Home  »  [AIG Bonus] Contracts Are Made To Be Broken — Or Are They?

[AIG Bonus] Contracts Are Made To Be Broken — Or Are They?

“I expect you to be honest, hard working, and treat the company as if you own it.”
– C.V. Starr

“AIG’s ongoing efforts to be an outstanding corporate citizen and promote responsible and sustainable business practices are essential to our long-term business objective of creating value for our shareholders and serving the interests of our clients.”

“Honoring contractual commitments is at the heart of what we do in
the insurance business. I cannot have our clients lose faith in our desire and ability to do just that.”

– Quoting: AIG founder C.V. Starr in “Delivering on Our Commitments” section of AIG Employee Code of Conduct ; AIG Corporate Responsibility Statement ; and AIG CEO Ed Liddy’s March 14, 2009, Letter to Treasury Secretary Geithner, respectively.

We have earlier participated in the debate over Wall Street bonuses, including providing a forum for views sympathetic to the bonus recipients and warning against assuming they’re all undeserving millionaires responsible for causing the financial crisis.

The current controversy over the AIG bonuses finds us squarely joining what appears to be the vast majority of the public — and politicians of all stripes — in condemning outrageous waste of taxpayer bailout dollars.

Of course, much has been written about these bonuses — and more will be written daily as the situation continues to play out. Our angle today is the validity of the “but we have binding contracts” position taken by AIG and the obligations employer have to pay employees as agreed.

Is Contract Law As Simple As “A Deal’s A Deal”? Hardly.

Just the other day, as I puzzled over a challenging issue in a lawsuit, I made the offhand remark that although contract law seems very fixed and doctrinaire, creative lawyers and judges can always mold it to support the right result in a given case.

Little did I know how soon that thought would occur to me again in connection with a hot national news story. I’m not sure to what extent my conclusion about the malleability of contract law is my own and to what extent I owe it to my first-year contracts course in law school with Indiana’s legendary Harry Pratter.

It was just an off-the-cuff thought I had that there must be a way to avoid or invalidate payment of the AIG bonuses — as there seems to always be a contract theory available to avoid gross injustice perpetrated through application of a contract.

But I wasn’t sure what opinions would be expressed by academic lawyers and others treating the subject with deeper thought. Thus, I was pleased to see that the NY Times.com Room for Debate Blog put this very question to a panel of experts.

Before a brief summary of the experts’ opinions, which I read as largely affirming my general attitude, but in more detail, here are a few key facts:

Minting Millionaires by the Dozens

  • NY Attorney General Cuomo wrote: “A.I.G. made more than 73 millionaires in the unit which lost so much money that it brought the firm to its knees, forcing a taxpayer bailout.”
    • The highest bonus was $6.4 million, and six others exceeded $4 million.

    • Fifteen others were over $2 million, and 51 between $1 million and $2 million.

    • Cuomo is considering applying fraudulent conveyance law. His theory would be that AIG was undercapitalized and the people who received bonuses did not earn them.
  • Eleven recipients of “retention” bonuses of $1 million or more don’t require retention — they’ve already left the firm.

    • UPDATE/SCOOP

    Findlaw’s scoop: the AIG retention contract itself.

    Most commentators and politicians sound like they haven’t seen the executive retention bonus contract itself. But Findlaw maintains a large online reference library of corporate documents for lawyers’ use in drafting.

    Many major corporations contribute documents, on a give-and-get-back basis, so perhaps AIG submitted this one before there was a whiff of controversy (well, clearly there should have been a foul odor, but the millionaire class has been remarkably out-of-touch, used to living in the 1980-2008 New Gilded Age, which is most decidedly OVER!). Or perhaps it was leaked.

    In any event, it looks like there are exceptions that may apply to at least some individuals: resignation or termination for cause (defined to include fraud, dishonesty, gross negligence, and violation of AIG Code of Conduct).

    Some bonus recipients have already left AIG, so they either resigned or were terminated, perhaps for cause; others may have committed acts allowing terminating for cause, though doing so may or may not be worth saving the money, depending on the value of their institutional knowledge to unraveling the AIG mess.

    Contract Law Experts Speak

    Tom Baker of the University of Pennsylvania Law School:

    Contracts get repudiated, renegotiated, modified, delayed, worked out, managed … all the time. A.I.G. knows this. Its insurance businesses pioneered the use of commercial leverage to get people to accept less than what the contract supposedly required.

    Coming from A.I.G., the contract defense was a gilt-edged invitation for the government to push back, to exercise the bare-knuckled power of the deal that A.I.G. surely would exercise if the shoe were on the other foot.

    Our system requires a balance between “the sanctity of contract” and that “bare-knuckled approach.” I’d like to see it closer to the former, but having been involved in litigation for over twenty years I’m not naive about the fact that the reality is more “bare-knuckled” and “hardball.”

    It’s certainly true that some of the companies and individuals most single-mindedly driven by short-term profit — such as those at the heart of the present crisis — often lean in the “bare-knuckled” direction, and giving it back to them seems perfectly appropriate here.

    Charles Fried of Harvard Law School:

    Since the alternative to the government bailout would have been bankruptcy with a resulting abrogation of these bonus promises along with other contractual obligations, was management remiss in not pressing for a renegotiation and were any of the recipients themselves involved in a self-dealing way in deciding not to renegotiate? And most pertinently, as these bonuses appear to have been related to performance of services, is it clear that the recipients faithfully performed the services for which they were being compensated?

    Good questions all. I like the “bankruptcy is the alternative to a negotiated reduction” approach. But don’t make that threat unless you’re prepared to follow through on it.

    Frank Snyder of Texas Wesleyan University, dissenting:

    I don’t think there’s much chance of using contract law to get the money back from the employees. If some … were personally involved in causing the failure …, courts might allow recovery based on the equitable principle that no one should profit by his own wrongdoing. But most … weren’t the ones who led the ship onto the rocks.

    [T]he taxpayers still might get repaid. If A.I.G. turns around, the government will probably demand payment of all of the bonus money from A.I.G. … If the A.I.G. directors violated their duty of loyalty in approving these bonuses, then A.I.G. shareholders can sue them to get reimbursed.

    While I think he’s being too fatalistic about the creative contract law options, he makes a good point at the end: the money wasn’t a gift to AIG, was it? However they choose to spend federal aid, as long as it doesn’t prevent them from getting their act together and eventually making repayment, perhaps we taxpayers should be patient? (Not as if they’ve exactly earned our confidence in their business acumen!)

    Glenn Greenwald, former constitutional lawyer and columnist at Salon.com:

    As any lawyer knows, there are few things more common — or easier — than finding legal arguments that call into question the meaning and validity of contracts. Every day, America’s commercial courts are filled with litigations between parties to seemingly clear-cut agreements. Particularly in circumstances as extreme as those prevailing at A.I.G., there are arguments and legal strategies that any lawyer would immediately recognize that bestow A.I.G. with leverage either to be able to avoid these dubious payments or, at the very least, force substantial concessions.

    The consensus of this “panel” surely is that the “we’re bound by contract” line is way too passive and uncreative.

    James P. Tuthill, lawyer and lecturer at UC-Berkeley law school:

    Every first-year law student learns that a court can invalidate a contract’s “unconscionable” terms, rescind it or reform it. If these bonus contracts benefiting the very people who have destroyed incalculable amounts of wealth in the pursuit of their own personal greed don’t warrant revision, rescission or reformation, then our legal system is seriously deficient.

    A.I.G.’s argument is that it had to agree to these bonuses to retain the “best and brightest talent.” But how can these executives be the best and brightest talent when shareholders have been wiped out, bondholders have incurred substantial losses and the American taxpayer has pumped $170 billion into the company?
    ***
    If we can’t find a way to void these egregious payments and recoup them, then we have a more serious problem because our legal system has grievously failed us by rewarding those who have wrought this economic destruction. Such a systemic failure will destroy confidence in our entire legal system.

    Public confidence in the entire legal system is already poor.

    Successful use of the system to achieve what is clearly the right result here, through contract law or by taxing away the bonuses, or any other creative ideas, might actually restore some confidence in lawyers and/or elected officials as the “good guys.”

    Nonpayment of bonuses is clearly the right result here

    Deborah W. Post, interim associate dean for academic affairs at Touro Law School, and co-president of Society of American Law Teachers:

    Ask G.M. Union Workers About Binding Contracts

    If the union workers at General Motors agreed to give up or modify their expectations, there is no reason the management at A.I.G. cannot be asked to do the same. There is nothing in the law that would prevent this. Intervention by the federal government should not be necessary. It is simply a matter of good business judgment.

    This comment gets at the socioeconomic heart of the issue: With each passing day of economic downturn and financial crisis, we as a nation are having class divisions rubbed in our faces — and widened.

    One danger is that the outcome will be bad economic policy based too much on emotional populism and too little on supporting the entrepreneurship and investment that creates jobs.

    And Finally: My Favorite Soundbite from the Comments

    As these erudite, knowledgable lawyer/writers above have said there are numerous arguments to be made and nobody is better at avoiding payments than insurance companies.

    Indeed, having studied some insurance contracts pretty closely back in the day, and worked on plenty of employment contracts in more recent years, I would be quite surprised if these compensation agreements didn’t have some good exclusions and exceptions built in. Who’s ever hear of an insurance contract that didn’t have those?

    UPDATE: Steven M. Davidoff, University of Connecticut School of Law:

    The contract … appears as inviolable as it states. Of course, this is not to say that it cannot be broken some other way, such as through bankruptcy, taxation or perhaps legislation. And there are many contract doctrines that allow for abrogation of contracts that might apply here. …

    But … we may not even want to do that as we need these people. Of course, this contract should have been better written to align pay with going-forward performance … This leads to my final point:

    This was not a boilerplate contract. Rather, it was highly negotiated… to pay retention fees at high levels without regard to performance. This … makes me wonder: perhaps one area of direction here should be actually looking at [is] who negotiated this and why?

    It strikes me that the A.I.G. financial products division received an unbelievably sweet deal. Did its managers slip it under the radar? Did the managers act in good faith? And who at A.I.G. signed off on this and did they focus on the risks and rewards? Yet more avenues for possible litigation.

    But of course, this is all merely a diversion for what should be the main focus: Where did the $170 billion go that taxpayers spent on A.I.G and why, and what we are going to do with A.I.G. going forward?

    Sources/Further Reading

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Posted by George Lenard on March 18, 2009

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