In 2001 and 2002, two hundred and eight CEOs and corporate
directors walked away from twenty five of the largest corporations
to file for bankruptcy with gross “earnings” of $3.3 billion.
Contributing in large part to the excessive “earnings” of these
corporate insiders were all-cash retention bonuses, or Key Employee
Retention Plans (“KERPs”). Debtor corporations utilized KERPs
to retain executives and directors and insulate them from the
financial risks facing nearly all employees, creditors, and
shareholders in reorganization.
The inequity of KERPs, approved by bankruptcy courts and paid out
amidst massive layoffs and record-breaking creditor claims,
garnered intense public scrutiny and congressional attention.
This attention resulted in newly enacted 11 U.S.C. § 503(c)(1),
part of the Bankruptcy Abuse Prevention and Consumer Protection Act
of 2005 (“BAPCPA”). Section 503(c)(1) prohibits any “transfer
made to, or an obligation incurred for the benefit of, an insider
of the debtor for the purpose of inducing such person to remain
with the debtor’s business.”
Seemingly, § 503(c)(1) has eliminated KERPs. Debtor
corporations, however, are currently attempting to circumvent §
503(c)(1)’s prohibition by restructuring and re-characterizing
KERPs as incentive bonus plans. In theory, incentive bonus
plans, unlike KERPs, require executives to reach certain
productivity levels and performance goals before receiving their
bonuses. The emergence of incentive bonus plans, therefore,
has raised the issue of whether such plans are essentially “for the
purpose of inducing [an insider] to remain with the debtor’s
business,” and thereby explicitly prohibited by § 503(c)(1), or
whether incentive bonus plans are only incidentally retentive in
effect and thus allowable.
Debtor corporations assert that incentive bonus plans are not
prohibited under § 503(c)(1) because “the purpose” of such
“incentive” plans is not simply to induce executives to remain with
the corporation through reorganization, but rather to achieve
specified challenging productivity goals. United States
trustees, creditors, employees, and shareholders disagree.
They assert that incentive bonus plans, more often than not, have
“terribly low performance thresholds” making them in effect “merely
‘artfully worded creations’ that bear no actual distinction from
ordinary retention packages under the prior KERP standards.”
Moreover, they assert that—regardless of the performance level
specified—an unavoidable purpose of incentive bonus plans is to
induce the recipient to remain with the corporation through
reorganization and, as such, are prohibited under § 503(c)(1).
This Note argues that incentive bonus plans, although violating
§ 503(c)(1)’s intent to curb excessive executive compensation in
reorganization, are not prohibited by the statute’s express
language. While incentive bonus plans may have some
incidental retentive effect, “the purpose” of such plans is not to
“induc[e the insider] to remain with the debtor’s business.”
Incentive bonus plans therefore technically remain a viable option
for corporations in reorganization; however, such plans circumvent
the spirit of the legislation and therefore must be closely
monitored by bankruptcy courts and, if necessary, Congress.
This Note suggests an approach to monitoring the use of incentive
bonus plans in reorganization.