A rose by any other name may still smell as sweet, but execs at Dana Corp. recently discovered that calling executive compensation by another name did not pass the smell test in court. S.D.N.Y. Bankruptcy Judge Burton Lifland recently denied Dana's proposed executive compensation package as contrary to the provisions of the Bankruptcy Code. [1]  Nearly one year after BAPCPA, has the Dana case finally ushered in a new approach to evaluating executive compensation plans, as envisioned by Congress?

Executive Compensation After BAPCPA

The Bankruptcy Abuse Prevention and Consumer Protection Act, enacted last October, added some severe restrictions on the ability of Chapter 11 debtors to adopt so-called "pay to stay" executive compensation plans. [2]

New Code section 503(c) establishes the guidelines for insider retention, bonus, and severance plans, also known as KERPS. [3] Under the new evidentiary standards,the Code bars bonuses to corporate insiders as an inducement to stay with the company unless the Debtor can show that the executive had a "bona fide job offer from another business at the same or greater rate of compensation." [4] Furthermore, the services provided must be "essential to the survival" of the reorganized business. [5]  Finally, the Code caps the pay-scale ratio so that no transfer to an insider may be greater than "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" or if no such transfer was made, then no greater than 25 percent of the amount of any similar transfer or obligation made to the insider during the prior calendar year. [6]

The Code also places restrictions on so-called "golden parachute" severance packages, by restricting severance payments to insiders. No severance payments are permitted unless "the payment is part of a program that is generally applicable to all full-time employees" [7] and the "amount of the payment is not greater than 10 times the amount of the mean severance pay given to nonmanagement employees during the calendar year in which the payment is made." [8]

As a final catch-all, the Code also prohibits "other transfers or obligations that are outside the ordinary course of business and not justified by the facts and circumstances of the case, including transfers made to, or obligations incurred for the benefit of, officers, managers, or consultants hired after the date of the filing of the petition." [9]

Stealth Compensation in Bankruptcy

A current trend is for companies to assign signing bonuses, retirement benefits, death retention bonuses, options reloads, and consulting payments to avoid the Code requirements that are applicable to traditional compensation packages. [10]

Dana Corp. modeled compensation for its top six executives after a similar plan approved by Judge Lifland in In re Calpine. [11] Unlike in Calpine, however, Dana's compensation package was vigorously opposed by the U.S. Trustee, the Justice Department, unions, and creditors as a violation of § 503(c).

From the bench, Judge Lifland ruled that "this compensation scheme walks like, talks like, and is a KERP." [12]

Professor Lawless makes a compelling argument that while appropriate, Judge Lifland's ruling really doesn't align with the intent of Congress: "The statute does not reach things that walk like, talk like, and look like KERPs. Rather, it reaches payments "for the purpose of inducing [a corporate insider] to remain with the debtor's business."" [13]

Sources

[1] Order, In re Dana Corp., 2006 WL 2563458 (Bankr. S.D.N.Y. Sept. 5, 2006), available at http://www.bankruptcylitigationblog.com/Ruling.pdf.

[2] Bankruptcy Abuse Prevention and Consumer Protection Act, Pub. L. 109-8, 2006 (codified at 11 U.S.C. § 101 et seq.).

[3] See 11 U.S.C. § 503(c)

[4] 11 U.S.C. § 503(c)(1)(A)

[5] 11 U.S.C. § 503(c)(1)(B)

[6] 11 U.S.C. § 503(c)(1)(C)

[7] 11 U.S.C. § 503(c)(2)(A)

[8] 11 U.S.C. § 503(c)(2)(B)

[9] 11 U.S.C. § 503(c)(3)

[10] See, e.g., Lucian Bebchuck and Jesse Freid, Pay Without Performance: The Unfulfilled Promise of Executive Compensation (Harvard Univ. Press 2004). Preface and Introduction available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=537783. See also Doris Burke and Julie Schlosser, CEO Pensions: The Latest Way to Hide Millions, CNNMONEY.com, Apr. 28, 2003, http://money.cnn.com/magazines/fortune/fortune_archive/2003/04/28/341732/.

[11] Order, In re Calpine Corp., No. 05-60200 (S.D.N.Y. May 15, 2006), available at http://www.bankruptcylitigationblog.com/calpine%20order%20approving%20incentive%20plan.pdf. For an excellent comparison of the Dana and Calpine compensation plans, see Steve Jakubowski, Duck Soup: NY Judge Nixes Dana Corp's "Incentive" Plan for its Top Six Executives (Sept. 8, 2006), http://www.bankruptcylitigationblog.com/archives/bankruptcy-in-the-news-duck-soup-nys-judge-burton-lifland-nixes-dana-corps-incentive-plan-for-its-top-six-executives.html.

[12] Order, In re Dana Corp., 2006 WL 2563458 (Bankr. S.D.N.Y. Sept. 5, 2006), available at http://www.bankruptcylitigationblog.com/Ruling.pdf.

[13] Robert Lawless, Lifland Rules, Credit Slips, Sept. 6, 2006, http://www.creditslips.org/creditslips/2006/09/lifland_rules.html.