once employees became participants in the plan, they were entitled to receive compensation equal to their weekly salary for a number of weeks determined by their years of employment. LandAmerica’s board of directors retained the unilateral right to modify or terminate the plan.

Between August 2008 and November 2008, within the 180 days before LandAmerica filed its bankruptcy petition, LandAmerica terminated 125 employees. These employees qualified for severance benefits under the plan, but received no severance compensation from LandAmerica before it filed its bankruptcy petition. These employees filed proofs of claim asserting priority claims for the entirety of the severance compensation owed to them. The bankruptcy trustee objected, contending that each employee “earned” severance compensation daily during the employee’s tenure, and that only the pro rata portion of the severance “earned” before the employees’ termination and within the 180 days before the bankruptcy filing was entitled to priority treatment under section 507(a)(4) of the Code. The Bankruptcy Court denied the trustee’s objection and allowed the employees’ claims. The trustee appealed.  

COURT ANALYSIS

Section 507 of the Bankruptcy Code sets forth the categories of expenses entitled to priority treatment. Section 507(a)(4) provides priority to “allowed unsecured claims, but only to the extent of $10,950 for each individual … earned within 180 days before the date of the filing of the petition … for (A) wages, salaries, or commissions, including vacation, severance, and sick leave pay earned by an individual.” (Emphasis in opinion.)

The court’s task was to “determine the method by which an individual ‘earns’ ‘severance pay,’ within the meaning of this statute, to decide whether the claimants ‘earned’ their full severance pay or only a pro-rated portion of that pay during the pre-petition period.” Quoting Webster’s Dictionary, the court defined “severance pay” as “an allowance usually based on length of service that is payable to an employee” upon termination without cause.  

The court noted that interpreting the word “earned,” as used in section 507(a)(4), was a matter of first impression for the Fourth Circuit. The statute does not define the word, so the court looked to the plain and ordinary meaning of “earned,” citing Webster’s Dictionary. The court stated that “earn” means to “receive as equitable return for work done or services rendered” or “to come to be duly worthy of or entitled.”  

The court rejected the trustee’s argument that, because the amount of severance pay under the plan was based on length of employment, an employee earned severance pay daily throughout the length of the employee’s tenure. “[E]mployees do not ‘earn’ ‘severance pay’ in exchange for services rendered as they do when they ‘earn’ wages, salaries and commissions.” Instead, the court concluded that the employees become “entitled to” severance pay as compensation for the injury and losses resulting from the employer’s decision to terminate the employment relationship, which decision and the decision to provide severance compensation in the first place are both the employer’s. Thus, the debtor’s employees “earned” the severance compensation in full on the day they first became qualified for the severance under the plan.

The court also relied on the fact that LandAmerica’s board of directors had the right to amend or terminate the severance plan at any time to support the conclusion that the employees became entitled to the severance pay in full on a date certain rather than earning it over time. If the court were to hold that the employees had earned severance pay throughout their term of employment, an employee that worked for LandAmerica before the plan was adopted would have earned severance before the plan even existed. Moreover, if the board eliminated the plan before an employee was terminated, that employee would have earned severance but would never receive it. Thus, the court found logical flaws in the trustee’s position. Finally, the court distinguished other Circuit Court decisions related to priority administrative expense claims based on section 503(b)(1) (A) because those cases involve statutory language materially different from section 507(a)(4), i.e., section 503(b)(1)(A) provides employees with priority claims for employee compensation for “services rendered” to the debtor postpetition rather than for employee compensation “earned” by the employees pre-petition.

Therefore, the court held that the employees’ claims were entitled to priority treatment, subject only to the statutory cap provided in section 507(a)(4).  

PRACTICAL CONSIDERATIONS

Implicit in the court’s decision is that the employer’s board of directors could have avoided the employees’ entitlement to priority claims for severance compensation by simply terminating the severance plan before terminating the employees. Suffice it to say that an employer’s severance and employee termination plans should be carefully reviewed and discussed prior to the employer filing for bankruptcy protection.