Insolvency proceedings and compensation under a senior management contract

Senior management contracts are subject to special regulations. In the article ‘The Dismissal of a Senior Manager’, we discussed this category of staff and the compensation to which they are entitled, but there is one scenario that can affect this compensation: the company’s insolvency proceedings. As lawyers specialising in senior management contracts, we have encountered this situation and wish to analyse it to explain what happens in such cases: Is the full severance pay paid out? Can the insolvency judge reduce it? We look at this below.

The general rule for employment contracts in a company entering insolvency proceedings is that they do not automatically terminate; this also applies to senior management contracts. As mentioned earlier, senior managers are subject to specific regulations, and the general legislation (Workers’ Statute) only applies when the specific regulations refer to it.

What happens to a senior management contract in the event of insolvency proceedings?

You may find yourself in a situation where you are a senior manager of a company that has filed for insolvency. In such cases, the treatment of senior management contracts is governed by sections 186 et seq. of the Insolvency Act, and several outcomes are possible:

• The insolvency administrators may decide, either on their own initiative or at the request of the insolvent company, to terminate or suspend the senior management contracts.
• The senior manager, faced with suspension, may opt for termination with one month’s notice.

In these two cases, the compensation agreed in favour of the senior manager may:

• If the insolvency administrators opt to terminate the contract, the judge handling the insolvency proceedings may determine the compensation due to the senior manager, and the amount agreed in the contract shall be set aside, subject to the limit on compensation established by the Workers’ Statute for collective redundancies.
• If it is the senior executive who opts for the termination of the contract, they shall be entitled to the same compensation as indicated in the previous paragraph.

Furthermore, the insolvency administrator may request the judge to defer payment of the senior executive’s compensation until the judgment classifying the insolvency proceedings becomes final.

What happens to severance clauses in senior management contracts in the event of insolvency proceedings?

It is common for senior management contracts to include so-called severance clauses, which provide for substantial compensation in the event of the senior manager’s dismissal. If the company where the senior executive works enters into insolvency proceedings, paying such compensation could entail a significant financial cost for the company and be detrimental to the other creditors in the proceedings, including the rest of the employees. For this reason, the Insolvency Act provides for the possibility of a judge reducing the compensation arising from severance clauses.

By how much is the severance pay reduced?

As we have seen, the Insolvency Act does not specify anything regarding the amount by which a senior manager’s severance pay may be reduced, so the judge may decide independently how much it will be reduced. The most appropriate course of action would be to reduce the severance pay and apply the provisions of the Royal Decree relating to senior management, which sets the amount at seven months’ salary per year of service, capped at six months’ salary.

However, the Insolvency Act sets a limit, namely the severance pay established in labour legislation for collective redundancies, which will act as a minimum cap on severance pay, amounting to twenty days’ pay per year worked; periods of employment of less than one year will be pro-rated on a monthly basis, up to a maximum of twelve months.

Can a claim be made against the reduction in severance pay?

Insolvency law does not specifically address this, but in practice it is possible, as there is a procedure for bringing an insolvency-related claim in labour matters. In this case, a claim could be made against the reduction in severance pay for the senior executive decided by the insolvency judge.

What happens if a senior executive is responsible for the company’s insolvency?

Another possibility is that the senior executive themselves may have caused or contributed to the financial difficulties that led to the company being declared insolvent. For this reason, the Insolvency Act provides for the possibility of deferring payment of the compensation that the insolvency judge may award until the judgment classifying the insolvency proceedings becomes final. In other words, a request may be made to defer payment of the initial compensation until it is established whether the insolvency is a culpable one. This provision exists because, if the insolvency is culpable, there may be individuals who are complicit (such as a director whose actions contributed to the company’s financial difficulties). In such cases, they may forfeit any rights they held as insolvency creditors or as part of the estate and will be obliged to return any assets or rights they have received unjustly from the company’s assets. Furthermore, they may be held liable for damages caused.

Therefore, in conclusion, a senior executive may find that their employment contract is suspended or terminated in the event of insolvency proceedings, and that the agreed severance pay (the ‘contractual protection’) is reduced, or even suspended, until a ruling is issued determining whether the insolvency proceedings are culpable or not.

As a result of all the above, if you are a senior executive and your company enters into insolvency proceedings, it is essential that you seek advice from lawyers specialising in senior management contracts to find out what happens to your contract and the severance pay to which you are entitled.