In re Appliedtheory Corp.

Decision Date14 July 2004
Docket NumberNo. 02-11868 (REG).,02-11868 (REG).
Citation312 B.R. 225
PartiesIn re APPLIEDTHEORY CORPORATION, et al., Debtors.
CourtU.S. Bankruptcy Court — Southern District of New York

Angel and Frankel, by Joshua Angel, Esq., Neil Y. Siegel, Esq., New York, NY, Attorneys for Debtors.

Arent Fox Kintner Plotkin & Kahn, PLLC, by Andrew I. Silfen, Esq. (argued), Carol Connor Flowe, Esq., Schuyler G. Carroll, Esq., Leah M. Eisenberg, Esq., New York, NY, for Official Committee of Unsecured Creditors.

Duval & Stachenfeld LLP, by Kirk L. Brett, Esq. (argued), Stephanie K. Hoos, Esq., New York, NY, for Secured Creditors Halifax Fund, L.P., Palladin, Partners I, L.P., Palladin Overseas, Fund Ltd., DeAm Convertible Arbitrage Fund, Ltd., and Lancer Securities (Cayman) Ltd.

Kleinberg, Kaplan, Wolff & Cohen, P.C., by David Parker, Esq., New York, NY Attorneys for Elliott Associates LP and Elliott International LP.

Boylan, Brown, Code, Vigor & Wilson, LLP, by Robert F. Mechur, Esq., (argued) on his own behalf and on behalf of other executives, Rochester, NY, Attorneys for Robert F. Mechur.

DECISION AND ORDER ON EXECUTIVES' MOTION FOR PAYMENT, AS ADMINISTRATIVE EXPENSES, OF "SEVERANCE" PAYMENTS UNDER EMPLOYMENT AGREEMENTS

ROBERT E. GERBER, Bankruptcy Judge.

In this contested matter in the jointly administered chapter 11 cases of AppliedTheory Corporation and its affiliates ("AppliedTheory," or the "Debtors"), five former executives of the Debtors (the "Executives")1 — each of whom had a pre-petition employment contract that was duly rejected by the Debtors — move for payment, as an administrative expense with priority over the Debtors' other creditors, of an aggregate of $2.4 million2 payable to them under their employment contracts upon their departure "with good reason." They rely, in a familiar refrain, on the Second Circuit's 1967 decision in "Straus-Duparquet,"3 and in two other "Act" cases that followed it,4 and on the interval — here approximately six weeks — during which they provided post-petition service before leaving the Debtors' employ, before their employment contracts were rejected.

The Executives' motion is opposed by all of the other creditors who have appeared in the case — by the Official Committee of Unsecured Creditors ("Creditors' Committee"), and by Halifax Fund, L.P., Palladin Partners I, L.P., Palladin Overseas Fund Ltd., DeAm Convertible Arbitrage Fund, Ltd., and Lancer Securities (Cayman) Ltd. (collectively, the "Secured Lenders").5

Upon consideration of the Executives' contentions, the Court concludes, for reasons set forth more fully below, that the requested amounts cannot be awarded for at least three reasons.6 First, and most fundamentally, the Court believes that Straus-Duparquet has no application here, where the claimed entitlement arises from the termination of a pre-petition contract that was duly rejected. Second, the Executives' request fails to pass muster for allowance of an administrative claim, under section 503(b) of the Code and the case law thereunder. And third, assuming that Straus-Duparquet retains vitality under the Code with respect to the factual situation it there addressed, that decision, which authorized payment for severance (and then for only two weeks' pay per employee, an amount which fairly could be said to be "in lieu of notice"), does not apply to claims like these. In contrast to Straus-Duparquet, the Executives here seek payment of multiple years' salary under contracts with most, if not all, of the attributes of a "golden parachute," and assertions that the requested payments are "severance" amount to no more than a play on words — where the claimed entitlements substantially exceed the amount that would have been earned if the employee remained employed; do not turn on length of service; are not in lieu of notice; and would be due even upon the employee's decision to quit. The claims here are not for "severance" of the type that Straus-Duparquet deemed worthy of priority status, and it is distinguishable for that reason.

Accordingly, the objections to payment are sustained. The Executives' claims are disallowed as administrative claims, and will be reclassified as general unsecured claims, without prejudice to the rights of parties in interest with respect to the allowability of those claims, or statutory limits on their amount.7

Facts

Though it is at least probable that a number of matters, if relevant to the determination of this motion, would create material disputed issues of fact, many other facts are undisputed. Without objection, the Court determined to take the Executives' allegations as true for the purposes of this motion, and to treat the objections as a demurrer.

On April 17, 2002 (the "Filing Date"), each of the Debtors filed a voluntary petition for relief under chapter 11 of the Code. The Executives were employed by the Debtors prior to the Filing Date, and remained in the Debtors' employ until June 5, 2002,8 approximately six weeks after the Filing Date, when they ceased rendering services. They performed services including those described below, and their statement as to the work they performed during that time has been taken as true for the purposes of this motion.

On July 10, 2002, about weeks after their departure and 8 weeks after the commencement of the Debtors chapter 11 case, the Executives filed the administrative expense claims which are the subject of this motion, requesting a total of $2.4 million pursuant to their respective employment contracts.9

The Employment Contracts

Each of the Executives was a party to an employment contract with the Debtors, entered into (and with respect to three of the Executives,10 amended one or two times) prior to the Filing Date. Except with respect to the amounts payable thereunder, the contracts did not differ in any respects material to this motion.

As each contract provided, it was entered into "in consideration of the mutual covenants and representations contained herein," after which followed a series of covenants — i.e., promises — each of the two contracting sides made to the other. Like most of the other employment contracts this Court has seen, each provided for certain matters to provide basis for "Termination for Cause" (generally, matters involving the Executive's wrongful conduct or material breach) and for other matters to provide basis for "Termination for Good Reason."11 Each further provided that the Executive would have the right to terminate his employment with the Company for any reason. Each then described the Executive's entitlement if he were dismissed for cause, and the (greater) rights he would have if his employment were terminated without Cause, or if he chose to end it for "Good Reason."

As is apparent from the foregoing, the Executive could have substantial rights even if he left voluntarily, so long as the circumstances surrounding his decision to leave constituted "Good Reason." One of those rights was a substantial payment, pegged to salary, after the Executive's departure. Each contract provided, in its Section 5(a), for payment to the Executive in the event of termination:

Without Cause or for Good Reason. In the event of a termination of the Executive's employment during the Employment Period (i) by the Company other than for "cause" (as provided for in Section 4(a) hereof), (ii) by the Executive for "good reason" (as provided for in Section 4(b) hereof) ... the Company shall pay the Executive and provide him with the following:

(i) Payments. The following payments:

(A) Salary. The Executive's then-current base salary payable for the Non-Compete Period (as defined in Section 8 hereof)12

Under the Executives' employment contracts, the Non-Compete period would last two years for Stroud13 and one year for the others.14 Their contracts further provided that if their employment terminated within one year of a change of control for any reason other than by the Company for "cause," the Non-Compete period would be doubled15i.e., to four years and two years, respectively. Thus the practical effect of those provisions — which had at least most of the trappings of "golden parachutes"16 — was that upon a termination other than for cause, including a voluntary departure by the Executive for "Good Reason", Stroud would receive four year's salary,17 and the other Executives would receive two.18

On February 2, 2001, when a prospective transaction was under discussion that could lead to a change in control of the Debtors, some or all of the contracts were amended to give the affected Executives an even clearer ability to leave their employment voluntarily and still receive the multiple-years' salary. As described by Claimant Stroud in his affidavit:

When the Amendments were entered into, the Executives were attempting to sell the Debtors, at the behest of the Board. Both the Executives and the Board believed it to be likely that any acquirer would terminate, or require the termination of, some or all of the Executives. The Amendments were entered into to induce the Executives to remain in the employ of the Debtors during the effort to sell the Debtors in the face of the possibility of the termination of their employment.19

The February 2 amendment added to the list of circumstances under which the Executive could terminate his employment with Good Reason. Section 4(b), which listed circumstances under which the Executive would have "good reason" to voluntarily terminate his employment, was amended to provide, in relevant part:

In addition to the foregoing, any resignation by Executive from his employment by the Company, whether or not with cause, as to which the Executive gives notice on or after the date six (6) months after, but not later than the first anniversary of, the closing of a transaction resulting in a Change of Control ... shall be deemed to be a termination by Employee of his employment with the Company for "good reason"....20

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