Bankruptcy Pay: Will ‘Stay’ Bonuses Go?

A provision in the new bankruptcy law amendments has companies scurrying to transform executive retention packages into performance-based incentive pay.

The new bankruptcy law, passed last October, makes it harder for companies working through a Chapter 11 reorganization to award executives retention bonuses. But the new law didn’t shut the door on incentive bonuses.

As a result, several bankrupt companies have reworked traditional key employee retention plans (KERPs) into incentive plans. The new models feature performance targets that, if they’re met, are designed to benefit creditors and shareholders. Bankruptcy courts seem to like the new bonus structures.

Since the Bankruptcy Abuse Prevention and Consumer Protection Act went into effect last year, several companies—including Nobex, Calpine, and Plaint—have won U.S. Bankruptcy Court approval for their bonus plans. Next week, another company in Chapter 11, Radnor Holdings, will bring its bonus petition before the U.S. Bankruptcy Court in Delaware. Radnor wants to determine if its proposal, which is tied to asset-sale proceeds, will pass muster.

Meanwhile, another case has debtors rethinking their bonus strategies. On September 5, New York Judge Burton Lifland denied the bonus petition submitted by Dana Corp., saying that its plan failed to qualify as an incentive bonus and that it fell short of the new, more stringent KERP criteria laid out in Section 503(c) of the bankruptcy code.

If the plan had qualified as an incentive bonus, Section 503(c) would have allowed the court to evaluate its merit based on the older, less stringent, “business judgment rule,” according to court documents. That seemed to be the intent of Dana’s attorneys.

Lifland ruled, however, that while Dana had labeled the plan an incentive bonus, it was actually a KERP that paid executives for “staying with the company” rather than tying bonuses to performance goals. In the footnotes of Lifland’s written opinion, the judge wryly noted that if a bonus plan “walks like a duck (KERP) and quacks like a duck (KERP), it’s a duck (KERP).”

Classifying Dana’s plan as a KERP, Lifland evaluated it under the more stringent provisions of Section 503(c). Specifically, the bankruptcy act provision mandates that for a KERP to win approval, the company must provide evidence that: the executive receiving a retention bonus has a legitimate job offer from another company; the executive is essential to the bankrupt company’s survival; and the bonus doesn’t exceed 10 times the amount paid to other employees.

According to court documents, Dana did not meet the evidentiary requirements laid out for retention bonuses the in section. (Dana officials and attorneys representing Dana at Jones Day didn’t return CFO.com calls requesting comment on the case.)

In its petition, Dana characterized its bonuses as incentive pay. But that argument fell flat because the payout would be made “without regard to performance or creditor recovery,” wrote Lifland in his opinion. For example, chief executive Michael Burns would receive a “minimum completion bonus” of $3.1 million, payable when the company emerges from Chapter 11, regardless of the outcome of the case, noted Lifland. “Without tying this portion of the bonus to anything other than staying with the companyÂÂ…this Court cannot categorize a bonus of this size and form as an incentive bonus,” concluded Lifland.

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