It's a Contract!

I was a little floored over the weekend to hear about the inviolability of the AIG executives' contracts, specifically with respect to their bonus clauses. The CEO of the company has apparently told the Government that "our hands are tied," and that they have no choice but to pay. On the advice of outside counsel.

Right. Let's play this out. AIG refuses to pay bonuses. If there's an arbitration clause in the contract, that may be a problem. But let's assume that there's not. That means that the executives would eventually have to sue AIG. AIG says, OK, outside counsel, earn some of that money and devise some affirmative defenses: fraud; unconscionability; contrary to public policy; impossibility of performance. These are just the "law school exam" answers that leap immediately to mind. The executives are now forced to litigate out of their own pockets. Everyone pays their own costs, their own lawyers, and it gets expensive. Let's say that the Government intervenes, in some manner. That complicates the litigation and jacks up the costs to the executives.

AIG doesn't need to "win." It just needs to get past summary judgment. (Which, given it's a contract case, may be difficult.) Because AIG's whole strategy should be to get this case before a jury and have the executives make their case for hundreds of thousands or millions of dollars to a jury of plain folks. Good luck with that. So if AIG can get past summary judgment, it's best play is probably to reach a low-ball settlement with the executives. Maybe the settlement will cover what the executives have already spent litigating the case. Maybe, maybe not.

I think that the "AIG damages its reputation" by refusing to pay and that "AIG will have trouble attracting talent" arguments really shouldn't carry much weight here. As for AIG's reputation, I'm not sure I would lose sleep over that. And are outside counsel advising AIG on legal matters . . . based on how difficult it will be for AIG to hire executives in the future? That isn't how I interpreted the CEO's letter.

My one hesitation is, again, whether there's an arbitration clause. Depending on how its drafted, and a bunch of other legal questions I don't have the energy to explore right now, that might actually bind AIG's hands. Of course, there's always the suspicion that arbitration favors the large corporation; maybe AIG does fine in arbitration, too? But the executives aren't consumers; they are wealthy people with clout. So I just don't know.

Of course, nothing would stop Congress from prohibiting such bonuses being handed out by firms receiving bailout money. Even abrogating the contract terms would be constitutional--the Contract Clause only prohibits states from abrogating contracts, when it applies at all. But I heard Larry Summers of all people say that the Government simply can't abrogate contracts. Sure it can, if it has the will to do so.

Btw, George Will on "This Week" compared this to the mortgage cram-down provisions. Will didn't seem to realize that mortgages are one of the few kinds of contracts that bankruptcy judges can't revise in bankruptcy. So this isn't comparable. Bankruptcy is already about revising the terms of contracts. It would be something for the Government to start abrogating executives' contracts. Because of the politics of the thing, it really is unthinkable. But abrogating contracts outside of bankruptcy--major deal. Abrogating contracts in a bankruptcy--fairly minor change to the law. Now, that's a minor change that mortgage lenders hate. Which is why it's so controversial.

Update: Too busy to follow in detail, but apparently these bonuses are REALLY written into the credit swap deals. So maybe not a simple matter of breach and see.