Tom Horton's Severance is Probably in the Golden Parachute Bag if the Court Applies the Business Judgment Rule Rather Than Section 503(c) of the Bankruptcy Code

The U.S. Trustee in American’s Chapter 11 bankruptcy proceedings is challenging American’s $19.8 million golden parachute for its CEO Tom Horton.  The Trustee contends that the $19.8 million payment is too much under Section 503(c) of the Bankruptcy Code because $19.8 million is more than 10 times the mean severance payment to non-management employees.  American responds that Section 503(c) and its limit on severance payments does not even apply because American – the debtor in the bankruptcy – won’t be paying Horton’s severance.  Rather, the $19.8 million will be paid after the proposed merger between American and US Airways is completed by the new company that will be formed in the merger.   According to American, because Section 503(c) doesn’t apply, the bankruptcy court should defer to the company’s business judgment regarding Horton’s severance.

Section 503(c) of the Bankruptcy Code was Congress’s response in 2005 to outrage over large severance payments to Enron and Worldcom executives while the companies were in bankruptcy and rank and file employees suffered.  It provides that insiders of Chapter 11 debtors should not be paid severance unless (1) the payment is part of a program that is generally applicable to all full-time employees, and (2) the payment is not greater than 10 times the mean severance pay for non-management employees that year.  It is a rare exception to the general rule, called the business judgment rule, that courts defer to the decisions of company boards about all sorts of intra-company issues, including executive compensation. 

Under the business judgment rule, courts will not disturb decisions made in good faith by disinterested board members – that is, members having no personal stake in the decision.  Therefore, if the bankruptcy court agrees with American that Section 503(c) does not apply, then Horton’s golden parachute is likely in the bag.      

• Bankruptcy
• Change-in-Control Provisions
• Executive Compensation