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By CYRIL TUOHY, managing editor of Risk & Insurance®

AIG executives who take it upon themselves to return their bonuses, rightfully earned or not, would be setting a dangerous precedent.

Certainly, the Financial Products posse deserves to take a hit for selling credit-default swaps knowing full well that the damned things could one day blow up in their faces.

Forcing them to return their bonus isn't the way to do it.

What we're really talking about here is contract law, the importance of legally binding documents and the obligation between two parties to follow the terms of the contracts.

Theses documents were signed 12 months or more before this latest scandal and should so be honored.

If executives want to return the money, more power to them. They will have shown themselves sensitive to many of us less well off, and will have done the U.S. Treasury and the U.S. taxpayer a service.

But under no circumstance should these managers be forced to return the money. For anyone to threaten these executives--indeed any executive or anyone else--with blackmail, as New York Attorney General Andrew Cuomo appeared to be doing in mid-March, is irresponsible.

Not only that, it makes a mockery of contract law.

Perhaps in another industry, there wouldn't be so much at stake. Hey, you modify the terms of a new residential development over a round of golf and everyone walks away and makes up at the 19th hole. No big deal.

Not in insurance. You live and die by the terms of the contract. What in heaven's name do you think insurance is? A promise to pay in the future.

And AIG last year promised to pay these two dozen executives $165 million for staying with the firm. It doesn't really matter if this was a bonus or a "retention" fee to prevent talented managers from jumping ship.

What matters is that both AIG and the executives were party to the terms of the contract, whether it was worth $165,000, $165 million or $165 billion.

Lost in the outrage over the payments is that the $165 million in contractual obligations to the executives amounts to exactly 0.097 percent of the $170 billion in bailout funds paid by taxpayers to prevent AIG's collapse.

Paying these guys leaves a bad taste in everyone's mouths, I agree, but that's why contracts exist?so that one party isn't subject to the personal whims of another. If AIG refused to pay, it would set a ghastly precedent for abrogating the terms of an employment contract, not to mention the torrent of separate breach-of-contract suits that would rain down on an already wounded company.

Andrew Cohen, CBS News' chief legal analyst and legal editor, recently made note of an important distinction in this case.

"Sometimes contractual obligations can be voided if their terms are deemed 'unconscionable' or against 'public policy.' But unconscionable contracts usually involve some great unfairness to one of the parties to the contract. The U.S. is not a party to these contracts." Indeed not, as the contracts were entered into months before the bailout.

No one's pleased with another $165 million going to suits who've already collected millions of dollars as their employer was going down the tubes. But those are the terms of the contract. If you want to change the outcome, you've got to alter the terms.

(Read Senior Editor Dan Reynold's Point on this topic.)

May 1, 2009

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