The judge ruled Thursday that the proposed payment to CEO Tom Horton exceeded limits that Congress set for bankruptcy cases in 2005.
The U.S. trustee's office, part of the Department of Justice, had objected to Horton's compensation. Judge Sean Lane declined to approve the payment during a hearing on March 28, but he didn't issue a ruling until Thursday.
Although Lane denied the severance as part of the merger, he left open the possibility of a payment as part of American's final reorganization plan, which has not yet been filed. American Airlines spokesman Mike Trevino said the airline intends to address Horton's compensation that way.
Lane has approved the plan for American Airlines parent AMR Corp. to merge with US Airways Group Inc. in a deal that would create the world's largest airline. The merger is being reviewed by U.S. antitrust regulators.
Under the merger deal, the new company will be called American Airlines but run by US Airways CEO Doug Parker. Horton would serve as chairman for a few months and then leave with a severance of $19.875 million equally divided between cash and stock.
The trustee's office argued that severance payments to insiders such as CEOs can't be more than 10 times the average severance pay for non-management employees.
AMR argued that the limit didn't apply because the payment would be made by the new company formed after AMR emerges from bankruptcy protection.
But Lane called that argument "somewhat of a legal fiction" because the money was Horton's reward for his work at AMR, not at the new company, which will be called American Airlines Group Inc.
AMR also argued that Horton's payoff was similar to payments made to CEOs in other airline mergers. But Lane said the earlier deals - Delta's purchase of Northwest and United's merger with Continental - didn't occur under bankruptcy and its limits on insider severance payments.