Alliance Bioenergy: 502(b)(7) “Claim-Cap” Limits Payouts under all Employment Contracts

By: Joseph Gusmano

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff Member

            In In Re Alliance Bioenergy Plus, Inc., a bankruptcy court in Florida held that a terminated employee’s claims for future base pay and discretionary annual bonuses are capped under title 11 of the United States Code (the “Bankruptcy Code”), regardless of whether he qualified as a “key-executive.”[1] According to his employment agreement with Alliance Bioenergy Plus (“Alliance”), Dennis Lenaburg (“Lenaburg”), the controller of Alliance, would be entitled to a quarterly bonus of no less than $5,000 if Alliance was current in its reports to the Securities and Exchange Commission (“SEC”).[2] The agreement further provided that Lenaburg would be eligible for a discretionary target incentive compensation between 20% and 70% of base salary subject to approval by Alliance’s compensation committee.[3] Lenaburg was terminated by Alliance months after executing a five-year contract extension that was due to end in 2027.[4]

            Immediately after his termination, Lenaburg filed suit in Florida state court against Alliance seeking damages for all amounts due under the employment contract. This suit was stayed following Alliance’s Chapter 11 filing with the United States Bankruptcy Court for the Southern District of Florida.[5] Lenaburg then filed a proof of claim with the bankruptcy court, in which he asserted a claim for future base pay and  discretionary bonuses.[6] Alliance responded by filing a motion for summary judgment with the bankruptcy court on Lenaburg’s claim for damages under his employment contract, arguing that, pursuant to Section 502(b)(2) of the Bankruptcy Code, Lenaburg’s potential damages under his employment contract should be capped because “such claim exceeds the compensation provided by such contract . . . for one year following the date on which the employer directed the employee to terminate . . . performance under such contract.”[7] In opposition to Alliance's motion, Lenaburg argued that Section 502(b)(7)’s claim cap was designed to apply only to key-executives who managed to negotiate contracts with very beneficial terms.[8] The bankruptcy court disagreed with Lenaburg, instead finding: (1) that no precedent supported Lenaburg's proposition that Section 507(b)(7) applied only to key-executives; and (2) that Lenaburg's sole cited authority did not even stand for Lenaburg's proposed interpretation of Section 507(b)(7)'s claim cap.[9] The bankruptcy court then proceeded to grant partial summary judgment, limiting Alliance's potential liability to $278,916.30; this was an immense savings considering Lenaburg's original claim for $2,652,774 plus an "unknown" value of stock warrants.[10]

            Section 502(b)(7)’s claim cap has two requirements. First, the claim must be that of an employee. Second, the claim must be for damages resulting from the termination of an employment contract.[11] Various courts have stated that Section 502(b)(7) was designed to limit the claims of key executives who had been able to negotiate contracts with very beneficial terms.[12] One purpose of Section 502(b)(7) was to relieve bankrupt employers of the continuing duty to pay high salaries to officers who had been able to exact favorable contract terms while the employer was prospering.[13]

            The Alliance decision clarifies the reasonable expectations for both employers and employees when dealing with unpaid employment contracts in bankruptcy court. Unlike prior courts, which have hinted that § 502(b)(7) was designed to afford insolvent firms the opportunity to limit claims of top executives,[14] the Alliance court explicitly held that the claim-cap applies to all employment contracts, therefore limiting potential payouts under all employment contracts.