Calpine Corporation (NYSE: CPN) is a Fortune 500 power company founded in 1984 in San Jose, California.
Calpine's headquarters were permanently moved from San Jose to Houston, Texas in 2009. The company's stock was traded on the New York Stock Exchange under the symbol CPN until it was delisted on December 5, 2005 due to low share price. On 1/31/08, Calpine emerged from bankruptcy and now trades on the NYSE under the ticker symbol CPN. The company is headquartered in the Calpine Center in Downtown Houston.
The amendments contained in the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) include one with significant ramifications for business bankruptcies – the amendment to section 503(c)(1) of title 11 of the United States Code (the Bankruptcy Code). The purpose of this new law is to make it difficult for debtor companies to gain court approval of plans to pay retention compensation to management as an inducement for such employees to remain with the company through the course of its bankruptcy (i.e., key employee retention plans or KERPs). BAPCPA took effect in October 2005 and became applicable to all bankruptcy cases filed thereafter, and since then several cases have addressed section 503(c)(1) and KERPs.
(A) the transfer or obligation is essential to retention of the person because the individual has a bona fide job offer from another business at the same or greater rate of compensation;
(B) the services provided by the person are essential to the survival of the business; and
(C) either—
(i) the amount of the transfer made to, or obligation incurred for the benefit of, the person is not greater than an amount equal to 10 times the amount of the mean transfer or obligation of a similar kind given to nonmanagement employees for any purpose during the calendar year in which the transfer is made or obligation is incurred; or
(ii) if no such similar transfers were made to, or obligations incurred for the benefit of, such nonmanagement employees during such calendar year, the amount of the transfer or obligation is not greater than an amount equal to 25 percent of the amount of any similar transfer or obligation made to or incurred for the benefit of such insider for any purpose during the calendar year before the year in which such transfer is made or obligation is incurred[.]
The Treatment of KERPs Post-BAPCPA: An Old KERP with a New Name?
Despite the new section 503(c)(1) with its specific test to be applied formulaically, the application of the law did not pan out as its drafters had intended. In sum, debtors were creative in drafting retention plans and judges played along. Mindful of the new requirements, debtors requesting approval of KERPs structured their plans as “incentive plans” instead of retention plans, seeking to gain approval under the more lenient business judgment rule pursuant to section 363 of the Bankruptcy Code, and to avoid triggering the stricter standards of section 503(c)(1).
A review of the cases decided after the effective date of BAPCPA (October 17, 2005) demonstrates that debtors have been successful in reconfiguring their old KERPs with a new name and purpose. As the cases discussed below illustrate, judges have found that these plans pass muster.
In re Nobex: One of First to Offer “Incentive Plan,” Not Retention Plan
In re Nobex Corporation (05-20050) (MFW), was one of the first post-BAPCPA cases to discuss the approval of a retention program. In that case, the debtor presented an “incentive plan” rather than a retention plan for approval by the court. 2006 Bankr. LEXIS 417 (Bankr. D. Del. 2006). Specifically, the debtor sought to provide incentive bonuses in addition to regular compensation, for its chairman (acting as chief executive officer) and its vice president of finance and administration, claiming that those individuals were the debtor’s only personnel who could successfully bring the debtor through the sale of substantially all of its assets, in light of their knowledge of the science and technology of debtor’s business. The plan only provided incentive compensation if the sale price exceeded the stalking horse bid price.
The court analyzed the incentive plan under section 363 of the Bankruptcy Code, rather than section 503(c)(1) because it found that the payments were not meant as an inducement to stay with the debtor, but rather an inducement to increase the sale price and ultimately bring more money into the estate for creditors. Under the business judgment standard, the court approved the plan.
In Pliant, Court Overrode Creditor Objections and Approved MIP as Incentive Plan
Similarly, in the case of In re Pliant Corporation,(06-10001) (MFW), the Bankruptcy Court for the District of Delaware approved the debtors’ management incentive compensation plan (the MIP). In its motion seeking authorization for the plan, the debtors argued that its MIP had been in place prior to the petition date and they were only seeking to pay the amounts they would have otherwise paid in the ordinary course pre-petition. See Motion of the Debtors for an Order Authorizing the Debtors to Make Certain Payments Pursuant to a Management Incentive Plan, February 23, 2006. Thus, the debtors argued, the MIP should be analyzed under section 363 of the Bankruptcy Code.
Despite objections from several creditors that the plan should be reviewed as a retention plan under section 503(c)(1), the court did analyze the plan pursuant to section 363 and found that the plan was in accordance with the debtors’ policies and in the ordinary course of business.
Several objecting parties argued that the completion bonuses were based on “artificially low threshold,” which pretty much guaranteed that the bonuses would be paid under any circumstances, making them more similar to retention bonuses.
The court agreed with this reasoning and ruled that the proposed incentive plans were retention plans in disguise. The court stated, “sing a familiar fowl analogy, this compensation scheme walks, talks and is a retention bonus” and in the footnote to this statement added “if it walks like a duck (KERP) and quacks like a duck (KERP), it’s a duck (KERP).” Id. at *5-*6. The court held that the large incentive bonus, tied to nothing other than the emergence from Chapter 11 regardless of any other outcome, could not be considered a form of incentive bonus. Thus, the court denied the debtors’ motion.
Implications for the Future of KERPs under BAPCPA
Does the Dana decision signal an end to the approval of retention/incentive plans under BAPCPA? Not necessarily. On closer analysis of the decision, there were several reasons specific to that case which explain why the Dana decision is probably not the end of retention plans in bankruptcy cases.
Significantly, the debtors in Dana did not have the approval of several key creditor groups and the United States Trustee. As the court stated, “[a] significant aspect of these cases in the context of the Compensation Motion, are the issues raised in the strong objections filed by several parties in interest, including the Creditors’ Committee, Equity Committee and United States Trustee and therefore, the Compensation Motion cannot fairly be compared to other compensation motions brought before this Court or other courts.” Id. at *4.
These parties’ objections had clearly sent up red flags for the court. Judge Lifland noted in closing that, while holding that the plan did not pass muster, “I do not find that incentivizing plans which may have some components that arguably have a retentive effect, necessarily violate section 503(c)’s requirements.” Id. at *5.
Thus, the court left open the possibility that a plan could gain approval under 503(c), while not providing any guideline on how to fashion such a plan. Fashioning such a plan will be the challenge for a debtor facing approval of a retention/incentive plan under section 503(c)(1).
One of the significant changes made by the Bankruptcy Code amendments that took effect in October 2005 was the imposition of severe restrictions on "key employee retention plans," known in the bankruptcy world as KERPs. In this post I'll discuss how several courts have handled these issues in the year and a half since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, known as BAPCPA, became effective. The most recent decision, issued late last week by the Delaware Bankruptcy Court in the Nellson Nutraceutical case, gives debtors added flexibility when trying to craft plans consistent with these new restrictions.
Changes Aimed At Curbing KERPs. Prior to BAPCPA, KERPs were a very popular way of making sure that a company could retain its most important officers and employees to guide it through bankruptcy. Citing perceived abuses, however, Congress added language in BAPCPA that requires debtors to satisfy nearly impossible standards before courts would be permitted to approve payment of retention bonuses (or severance payments) as administrative claims to officers and other insiders of a bankrupt company. The restrictions apply only to insiders; no similar limitations have been placed on payment of retention bonuses and severance to non-insiders.
The New Law's High Hurdles. To give you a flavor of the restrictions BAPCPA added to "Section 503(c) of the Bankruptcy Code, a debtor company must now prove the following before it can gain approval for payment of a retention bonus to an insider:
the transfer or obligation is essential to retention of the person because the individual has a bona fide job offer from another business...
Enron was the next major bankruptcy to hit the public consciousness.
88 The debtors quickly moved for and received judicial approval of a retention bonus plan. “Under the proposal, about 1,700 employees would share $40 million in retention bonuses, $7 million in severance payments and from $47.4 million to $90 million in incentive bonuses based on the amount of cash raised from asset sales.”89 While these huge amounts raised public ire, an even more controversial provision of the Enron plan allowed waivers to be given to certain employees, which allowed those employees to retain large bonuses just before Enron filed for bankruptcy.90
Kmart also implemented a large executive retention bonus plan. As one reporter pointed out, the disparity between the treatment of executives and the treatment of rank-and-file employees was often astounding: “Kmart . . . is awarding retention bonuses worth $150 million to managers while more than 22,000 workers are sent home without severance, for example, and . . . Enron is paying $140 million to hold key personnel while cutting about 4,500 jobs.”
91 Public pressure was mounting—“some view it as ironic that company captains are receiving major money to stay on board when they are presumably the ones who steered the business into the rocks.”92
In 2002, Global Crossing Ltd. sought bankruptcy court approval of a retention plan that “would pay nine executive vice presidents bonuses of up to half of their annual salaries and 295 other high level executives up to 27.5% of their pay.” The companies, however, kept the plans coming even as public scrutiny increased.
93 The plan would pay out up to $15 million total.94 The company would, however, also be cutting 16% of its workforce in the reorganization process.
Nobex was the first case in which the court declared that an incentive-based plan was not the same as a retention plan.210 Because it was incentive-based, the plan did not fall into the purview of section 503(c)(1) and section 503(c)(3) did not prohibit incentive-based pay to employees.211
Following Nobex, the United States Bankruptcy Court for the Southern District of New York heard a motion to approve debtor Calpine Corporation’s incentive program. Thus, the first inkling of how to avoid the anti-KERP provisions was blotted into precedent.
212 With no memorandum explaining the decision, the court granted the debtor’s motion in a bench order and approved an incentive program consisting of an “Emergence Incentive Plan,” “Management Incentive Plan,” “Supplemental Bonus Plan,” and “Discretionary Bonus Plan.”213 Payments under the Emergence Incentive Plan and Management Incentive Plan were contingent upon an employee’s achievement of certain performance targets.214 The Supplemental Bonus Plan, interestingly, was a retention-type program but was written to exclude the debtor’s “insiders.”215 However, no definition of an “insider” was provided.216
103, at 95; Margaret Howard, The Law of Unintended Consequences, 31 S. ILL. U. L.J. 451, 457 (2007). 209. Ira L. Herman, Statutory Schizophrenia and the New Chapter 11, 2 AM. BANKR. INST. J. 30, 30 (2007) (“The uncertainty, delay and added expense that may be engendered by these BAPCPA provisions could be particularly nettlesome if the courts are to move reorganization cases more quickly through the bankruptcy system to give effect to the second policy imperative embedded in BAPCPA chapter 11 provisions: ‘the need for speed.’” (citation omitted)). 210. In re Nobex Corp., No. 05-20050, 2006 WL 4063024, at *3 (Bankr. D. Del. 2006). 211. Id. 212. See Order Authorizing the Implementation of the Calpine Incentive Program, supra note 134. 213. Id. ¶ 2, Ex. 1. 214. Id. at Ex. 1. 215. Id. 216. Id. Finally, the Discretionary Bonus Plan was simply a $500,000 pool from which could be distributed, at the sole discretion of the CEO, bonuspayments of up to $25,000 per employee per year.
217 No reference was made to section 503(c) in the order.218
Dana I succeeded Calpine in the bonus plan hunt, and the debtors urged the court to follow the Calpine lead.
219 The court, however, paused to examine the plans proposed by the debtor and found that the plans themselves were not truly incentive-based.220 The sticking point was that the plans proposed involved some “fixed” payments that would be made to an employee simply because he had remained at the company until the “effective date of a plan of reorganization.”221 Thus, the court brought section 503(c)(1) into play and held that this non-incentivizing—or retention—plan could not be approved.222 The court did, however, go out of its way to leave the door open for truly incentive-based bonus plans.223
The door being left wide open, Dana Corp. adjusted its plan and tried again to cross the threshold. With a slightly different plan laid before it, the court declared it to be properly incentive-based.
224 Following the Nobex and Calpine lead, the court applied section 503(c)(3) to the plan in order to determine if it should be authorized.225 As section 503(c)(3) really requires “no more stringent a test than” the business judgment rule,226 “section 503(c)(3) gives the court discretion as to bonus and incentive plans, which are not primarily motivated by retention or in the nature of severance.”227 The plans were authorized as reasonable business judgments on the part of the debtors.
Calpine's headquarters were permanently moved from San Jose to Houston, Texas in 2009. The company's stock was traded on the New York Stock Exchange under the symbol CPN until it was delisted on December 5, 2005 due to low share price. On 1/31/08, Calpine emerged from bankruptcy and now trades on the NYSE under the ticker symbol CPN. The company is headquartered in the Calpine Center in Downtown Houston.
The amendments contained in the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) include one with significant ramifications for business bankruptcies – the amendment to section 503(c)(1) of title 11 of the United States Code (the Bankruptcy Code). The purpose of this new law is to make it difficult for debtor companies to gain court approval of plans to pay retention compensation to management as an inducement for such employees to remain with the company through the course of its bankruptcy (i.e., key employee retention plans or KERPs). BAPCPA took effect in October 2005 and became applicable to all bankruptcy cases filed thereafter, and since then several cases have addressed section 503(c)(1) and KERPs.
(A) the transfer or obligation is essential to retention of the person because the individual has a bona fide job offer from another business at the same or greater rate of compensation;
(B) the services provided by the person are essential to the survival of the business; and
(C) either—
(i) the amount of the transfer made to, or obligation incurred for the benefit of, the person is not greater than an amount equal to 10 times the amount of the mean transfer or obligation of a similar kind given to nonmanagement employees for any purpose during the calendar year in which the transfer is made or obligation is incurred; or
(ii) if no such similar transfers were made to, or obligations incurred for the benefit of, such nonmanagement employees during such calendar year, the amount of the transfer or obligation is not greater than an amount equal to 25 percent of the amount of any similar transfer or obligation made to or incurred for the benefit of such insider for any purpose during the calendar year before the year in which such transfer is made or obligation is incurred[.]
The Treatment of KERPs Post-BAPCPA: An Old KERP with a New Name?
Despite the new section 503(c)(1) with its specific test to be applied formulaically, the application of the law did not pan out as its drafters had intended. In sum, debtors were creative in drafting retention plans and judges played along. Mindful of the new requirements, debtors requesting approval of KERPs structured their plans as “incentive plans” instead of retention plans, seeking to gain approval under the more lenient business judgment rule pursuant to section 363 of the Bankruptcy Code, and to avoid triggering the stricter standards of section 503(c)(1).
A review of the cases decided after the effective date of BAPCPA (October 17, 2005) demonstrates that debtors have been successful in reconfiguring their old KERPs with a new name and purpose. As the cases discussed below illustrate, judges have found that these plans pass muster.
In re Nobex: One of First to Offer “Incentive Plan,” Not Retention Plan
In re Nobex Corporation (05-20050) (MFW), was one of the first post-BAPCPA cases to discuss the approval of a retention program. In that case, the debtor presented an “incentive plan” rather than a retention plan for approval by the court. 2006 Bankr. LEXIS 417 (Bankr. D. Del. 2006). Specifically, the debtor sought to provide incentive bonuses in addition to regular compensation, for its chairman (acting as chief executive officer) and its vice president of finance and administration, claiming that those individuals were the debtor’s only personnel who could successfully bring the debtor through the sale of substantially all of its assets, in light of their knowledge of the science and technology of debtor’s business. The plan only provided incentive compensation if the sale price exceeded the stalking horse bid price.
The court analyzed the incentive plan under section 363 of the Bankruptcy Code, rather than section 503(c)(1) because it found that the payments were not meant as an inducement to stay with the debtor, but rather an inducement to increase the sale price and ultimately bring more money into the estate for creditors. Under the business judgment standard, the court approved the plan.
In Pliant, Court Overrode Creditor Objections and Approved MIP as Incentive Plan
Similarly, in the case of In re Pliant Corporation,(06-10001) (MFW), the Bankruptcy Court for the District of Delaware approved the debtors’ management incentive compensation plan (the MIP). In its motion seeking authorization for the plan, the debtors argued that its MIP had been in place prior to the petition date and they were only seeking to pay the amounts they would have otherwise paid in the ordinary course pre-petition. See Motion of the Debtors for an Order Authorizing the Debtors to Make Certain Payments Pursuant to a Management Incentive Plan, February 23, 2006. Thus, the debtors argued, the MIP should be analyzed under section 363 of the Bankruptcy Code.
Despite objections from several creditors that the plan should be reviewed as a retention plan under section 503(c)(1), the court did analyze the plan pursuant to section 363 and found that the plan was in accordance with the debtors’ policies and in the ordinary course of business.
Several objecting parties argued that the completion bonuses were based on “artificially low threshold
The court agreed with this reasoning and ruled that the proposed incentive plans were retention plans in disguise. The court stated, “sing a familiar fowl analogy, this compensation scheme walks, talks and is a retention bonus” and in the footnote to this statement added “if it walks like a duck (KERP) and quacks like a duck (KERP), it’s a duck (KERP).” Id. at *5-*6. The court held that the large incentive bonus, tied to nothing other than the emergence from Chapter 11 regardless of any other outcome, could not be considered a form of incentive bonus. Thus, the court denied the debtors’ motion.
Implications for the Future of KERPs under BAPCPA
Does the Dana decision signal an end to the approval of retention/incentive plans under BAPCPA? Not necessarily. On closer analysis of the decision, there were several reasons specific to that case which explain why the Dana decision is probably not the end of retention plans in bankruptcy cases.
Significantly, the debtors in Dana did not have the approval of several key creditor groups and the United States Trustee. As the court stated, “[a] significant aspect of these cases in the context of the Compensation Motion, are the issues raised in the strong objections filed by several parties in interest, including the Creditors’ Committee, Equity Committee and United States Trustee and therefore, the Compensation Motion cannot fairly be compared to other compensation motions brought before this Court or other courts.” Id. at *4.
These parties’ objections had clearly sent up red flags for the court. Judge Lifland noted in closing that, while holding that the plan did not pass muster, “I do not find that incentivizing plans which may have some components that arguably have a retentive effect, necessarily violate section 503(c)’s requirements.” Id. at *5.
Thus, the court left open the possibility that a plan could gain approval under 503(c), while not providing any guideline on how to fashion such a plan. Fashioning such a plan will be the challenge for a debtor facing approval of a retention/incentive plan under section 503(c)(1).
One of the significant changes made by the Bankruptcy Code amendments that took effect in October 2005 was the imposition of severe restrictions on "key employee retention plans," known in the bankruptcy world as KERPs. In this post I'll discuss how several courts have handled these issues in the year and a half since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, known as BAPCPA, became effective. The most recent decision, issued late last week by the Delaware Bankruptcy Court in the Nellson Nutraceutical case, gives debtors added flexibility when trying to craft plans consistent with these new restrictions.
Changes Aimed At Curbing KERPs. Prior to BAPCPA, KERPs were a very popular way of making sure that a company could retain its most important officers and employees to guide it through bankruptcy. Citing perceived abuses, however, Congress added language in BAPCPA that requires debtors to satisfy nearly impossible standards before courts would be permitted to approve payment of retention bonuses (or severance payments) as administrative claims to officers and other insiders of a bankrupt company. The restrictions apply only to insiders; no similar limitations have been placed on payment of retention bonuses and severance to non-insiders.
The New Law's High Hurdles. To give you a flavor of the restrictions BAPCPA added to "Section 503(c) of the Bankruptcy Code, a debtor company must now prove the following before it can gain approval for payment of a retention bonus to an insider:
the transfer or obligation is essential to retention of the person because the individual has a bona fide job offer from another business...
Enron was the next major bankruptcy to hit the public consciousness.
88 The debtors quickly moved for and received judicial approval of a retention bonus plan. “Under the proposal, about 1,700 employees would share $40 million in retention bonuses, $7 million in severance payments and from $47.4 million to $90 million in incentive bonuses based on the amount of cash raised from asset sales.”89 While these huge amounts raised public ire, an even more controversial provision of the Enron plan allowed waivers to be given to certain employees, which allowed those employees to retain large bonuses just before Enron filed for bankruptcy.90
Kmart also implemented a large executive retention bonus plan. As one reporter pointed out, the disparity between the treatment of executives and the treatment of rank-and-file employees was often astounding: “Kmart . . . is awarding retention bonuses worth $150 million to managers while more than 22,000 workers are sent home without severance, for example, and . . . Enron is paying $140 million to hold key personnel while cutting about 4,500 jobs.”
91 Public pressure was mounting—“some view it as ironic that company captains are receiving major money to stay on board when they are presumably the ones who steered the business into the rocks.”92
In 2002, Global Crossing Ltd. sought bankruptcy court approval of a retention plan that “would pay nine executive vice presidents bonuses of up to half of their annual salaries and 295 other high level executives up to 27.5% of their pay.” The companies, however, kept the plans coming even as public scrutiny increased.
93 The plan would pay out up to $15 million total.94 The company would, however, also be cutting 16% of its workforce in the reorganization process.
Nobex was the first case in which the court declared that an incentive-based plan was not the same as a retention plan.210 Because it was incentive-based, the plan did not fall into the purview of section 503(c)(1) and section 503(c)(3) did not prohibit incentive-based pay to employees.211
Following Nobex, the United States Bankruptcy Court for the Southern District of New York heard a motion to approve debtor Calpine Corporation’s incentive program. Thus, the first inkling of how to avoid the anti-KERP provisions was blotted into precedent.
212 With no memorandum explaining the decision, the court granted the debtor’s motion in a bench order and approved an incentive program consisting of an “Emergence Incentive Plan,” “Management Incentive Plan,” “Supplemental Bonus Plan,” and “Discretionary Bonus Plan.”213 Payments under the Emergence Incentive Plan and Management Incentive Plan were contingent upon an employee’s achievement of certain performance targets.214 The Supplemental Bonus Plan, interestingly, was a retention-type program but was written to exclude the debtor’s “insiders.”215 However, no definition of an “insider” was provided.216
103, at 95; Margaret Howard, The Law of Unintended Consequences, 31 S. ILL. U. L.J. 451, 457 (2007). 209. Ira L. Herman, Statutory Schizophrenia and the New Chapter 11, 2 AM. BANKR. INST. J. 30, 30 (2007) (“The uncertainty, delay and added expense that may be engendered by these BAPCPA provisions could be particularly nettlesome if the courts are to move reorganization cases more quickly through the bankruptcy system to give effect to the second policy imperative embedded in BAPCPA chapter 11 provisions: ‘the need for speed.’” (citation omitted)). 210. In re Nobex Corp., No. 05-20050, 2006 WL 4063024, at *3 (Bankr. D. Del. 2006). 211. Id. 212. See Order Authorizing the Implementation of the Calpine Incentive Program, supra note 134. 213. Id. ¶ 2, Ex. 1. 214. Id. at Ex. 1. 215. Id. 216. Id. Finally, the Discretionary Bonus Plan was simply a $500,000 pool from which could be distributed, at the sole discretion of the CEO, bonuspayments of up to $25,000 per employee per year.
217 No reference was made to section 503(c) in the order.218
Dana I succeeded Calpine in the bonus plan hunt, and the debtors urged the court to follow the Calpine lead.
219 The court, however, paused to examine the plans proposed by the debtor and found that the plans themselves were not truly incentive-based.220 The sticking point was that the plans proposed involved some “fixed” payments that would be made to an employee simply because he had remained at the company until the “effective date of a plan of reorganization.”221 Thus, the court brought section 503(c)(1) into play and held that this non-incentivizing—or retention—plan could not be approved.222 The court did, however, go out of its way to leave the door open for truly incentive-based bonus plans.223
The door being left wide open, Dana Corp. adjusted its plan and tried again to cross the threshold. With a slightly different plan laid before it, the court declared it to be properly incentive-based.
224 Following the Nobex and Calpine lead, the court applied section 503(c)(3) to the plan in order to determine if it should be authorized.225 As section 503(c)(3) really requires “no more stringent a test than” the business judgment rule,226 “section 503(c)(3) gives the court discretion as to bonus and incentive plans, which are not primarily motivated by retention or in the nature of severance.”227 The plans were authorized as reasonable business judgments on the part of the debtors.