Could Be Worse: AIG Double Bonus Jeopardy

March 17, 2009— -- When AIG chief executive officer Edward M. Liddy argued that legal obligations made it nearly impossible for the bailed-out firm not to pay $165 million in retention bonuses, critics found it hard to imagine a worse scenario for taxpayers whose money has already been used to keep the company afloat.

But AIG and legal experts agree that, as far as payouts to employees go, it could indeed be worse -- twice as bad, to be exact.

If the crumbling insurance giant didn't make good on its retention packages, employees could sue the firm for at least $330 million -- double the total size of the bonuses.

And, some say, a successful lawsuit could ultimately mean a higher tab for taxpayers, who are already footing the bill for $162.5 billion in rescue loans and investments into AIG from the federal government.

"If our tax dollars are being used to fund these payouts and the payouts end up being double, then we're paying double," said Joshua Hawks-Ladds, the vice chair of the Connecticut Bar Association labor and employment section executive committee.

The potential for a costly lawsuit stems in part from state law in Connecticut, where AIG's now-infamous financial products division -- the arm of the company that employs the 400-some employees awarded the $165 million bonuses -- is based.

In a document submitted by AIG to Treasury Secretary Timothy Geithner, the company argues that were it to renege on contractual agreements to make retention payments -- which were set in early 2008, before the government enacted compensation limits under its Troubled Asset Relief Plan -- the firm could be liable for "double damages and attorneys' fees" under the Connecticut Wage Act.

There "are legal, binding obligations of AIG, and there are serious legal, as well as business, consequences for not paying," Liddy wrote in a recent letter to Geithner.

Lawyers who spoke to ABCNews.com said AIG's concerns are legitimate.

"If we're talking about the possibility of violating the Connecticut or other states' wage act, then there is a real risk that one needs to be concerned about. ... Some of these states are fairly punitive," said Donald P. Carleen, of the law firm Fried, Frank, Harris, Shriver & Jacobson LLP. "For AIG to do what the public seems to want them to do and certainly what Congress would like them to do could in theory expose them to liability."

What Can the Government Do?

It's unclear whether AIG's contracts with employees might allow the firm to attempt to recoup or stop the bonuses, but at this point, it's a decision that might be left up to the federal government, said Randall S. Thomas, a professor of law and business at Vanderbilt University Law School.

"I think the question will be whether or not the federal government has the power to abrogate the contracts irrespective of what the terms of the contracts provide," Thomas said. "I think that comes down to a constitutional argument."

In remarks Monday, President Obama said that he would ask Geithner to "pursue every single legal avenue" to block AIG bonuses.

But the government also appears to be planning for the contingency that blocking the bonuses won't work: The Treasury Department will be making arrangements for AIG to pay the government back for the "excessive retention payments" made to AIG employees, a Treasury official told ABC News.

Meanwhile, New York Attorney General Andrew Cuomo said Monday that he was looking at using New York state law to recoup the bonuses -- something legal experts say will be difficult to do.

Retention in a Time of Uncertainty

Why AIG would provide retention bonuses for employees in the unit blamed for the company's decline -- the company's financial products unit was the one that wrote the credit default swaps that ultimately proved disastrous to AIG -- might be traced back to the early days of the financial crisis.

A source close to AIG told ABC News that AIG believed that the company needed to put retention programs in place for two reasons: When Joe Cassano, chief of the financial products unit, left in early 2008, the company was worried that other employees would follow; and at the time, around $800 million in deferred compensation had been lost, so AIG's employees had not only seen their boss leave, but they'd also lost millions.

Ultimately, the retention program worked: Employees stayed with the company.

Should AIG Employees Stay?

While critics like Rep. Barney Frank, D-Mass., argue that the time has come to fire AIGFP employees, Russell Miller, the managing director of Executive Compensation Advisors, said there may still be reason to retain them.

"The difficulty here is that the same people who got us into this mess, we need them to help us turn it around, and we're doing that with taxpayer dollars," he said.

"We need to develop a plan that recognizes that: 1) this is a legal obligation and 2) these employees are needed to help turn the company around and 3) these employees likely want to continue working at AIG given the current market environment," Miller said.

But former AIG chief executive officer Hank Greenberg argues that retention bonuses should never have been used to entice employees in the first place.

"I know from long experience that you don't retain people by buying them. You don't buy loyalty," said Greenberg, who left the company in 2005.

A company achieves loyalty, he said, when "people believe and share the same values as you do."

With reports from ABC News' Matt Jaffe and Charles Herman.