AIRA Newsletter

Andrew Carnegie once commented, “Take away my factories, my plants; take away my railroads, my ships, my transportation, take away my money; strip me of all of these but leave me my key people, and in two or three years, I will have them all again.” Although Carnegie’s death came almost a century ago, his words still resound true for many floundering businesses. Corporations filing Chapter 11 constantly search for ways to retain their key employees during a thankless time of scrutiny, stress, and insecurity.

Retention bonuses, also known as pay-to-stay bonuses, have become common practice since the early 1990's and have been heralded by courts, debtors, and creditors alike as an important and useful way to help reorganization by maintaining those most valuable employees.¹ Following a corporation’s filing for Chapter 11 protection, key employees, generally executive and top-level management, are considered likely to leave for more secure and less stressful opportunities in the face of uncertainty.² Debtors argue that retention plans for key employees are essential to help alleviate employees’ fears, reward employees for hard work and dedication, prevent the exodus of critical employees, and save the cost of replacing key employees.³

Bankruptcy courts have agreed with this reasoning for years, and judges have used their judicial discretion to liberally award such retention plans.⁴ In order for a court to approve a plan, a debtor must use proper business judgment in formulating the program, and the court must find the program to be reasonable and fair.⁵

This two-pronged test has been construed loosely by judges. Yet case law in the last few years shows a gradual trend towards stricter scrutiny of proposed retention plans. Until recently, such requests for Key Employee Retention Plans (KERP) rarely encountered obstacles or criticism. However, in the wake of numerous high profile bankruptcy filings, people are becoming increasingly aggressive in questioning these plans.

Not surprisingly, this comes on the heels of bankrupt corporations requesting increasingly greater and more extensive bonuses. Many executives now expect such large bonuses before a corporation has even filed for Chapter 11 protection. And in a time where mega-bankruptcies are in the public spotlight daily, creditors, non-managerial workers, the general public, and the courts are becoming less and less tolerant towards a policy that debtors are leaning on more and more.

Bankruptcy Law Daily recently reported that lawmakers are questioning Enron’s tactic of paying $55.5 million in bonuses while undergoing Chapter 11 reorganization. “As the use of bonuses spreads, detractors are opposing the size of the awards and the message these awards send employees facing layoffs and reduced benefits.⁶

The practice of an executive having his or her salary increased, sometimes by up to 200% solely because the corporation files for bankruptcy, even when such an employee had no intentions of leaving the corporation, seems absurd to many. “In an enterprise where catastrophic amounts of money were lost, the notion that people should have to be compensated over and above what they were already getting is offensive.⁷

Even though there is generally no connection between the amount of retention bonuses for key executives and funds that would otherwise be awarded to lower level employees,⁸ perception and morale are affected. Unions and workers have become significantly more vocal on this issue, and the general public is paying closer attention.

Similar criticism is heard more frequently than ever from large unions. As bankrupt United Airlines seeks to retain a second round of critical professionals from leaving the corporation, the Association of Flight Attendants (AFA), who have endured pay cuts and ongoing fear of cutbacks, fight to prevent such bonuses from being approved.⁹ At the time this article was written, the AFA was waiting for a response from the bankruptcy court on the objection they filed against the proposed bonuses. A similar previous objection raised for the initial bonuses of over $20 million was unsuccessful.¹⁰

When Weirton Steel Corp filed for Chapter 11, the Independent Steelworkers Union immediately approached CEO John Walker to ask him to renounce any potential retention bonuses for top-level executives. Weirton Steel Spokesman Gregg Warren stated publicly, “Since the day we filed in court, Mr. Walker has no intention of accepting a retention bonus. Management is focused on a successful strategy to reorganize and emerge from bankruptcy, not bonuses.¹¹

The Unions are not the only group to challenge these sometimes excessive retention plans. Politicians in Washington have also become more aware and involved. When Enron executives were awarded lavish bonuses after filing for Chapter 11 in 2001, eyebrows were raised. “It seems to me there is something wrong when even a company in a troubled state or a failing state, that they have to use large amounts of money to hold onto people that they ought to be able to hold onto some other way” stated House Minority Leader Richard Gephardt (D-Mo)¹².

Nothing in the Bankruptcy law specifically provides for the approval of retention bonuses. Courts generally base their decisions on Bankruptcy statutes 11 U.S.C.A § 363(b)¹³ and 11 U.S.C.A. § 105(a)¹⁴. This, however, could potentially change in the near future. The U. S. House of Representatives recently passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2003 (H.R. 975). Although the bill is geared towards consumers and small businesses, an amendment was also passed, which places limits on retention bonuses to employees of companies filing for bankruptcy. It would allow a court to approve bonuses only when it finds that the employee has a job offer from another business at the same or greater rate of compensation.¹⁵ The bill now awaits a vote in the Senate.

If passed, this measure could considerably change corporations’ ability to receive court approval for retention bonuses. Judges may be faced with limited discretion to award such bonuses, and will be forced to look more closely at the evidence and reasoning of the corporation’s decisions. In turn, bankrupt corporations, and their attorneys and financial advisors will have less flexibility in trying to retain key employees through bonuses many consider a “necessary evil”.¹⁶ It may cause greater exodus of employees, further hindering the restructuring of a struggling company. It may also help prevent some serious abuses that have been arising under the current system.

Regardless of whether this or similar legislation passes, corporations filing for Chapter 11 should consider the backlash of these retention plans from unions, courts, and the general public. Creditors too, although not yet creating large resistance to employee bonuses, are likely not far behind.

A useful measure of a KERP’s reasonableness is to compare these bonuses and salaries to those of employees with similar skill sets and job descriptions from non-bankrupt corporations of similar size and industry. When an executive from a bankrupt corporation receives significantly more than he or she would if the company had not filed for Chapter 11, it can only create suspicion and resentment among other groups. Yet where a reasonable employee incentive is one step towards a successful reorganization, such incentives must be considered.

Perhaps Carnegie was right. Retaining crucial members of a corporate team, even while reducing equipment and downsizing other personnel, may be a large part of the solution of rebuilding. But corporate integrity and responsibility must be maintained at the same time if successful reorganization is to be accomplished.

Steven J. Solomon is a shareholder with the law firm of Adorno & Yoss in Miami, Florida, specializing in Bankruptcy and Creditors’ Rights. Steven can be reached at ssolomon@adorno.com. Sara Fain is a law clerk at the law firm of Adorno & Yoss and a second year law student at the University of Miami.

Footnotes -

¹ A. Mechele Dickerson, Approving Employee Retention and Severance Programs: Judicial Discretion Run Amok? 11 A. Bank. Inst. L. Rev. 93 (Spring 2003).

2 Lee Hecht Harrison, 2001 Severance Policies and Separation Benefits Study (http://www.lhh.com/solutions/organizations/severance.cfm).

³Id. at 98.

⁴ In Re America West Airlines, 171 B.R. 674 (Bankr. D. Az. 1994); In Re Matter of Interco Inc., 128 B.R. 229 (Bankr. E.D. Mo. 1991).

⁵ In Re Aerovox, 269 B.R. 74 (Bankr. D. Mass. 2001).

⁶ Enron’s Lavish Use of Retention Bonuses Could Spur Moves to Curb Growing Trend, Bankruptcy Law Daily, February 27, 2002.

⁷ Ann Davis, Want Some Extra Cash? File for Chapter 11, Wall St. J., Oct. 31, 2001.

⁸ See http://www.abiworld.org/abidata/online/conference/02nybc/Coleman.html

⁹ See, e.g., Paul Merrion, UAL Retention Plan Outrages Union, Chicago Business, July 7, 2003.

¹⁰ Dave Carpenter, Outraged Flight Attendants Rip United’s Bonus-Pay Plan, Miami Herald, July 7, 2003.

¹¹ Union Wants Guarantee of no Retention Bonuses, Associated Press, June 17, 2003.

¹² Kurt Ritterpusch and Lauren Couillard, Bankruptcy Reform: Gephardt Meets with Ex-Enron Employees. Bankruptcy Law Daily, Jan 31, 2002.

¹³“The trustee, after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate.”

¹⁴“The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.”

¹⁵ House Passed Bankruptcy Bill, 315-113, 22-APR Am. Bankr. Inst. J. 3, (April 2003).

¹⁶ Davis, supra.