Risks Arising from Subordinating Claims under Deferred Compensation Plans

A recent ruling in the ongoing Lehman Brothers bankruptcy case¹ serves as an important reminder about the risks of deferred compensation.

The ruling, issued by Judge Shelley C. Chapman of the U.S. Bankruptcy Court for the Southern District of New York, involved employee claims for payment of deferred compensation under the Lehman Brothers’ (formerly known as Shearson Lehman Brothers) deferred compensation plan.  The plan provided that employee claims would be subordinate to those of all other present and future creditors of the plan sponsor.  The relevant plan language read as follows:

Employee irrevocably agrees that the obligations of Shearson hereunder with respect to the payment of amounts credited to his deferred compensation account are and shall be subordinate in right of payment and subject to the prior payment or provision for payment in full of all claims of all other present and future creditors of Shearson whose claims are not similarly subordinated.

Although the Lehman employees made several arguments as to why the subordination provision should not apply, the court ultimately found that the plain language of the plan was unambiguous, and as such, the subordination provisions were enforceable.

While it is common – and generally necessary for tax reasons – to provide that participants in a deferred compensation plan will be unsecured creditors of the plan sponsor (and the use of a rabbi trust should not impact that status), the subordination language at issue in the Lehman plan is atypical, and not necessary for tax reasons.  We recommend that sponsors of deferred compensation plans review the plan language to determine whether it contains a subordination provision similar to that included in the Lehman plan. Amendments may be required in cases where subordination of employee claims to those of other unsecured creditors was not intended.

If you have any questions or would like to discuss this further, please do not hesitate to contact your regular contacts in the Executive Compensation and ERISA or Bankruptcy and Restructuring groups.

[1] Giddens v. 344 Individuals (In re Lehman Bros.), 2017 Bankr. LEXIS 1937 (Bankr. S.D.N.Y., July 13, 2017).