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Severance Payment to CEO Deemed Fraudulent Transfer and Uninsurable Under E&O Policy
Insurance Law Update
March 2010
By:
Nina McDonald
Fifth Circuit Court of Appeals
In In re TransTexas Gas Corp., ___ F.3d ___, 2010 WL 447323 (5th Cir. (Tex.) Feb. 10, 2010), the Fifth Circuit Court of Appeals upheld two Southern District Court of Texas opinions that 1) severance payments made to a departing CEO were fraudulent transfers under the Bankruptcy Code and the Texas Uniform Fraudulent Transfer Act, and 2) no coverage existed under an E&O policy for the CEO’s obligation to repay the fraudulent transfers.
Prior to filing for bankruptcy, the Board of Directors for TransTexas Gas Corporation terminated its CEO, John Stanley Sr. Stanley’s employment agreement provided for severance pay of $3 million if he was terminated for reasons other than cause, $1.5 million if he was terminated for cause, and no severance if Stanley voluntarily resigned. Subsequently, the board and Stanley executed a separation agreement whereby Stanley agreed to resign in exchange for a severance payment of $3 million. Stanley was paid more than $2.2 million before TransTexas filed for bankruptcy.
The bankruptcy court held the severance payments to Stanley were both preferential and fraudulent transfers and it ordered Stanley to repay the amounts he had received. On appeal, the district court reversed the bankruptcy court’s holding that the severance payments were preferential transfers but upheld the decision that they were fraudulent transfers and affirmed the order for repayment.
In the bankruptcy proceedings, Stanley was defended subject to a reservation of rights by TransTexas’ insurer, National Union Fire Insurance Company. After the rulings in the bankruptcy proceedings, National Union filed a declaratory judgment action against Stanley seeking a declaration that it had no duty to defend or indemnify Stanley. The court granted National Union’s motion for summary judgment, holding that the bankruptcy court’s order that Stanley must repay the severance payments was not a “loss” under the policy, and even if it were, it fell within the “profit or advantage” exclusion.
The Fifth Circuit upheld the rulings of both district courts. The court found that TransTexas “received less than reasonably equivalent value in exchange for [the severance pay]” under 11 U.S.C. § 548, as there was evidence that good cause existed to terminate Stanley (entitling him to $1.5 million), and evidence Stanley resigned (resulting in no severance). The court further held that Stanley’s severance repayment obligation was not a covered “loss” under the National Union policy because Stanley was never entitled to the severance pay in the first place. His obligation to repay was “a disgorgement of ill-gotten gains and a restitutionary payment,” which was not a covered loss.
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