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 companyÂÂÂ this Court cannot categorize a bonus of this size and form as an incentive bonus,” concluded Lifland.
Lifland also called attention to another bonus package based on Dana’s total enterprise value six months after the company exits bankruptcy protection. Under that plan, Burns would earn an added $6.2 million if Dana’s enterprise value remains at $2.6 billion. He would collect a “minimum completion bonus” of $4.1 million if the total enterprise value drops to $2 billion. The judge, however, held that the enterprise value bonuses are “more or less” guaranteed, which makes the pay plan “more akin to a retention bonus,” subject to the stricter bankruptcy code standards.
Efforts to retain executives through the course of a Chapter 11 reorganization is standard business procedure, and petitions for KERPs are one of the first submissions a debtor makes to a bankruptcy court, says William Lenhart, national director of Business Restructuring Services at BDO Seidman. Because the new law “severely” curbs KERPs, Lenhart expects companies to keep a close watch on which cases are approved and which are rejected.
So far, Nobex, Calpine, and Plaint received approval based on their bonus plans being deemed incentive pay.
At the same time, Lenhart contends, creditors are likely to object to the so-called “showing up” bonus, and will therefore push for bonuses aimed at generating improvements in operating and sales performance and a boost in total enterprise value. But the performance goals “should not be easily attainable,” says Lenhart, who contends that Dana seems to have reworked its incentive bonuses to make targets easy to hit.
Under the stricter legal regime, however, bankrupt companies will have to find a way to hold on to skilled management. A Chapter 11 company is generally worth more to creditors as a going concern than as a collection of liquidated assets, notes William Chipman, a bankruptcy attorney at Edwards, Angell, Palmer, and Dodge. Since “there is twice as much work when a company is in bankruptcy,” keeping good managers in place to help rehabilitate the company and create value for creditors is critical, he says.
What’s more, companies that are restructuring “don’t want key executives poached,” notes bankruptcy attorney Stephen Selbst of McDermott, Will and Emery. “That’s a risk for a company trying to emerge from Chapter 11.”
To mitigate such risk, Selbst predicts that some companies will venue shop before filing a bonus petition. That is, debtor companies will search for a court circuit that has already approved a bonus plan similar to their own. Companies can either choose to declare bankruptcy in the state where they are incorporated, or the state where their principle place of business operates, adds Selbst.