A difficult dilemma faced by most corporate debtors filing for bankruptcy is how to convince present management and employees (including potentially critical insiders) to stay with the company post-bankruptcy. This dilemma can be particularly daunting when these same officers, directors, managers, and other employees, whether insiders or not, could obtain more favorable job prospects or compensation working for another company, or even a competitor. Accordingly, one question I am asked by corporate debtors in bankruptcy frequently is how to retain talent within the company after the company has filed for bankruptcy and what is permitted by the bankruptcy court for incentives such as wages, bonuses, severance payments, etc., to retain this same talent.

This article is not intended as an exhaustive review of all of the legal requirements a corporate debtor must comply with to retain top talent during a bankruptcy case. However, this article will cover many of the basic principles and legal requirements that a corporate debtor must comply with in bankruptcy to retain the various types of talent who work for the company post-filing.

To begin, compensation of officers, directors, management, and all other employees, and regardless of whether such talent are insiders or non-insiders within the company, is broadly defined by 11 U.S.C. §503. 11 U.S.C. §503 (2020). When analyzing compensation in bankruptcy, it is generally useful to make a distinction between “insider” employees and “non-insider” employees, as discussed in greater detail below.

The bankruptcy code defines an “insider” under 11 U.S.C. §101(31)(B) as a “director, officer, or individual in control of the corporation, or a relative of such individual.” 11 U.S.C. §101(31)(B) (2020). The definition of “insider” is very relevant to an analysis of how such talent can be retained by the company, because compensation of insiders, particularly with regard to retention payments and severance payments, are permitted in a far more limited manner than for other non-insider talent, for which the requirements have greater flexibility.

Non-insider talent can often be retained to work for the company by offering reasonable wages, bonuses, severance payments, incentive plans, and other programs, as long as they are approved by the bankruptcy court. These payments can be approved as administrative expenses of the bankruptcy estate, which get extremely high priority in bankruptcy, to ensure that employees and other talent who work for the bankrupt corporate debtor get paid as agreed. 11 U.S.C. §503(b)(1)(A)(i) (2020). These plans are sometimes called “Key Employee Retention Plans” (KERPs) and in general are reviewed under the “business judgment rule,” which is a much more flexible standard where the bankruptcy court will generally approve the compensation if reasonable and not determined in a capricious or nonsensical manner. KERPs are also subject to the requirements of 11 U.S.C. §503(c)(3), which prohibits payments that are outside the ordinary course of business and that are not justified by the facts and circumstances presented in the case. 11 U.S.C. §503(c)(3) (2020). In general, most pre-petition compensation plans negotiated between arms-length parties and without collusion will pass this standard and obtain bankruptcy court approval for post-petition use or continuation. Many bankruptcy attorneys apply for approval to pay critical employees within a short period after the company files bankruptcy, and many times, as part of “first day motions” submitted to the bankruptcy court.

In contrast, retaining insider talent is much more heavily restricted and there are a multitude of provisions which render certain types of compensation to insiders effectively not worthwhile for most corporate purposes. Insiders can receive wages, bonuses, severance, and incentive payments, similar to non-insiders, but bankruptcy law restricts compensation to insiders in a plethora of ways listed in 11 U.S.C. §503(c)(1). 11 U.S.C. §503(c)(1) (2020). In general, the onerous restrictions required by §503(c)(1) with respect to the employment of insiders, make retention programs for insiders generally ineffective for most corporate debtors, particularly for any corporate debtor where insider management employees make significantly more income than non-insider “rank and file” employees. For many of the same reasons, severance packages are no longer used for insider management employees, because the restrictions of 11 U.S.C. §503(c)(2) often do not properly incentivize critical executive talent to stay, given that severance for “rank and file” employees is not generally enough to result in a proper severance package for a key executive. 11 U.S.C. §503(c)(2) (2020). While this very frequently impacts public company debtors, it can also frequently impact corporate debtors which are closely-held companies, such as family businesses, as it is generally the case that closely-held corporations will have more employees relative to the size of the company that qualify as “insiders.”

So how does a bankrupt corporate debtor compensate essential insiders of the company for post-petition work to retain them? Corporate debtors generally use what are called “Key Executive Incentive Plans” (KEIPs), which are not subject to the onerous requirements of 11 U.S.C. §503(c)(1), as they are not technically “retention plans” or “severance packages.” Id. KEIPs are essentially “pay for performance” plans which incentivize key executives to stay with the company by compensating them if they achieve certain “goals” or “targets,” which may be quantitative or qualitative in nature. These “goals” are often things like “raising revenues by 20%,” “obtaining a consensual plan,” “cutting expenses by 30%,” “selling XYZ property or technology to a buyer for more than ABC dollar amount,” or other easily verifiable metrics that can be achieved. Additionally, the bankruptcy court will not look favorably on “goals” which are set too low for executives, as these are often interpreted by the court as simply “retention plans” in disguise. In essence, accomplishing the goal needs to add value to the corporate bankruptcy estate in a manner that is challenging to achieve, but lucrative if success is obtained. These goals and other metrics should be authorized by the court prior to an executive starting to accomplish said goals, as otherwise the court may view such accomplishments as less challenging in hindsight than they actually were to complete.

If you are an officer, director, or other manager seeking advice regarding corporate bankruptcy for an entity filing in the San Francisco Bay Area, feel free to contact Nova Law Group and an attorney will be happy to assist you. Nova Law Group services clients throughout the Bay Area, including the cities of the peninsula (such as Mountain View, Palo Alto, Los Altos, Sunnyvale, Cupertino, Menlo Park, Redwood City, and East Palo Alto), the south bay (such as Campbell, Santa Clara, San Jose, Gilroy, and Santa Cruz), and the north peninsula, including San Francisco (San Mateo, Brisbane, Burlingame, Foster City, SSF, etc.). Nova Law Group assists debtors, creditors, and third parties as clients in all of the above communities in the San Francisco Bay Area. We also represent clients in associated bankruptcy litigation as needed.