Section 507(a)(4) Priority For Severance Pay: Fourth Circuit Holds Severance Earned On Termination Date

In a decision filed on July 6, 2011, the Fourth Circuit held that former employees of a debtor "earned" their severance compensation "on the date they became participants in the debtor's severance plan immediately after their termination from employment" rather than over the course of their employment, as argued by the trustee. Matson v. Alarcon, 2011 WL 2624437 at *1, 2011 U.S. App. LEXIS 13729 (4th Cir. July 6, 2011). This memorandum outlines the case and the practical implications for clients facing potential severance compensation claims.

Section 507(a)(4) of the Bankruptcy Code establishes priority for "allowed unsecured claims, but only to the extent of $10,950 [presently $11,725] 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." 11 U.S.C. § 507(a)(4). The issue raised here is how and when an individual earns severance pay for purposes of § 507(a)(4).

Background

LandAmerica Financial Group, Inc. (LandAmerica) filed its bankruptcy petition on November 26, 2008. LandAmerica established a severance benefit plan in April 2004 that entitled employees to receive compensation equal to their weekly salary for a certain number of weeks, based on the employee's length of service to LandAmerica. For example, an employee who worked for more than one year but less than two years received two weeks' pay, while an employee who worked for eight years received six weeks' pay.

LandAmerica terminated Diego Alarcon and 124 other claimants (together, the "claimants") in the 180 days before filing for bankruptcy. The claimants filed proofs of claim and asserted that their severance claims were entitled to priority treatment up to the statutory maximum provided in 11 U.S.C. § 507(a)(4). The LandAmerica Trustee objected to the priority treatment of the severance claims, arguing that severance was "earned" over the entire course of employment and that only the amount of severance "earned" during the pre-petition period was entitled to priority treatment. For example, according to the trustee, an employee who worked a total of 437 weeks (more than eight years, entitled to $8,500 of severance), 22 of which were during the pre-petition period, was entitled to receive priority treatment only for the severance that represented the 22 pre-petition weeks out of the 437 total weeks (5.03%) or $429.31.

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