Priority Treatment of Employee Severance Compensation Claims

(Excerpt) When a bankrupt company terminates employees, those former employees often have claims against the estate for severance compensation. Sections 507(a) and 503(b)(1)(A) of the Bankruptcy Code provide for the priority treatment of such claims. Those sections apply to claims arising both pre-petition and post-petition. In the pre-petition context, courts must determine if a claim was earned within the pre-petition period prescribed by section 507(a)(4). For post-petition claims, whether such claims are given administrative expense priority for the full amount claimed turns on courts’ analysis of when the claims were earned, when services were rendered, and if and when the employer benefited. Most courts have granted priority to only a pro-rated portion of post-petition severance claims, whereas the Fourth Circuit recently granted priority to the full amount of similar claims that arose pre-petition. The key consideration in most of these cases turned on when the employee became entitled to payment. When employees render services pre-petition, most circuits have ruled that those employees became entitled to payment pre-petition. Accordingly, those circuits have pro-rated the claims to grant priority treatment to only the post-petition portion. Part I of this memorandum outlines priority treatment of claims in section 507(a) and the allowance of administrative expenses under section 503(b)(1)(A) of the Bankruptcy Code. Part II discusses two groups of cases: cases that grant priority for the full amount of severance claims and cases that do not allow priority or allow it for only a portion of the claim. Part III examines the differences in the approaches of the courts in each group of cases based on the types of claims at issue. Part III also predicts how those other circuits might handle pre-petition claims for severance compensation, based on the trends in the circuit courts’ reasoning in cases of post-petition claims