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Delaware Bankruptcy Court Finds 502(b)(7) Termination Cap Applies to Change in Control Agreements

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On March 26, 2012, Judge Brendan Shannon of the United States Bankruptcy Court for the District of Delaware (the “Court”) reduced the claims of four former executives (the “Executives”) of VeraSun Energy Corp. (“VeraSun” or the “Debtors”) arising from “change in control” agreements (the “CIC Agreements”) for exceeding the 11 U.S.C. 502(b)(7) cap on employment contract termination damages.

In 2007, VeraSun and the Executives had entered into the CIC Agreements guaranteeing the Executives a large cash payment (in some cases up to three times annual salary) if they remained with the company through an impending merger and were subsequently terminated within two years without cause. The Executives continued their employment per the CIC Agreements and VeraSun eventually merged with its target in November, 2007. Less than a year later, severely impacted by the global economic crisis, VeraSun filed for bankruptcy protection in Delaware. The Debtors terminated the Executives during the course of their liquidation proceedings and in each instance less than two years after the merger closed.

The Executives submitted claims against the Debtors for amounts owed under the CIC Agreements. The Debtors’ objected, contending that the claims were on account of damages arising from termination of the Executives’ employment contracts and therefore subject to the “one year’s salary” cap imposed by section 502(b)(7) of the Bankruptcy Code. In response, the Executives argued that the CIC Agreements were separate and apart from their standard employment contracts and that amounts promised under the CIC Agreements were in recognition of consideration and services already received by the Debtors—retention of the Executives through the 2007 merger—not severance-type damages.

The Court agreed with the Debtors. While recognizing that the 502(b)(7) cap applies only to employment contracts, the Court found that the CIC Agreements and the Executives’ employment contracts were integrated based on the fact that the documents, though physically separate, were signed by the same parties and involved identical subject matter. In addition, the Court referred to the fact that the CIC Agreements actually established new terms and conditions by which the continued employment of the Executives was to be governed. Having found the CIC Agreements to be integrated with the Executives’ employment contacts, the Court held that the amounts claimed arose from termination of those employment contracts which were subject to the section 502(b)(7) “one year’s salary” cap.

A copy of the Court’s opinion can be found here.

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