Page 54 - Bankruptcy Volume 1

procedures that may be applied in the analysis of operations and other strategic or reengineering consult-
ing assignments. Accountants should consult industry literature and experienced bankruptcy and other
technical practitioners for further guidance.

Management Retention Plans

After filing for bankruptcy protection, companies often lose key members of management throughout
the bankruptcy process. Effective management is required to lead a company through this time. It is also
critical for the debtor to retain its accounting staff. Generally, it is less expensive for the debtor to use its
own accountants for financial support in operating the company than to use outside professionals.

Existing prepetition incentive and retention bonus plans and other deferred and supplemental compensa-
tion programs, especially for executives and other highly-paid employees, are often either suspended in
bankruptcy or the targets they set become impossible to meet. A debtor’s successful reorganization may
depend, in part, on its ability to retain key employees in the interim period between the petition date and
confirmation of a plan of reorganization, as well as to induce such employees to remain postconfirma-
tion. Upon filing, however, these key employees may be attracted to other less risky opportunities. As a
result, debtors often try to implement or continue key employee compensation programs to incentivize
such employees to remain with the debtor and to achieve positive results.

Following the 2005 amendments to the Bankruptcy Code, the ability to make retention or severance
payments to key employees has been restricted. Section 503(c)(1) of the Bankruptcy Code prohibits
payment of retention bonuses and similar liabilities to insiders of the debtor unless the court finds all of
the following: (a) the payment is essential to the person’s retention based on a bona fide job offer from
another business at the same or greater pay; (b) the person’s services are essential to the survival of the
business; and (c) the amount of the payment does not exceed either 10 times the mean amount of similar
transfers paid to nonmanagement employees for any purpose during the same calendar year or, if there
are no such transfers, 25% of the amount of any similar transfer to the insider for any purpose during the
previous calendar year. Section 503(c)(2) prohibits severance payments to insiders of the debtor unless
the court finds both that the payment is part of a program that is generally applicable to all full-time em-
ployees and that the amount of the proposed payment is not greater than 10 times the mean severance
paid to nonmanagement employees during the same calendar year. Section 503(c)(3) prohibits payments
that are outside the ordinary course of the debtor’s business and not justified by the circumstances of the
case, including amounts paid to officers, managers, or consultants hired after the bankruptcy filing.

Although retention payments are restrictive, the most common approaches to entice key members of
management to stay with the debtor company are either to (1) continue prepetition programs (if the pro-
grams comply with the requirements of Section 503(c)) or (2) develop postpetition compensation pro-
grams that offer insiders and other key employees incentives to create value. Several courts have held
programs that are primarily incentivizing, rather than retentive or in the nature of severance, do not need
to meet the exacting requirements of Section 503(c). See Global Home Products, LLC, 369 B.R. 778
(Bankr. D. Del. 2007). These incentive programs generally require the creation of value for the estate as
a condition to the payment of the compensation enhancements. To determine whether such value for the
estate has been created, certain milestones are typically identified, such as

 increased asset sale prices,

 increased enterprise value, or

 increased cash and operating sales levels and reduced expenses.

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