Is AIG Insolvent?

Apparently just about every law professor in the country had the same reaction I did upon reading that the AIG bonuses were paid because the contracts were binding, a reaction that can probably be summed up as: “What??” As a profession, we have been blogging up a storm. Several professors contributed to a New York Times forum on disputing the bonuses via contract law. Larry Tribe chimed in at the Atlantic on whether a 100 percent, retroactive bonus tax would be constitutional. (Surprisingly, the answer is a qualified yes.) At the risk of having only a hammer and thinking the bonus problem looks like a nail, I thought it was time to contribute my two cents on the applicability of fraudulent conveyance law. To be fair, Andrew Cuomo had the same idea, and his opinion has a bit more weight than mine.

A quick look reveals that New York has a pretty standard fraudulent transfer statute. Despite the use of the word “fraudulent” in the title, actual fraud is not required. Cuomo will just have to show that AIG was insolvent at the time of the payments and that it did not receive fair value for its money. How much value AIG received in exchange for these bonuses is a little tricky because the employees presumably did show up for work on a daily basis. Do we look at whether they literally did the work specified in their contracts, or can we examine whether their services provided any value after taking into account the damage they caused the company?

The insolvency question is even more difficult. As a matter of common sense, if the government is spending billions of dollars rescuing a company, it darn well better be insolvent. But on a literal level, we bailed out AIG for the precise purpose of preventing it from becoming insolvent. One standard test for insolvency (which New York uses a version of) is whether the entity can pay its debts as they come due. AIG is able to pay its debts, but only because it received bailout funds – and the reason it got that money was because the government was afraid it couldn’t pay its debts without it. The problem becomes almost circular because fraudulent conveyance law wasn’t written with bailouts in mind. It doesn't address the position of a company that would have been insolvent if the government hadn’t stepped in. As Adam Levitin pointed out on Credit Slips yesterday, there are about a million things Congress could have done to prevent this when it authorized the bailouts, but as it is, we’re stuck applying ordinary laws to an extraordinary situation.

By the way, I agree with Adam that undoing the AIG bonuses is much less important than sensibly re-regulating the financial industry and helping ordinary people weather the storm, but I still think there are important symbolic reasons for going after the bonus payments. Plus, maybe all this populist rage will finally push Congress into action on some important reforms to help people not in line for bonus payments – like the primary-residence cramdown bill.

Comments

[Fu]

>How much value AIG received in exchange for these bonuses is a little tricky because
> the employees presumably did show up for work on a daily basis.

Come on... be serious... Were the bonuses based on how many days the employees showed up at work?

[drscroogemcduck]

my understanding is sometimes bonuses are basically float money. instead of getting your salary every week/month the company holds onto a part of your salary until the end of the year. this is pretty good for financial companies because they can invest that money and there is some disincentive for employees to blow up the company because they will lose part of their salary. if the bonuses that were paid out were float then it is probably fair for them to be paid :) of course this all could have been avoided if the government didn't bail out AIG. if they wanted to stop the dominos falling then they could have just promised to make all counterparties whole.

[Sigmund]

I worry less about the bonuses than I do the fact that huge number of CDS contracts were written and the contracts were apparently not hedged, nor were reserves established nor did AIG have sufficient capital to honor the contracts in the event they came due. It is my understanding that the willful sale of the contracts in the absence of the ability to honor the contracts is at the least a tort and probably a felony. When is the Justice Department going to act?

[Independent Accountant]

I've been saying AIG is insolvent since November. I've done preference searches and the like in bankruptcies. Proving AIG's insolvency can be done through "retrojection". After getting $173 billion in federal bailout money it should be simple.

[killben]

Check this out ...

http://money.cnn.com/2009/03/18/news/companies/aig_hearing/index.htm?postversion=2009031812

"We have to continue managing our business as a business -- taking account of the cold realities of competition," Liddy will tell the House Financial Services subcommittee.

"Because of this, and because of certain legal obligations, AIG has recently made a set of compensation payments, some of which I find distasteful," Liddy added

What do you call Liddy "A politically correct (knows the meaning of distasteful) but SHAMELESS CEO"

What is the cold reality of competition Liddy is talking about .. that AIG is insolvent and file for bankruptcy and competition will pick up some of its pieces??

"We have to continue managing our business as a business"

Yeah .. squander money and start begging for help!!

After all when dumb suckers(tax-payers) are there to stick it up, Bailout Bandits can have a ball!!

[Pitt Jones]

I am very unimpressed by the "contractually binding" argument for several reasons: 1) the fraudulent conveyance argument in the primary post; 2)the fact that the bonuses were undoubtedly based upon inherently, if not fraudulently, flawed financial statements; and 3) most practically, the incredibly "tin eared" aspect of it from a political and moral standpoint. I would say to them--we're not paying the bonuses, times have changed, we have obligations to the taxpayers that we didn't have when the contracts were made, we have serious doubts about the enforceability of the contracts, we are deeply concerned that they are based upon faulty financial data, and we cannot defend paying extra money to those who contributed to the current collapse. If you disagree, stand up, identify yourself and sue us; be ready to defend all of the above and, remember, literally everything that you have done to deserve your bonus is discoverable. If you're right, you'll get your money. If you decide to leave instead, the market is full of people right now who can do your job as well or better than you.

[Gregman2]

AIG has long been insolvent. We bailed to avoid a domino cascade. The sad part is--as Hank Greenberg said on Charlie Rose--AIG's insurance companies are still healthy. Unwind the criminal hedge fund (and penalize its counterparties, who are actually accessories to this giant fraud.

[Christopher Coccio]

I like Jones' (Pitt's?) idea. Especially if Congress or the House could intervene legislatively. Perhaps they could vote to provide AIG with an amount of money and attach conditions to that money and any previous bailout money, giving management cover (and an ironclad directive) to rescind the bonuses. I am not a lawyer, but surely there is some way congress can legislate these contracts when one of the parties is receiving government money.

At any rate, Liddy's excuse don't ring true. AIG is an insurance company. It's their fiduciary duty to withhold money from the people they owe it to.

[anon]

It bears noting that, even without the excise tax, the government takes back something around 39.6% of the bonuses, meaning that the government's net harm from the bonuses is more like $100mm. If AIG is solvent at the end of the day, the other stockholders would bear 20% of that as well.

Not to be dismissed but there are far larger mistakes going on in the federal budget that get nowhere near the proportionate attention (e.g., although housing affordability is the best it's been in 40 years, and we are spending hundreds of billions to promote lower mortgages and avoid foreclosures, all to prop UP housing prices, the HUD budget has $5.5B budgeted for programs to "promote housing affordability"). The media and the average politician are doing a terrible disservice to the population in their ignorant ability to analyze quantitative subjects.