Bankrupt Firm Can't Recover Severance Paid to Ex-President

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By Diane Davis

Oct. 20 — Severance payments made by a company in bankruptcy to the company's former president as part of his separation agreement were “reasonably equivalent value” such that the company can't avoid or recover them in bankruptcy, the Tenth Circuit held Oct. 15.

Judge Gregory A. Phillips of the U.S. Court of Appeals for the Tenth Circuit affirmed the bankruptcy court's denial of debtor Adam Aircraft Industries, Inc.'s claim for avoidance and recovery under the Bankruptcy Code's fraudulent transfer provisions.

Debtor's President Terminated 

One year after terminating its president/defendant Joseph Walker, Adam Aircraft Industries (AAI) filed for bankruptcy and then sued in bankruptcy court to avoid further transfers to Walker and to recover some transfers previously made to Walker.

AAI's board decided to terminate Walker and replace him with Duncan Koerbel unbeknownst to Walker who ended up giving Koerbel a tour of AAI's facilities the day before he was fired. Because AAI was in the final stages of debt financing with Morgan Stanley and didn't want Walker's termination to cause any drama in the financial markets, the board allowed Walker to resign rather than being terminated.

The board accepted Walker's resignation as president in a telephone meeting, effective Feb. 2, 2007. Walker then negotiated a severance package that included a formal memorandum of understanding and a separation agreement. Walker didn't have an employment agreement with AAI.

Chapter 7 Liquidation 

AAI filed for Chapter 7 liquidation Feb. 15, 2008. Prior to this date, the company paid Walker $105,704 for his aircraft deposit, plus interest, and executed a second separation agreement that now stated that Walker's employment as president was terminated effective March 1, 2007. AAI also paid Walker $100,000 to repurchase his shares of Series F stock, and $250,000 in severance payments over 12 months.

Subsequently, plaintiff/appellant/Chapter 7 trustee Jeffrey A. Weinman sold substantially all of AAI's assets for $10 million, but Walker's post-resignation contracts weren't sold or assigned any value during the sale.

The bankruptcy court denied some of AAI's claims, but allowed AAI to avoid 90 days' worth of monthly severance payments before the petition date totaling $62,500 as ordinary preference to a creditor.

According to the bankruptcy court, Walker ceased begin a “statutory insider” under Section 548(a)(1)(B)(ii)(IV) after Feb. 1, 2007, and Walker didn't fit the definition of a non-statutory insider. The Bankruptcy Code defines an “insider” as an officer, director, or a person in control of a debtor, the court said.

The court also found that Walker gave reasonably equivalent value for the transfers he received from AAI.

The Bankruptcy Appellate Panel affirmed this ruling, and AAI appealed to the Tenth Circuit, arguing that its obligations and transfers to Walker were avoidable under Bankruptcy Code Section 548 because of his insider status or the non-insider portions of Section 548.

According to the Tenth Circuit, five things must be true under Section 548(a)(1) before AAI's transfers to Walker can be avoidable and recoverable: “(1) the transfers of the obligations to undertake them must have been made within two years of the petition date; (2) Walker must have been an insider either when the transfers were negotiated or when the money was paid; (3) the transfers must have been made under an employee contract; (4) AAI must have received less than reasonably equivalent value for the transfers; and (5) the transfers must have been made outside the ordinary course of business.”

The parties agreed that the transfers were made and the obligations incurred within two years of the petition date.

The appeals court found that there was more than enough evidence to support the bankruptcy court's finding that Walker made a “clean break” as an insider as of Feb. 1, 2007. The court also agreed that Walker couldn't qualify as a non-statutory insider.

AAI argued that it did not receive reasonably equivalent value from Walker in return for the obligations it undertook in the MOU and separation agreements.

‘Reasonably Equivalent' Value?

According to the court, “value” under Section 548 means “property, or satisfaction or securing of a present or antecedent debt of the debtor,” and “reasonably equivalent value” asks “whether the debtor has received value that is substantially comparable to the worth of the transferred property.” “Reasonably equivalent” means “approximately equivalent” or “roughly equivalent,” the court said.

AAI contended that Walker provided no value other than the agreement and used his insider leverage to gain severance payments.

The Tenth Circuit rejected AAI's argument, concluding that it did not meet its burden of showing a lack of reasonably equivalent value. The board fired Walker without providing Walker with any notice and under bad circumstances. The court found reasonably equivalent value. According to the court, the board seemed willing to grant Walker's requests in return for noncompetition, goodwill, and waiver of claims, and the court could not see how the board members would have granted Walker's requests for anything less than what they perceived as reasonably equivalent value. The court also noted that AAI wasn't “rolling in cash” when it terminated Walker. In this context, paying Walker 18 months of severance to ensure that his firing didn't disrupt negotiations for $80 million of capital looked like a “pretty good trade,” the court said.

From the undisputed record, the appeals court found that AAI didn't give Walker “free money” but compensated him for money he otherwise could have earned. In return, AAI got the benefit of avoiding a possible lawsuit and a high profile “mess” as it sought outside financing.

Chief Judge Timothy M. Tymkovich and Judge Harris L. Hartz joined the opinion.

Theodore J. Hartl, Lindquist & Vennum, Denver, represented plaintiff/appellant/Chapter 7 Trustee Jeffrey A. Weinman; Thomas H. Blomstrom, Montgomery, Kolodny, Amatuzio & Dusbabek, L.L.P., Denver, represented defendant/appellee Joseph K. Walker.

To contact the reporter on this story: Diane Davis in Washington at

To contact the editor responsible for this story: Jay Horowitz at

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