Severance Payments To Which an Employee Becomes Entitled Within 180 Days of Bankruptcy Filing Receive Priority Treatment

In Matson v. Alarcon, No. 10-2352, 2011U.S. App. LEXIS 13729 (4th Cir. July 6, 2011), the Fourth Circuit addressed the treatment of an employer’s liability under a severance benefits plan in bankruptcy.  The employer had established a severance benefits plan which entitled employees who were terminated without cause to compensation calculated based on the terminated employee’s length of service.  Simply stated, employees became “participants” in the plan, and thus entitled to compensation under it, upon being terminated without cause, and signing a severance agreement and release. Id. at *2-*3.  The size of the benefit to which a participant was entitled depended on the duration of his service to the employer.  Id.

The employer terminated approximately 125 employees within 180 days of filing its bankruptcy petition.  Id. at *4.  In the subsequent bankruptcy proceedings, the terminated employees asserted that their claims for severance were entitled to priority treatment up to the maximum amount provided under 11 U.S.C. § 507(a)(4).  Id. at *5.  The trustee argued that the former employees “earned” an entitlement to severance pay throughout the course of their employment, and were therefore only entitled to priority treatment for that portion of the severance that was “earned” within the 180 day pre-petition time period.  Id.  The Bankruptcy Court overruled the trustee’s objections to priority treatment, and the trustee’s appeal was certified to the Court of Appeals.  Id. at *6.

            The Fourth Circuit affirmed the Bankruptcy Court, holding that the former employees “earned” the full amount of their severance within the meaning of § 507(a)(4)(A) on the date they became entitled to receive such compensation.  Id. at *13-*14.  Although the amounts of compensation were based on length of service, the Court found that the employees did not “earn” severance compensation over the entire course of their employment.  Id. at *11-*12.  Rather, the Court, examining the “plain and ordinary meaning” of the terms in § 507(a)(4), found that employees do not “earn” severance pay as compensation for services rendered, but instead “earn” severance pay when they become entitled to receive it.  Id. at *9-*10.  Since the employees became entitled to receive severance pay only upon their termination, which was within the 180 day statutory window, priority treatment of the claims up to the statutory maximum was appropriate.  Id. at *10.

In so holding, the Fourth Circuit recognized the existence of potentially inconsistent decisions in the Third, First, and Ninth Circuits.  Id. at *12-*13, (citing In re Roth Am., Inc., 975 F.2d 949 (3d Cir. 1992); In re Mammoth Mart, Inc., 536 F.2d 950 (1st Cir. 1976); In re Health Main. Found., 680 F.2d 619 (9th Cir. 1982)).  Those Courts had held that severance compensation calculated based on length of employment has priority as an administrative expense of the bankruptcy estate “only to the extent that the compensation is based on services provided to the bankruptcy estate after the debtor files for bankruptcy.”  Matson, 2011 U.S. App. LEXIS 13729 at *12-*13.  The Fourth Circuit distinguished the decisions of the First, Third, and Ninth Circuits, explaining that those decisions interpreted 11 U.S.C. § 503(b)(1)(A), which was materially different from 11 U.S.C. § 507(a)(4).  Id. at *13.  Specifically, § 503(b)(1)(A) does not use the word “earned”, does not specifically include “severance pay” as a form of wages, and requires a calculation of the value of the “services rendered” during the relevant time period.  Id.