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Under ' 503(c)(1), a debtor is prohibited from transferring money to an insider as an incentive to remain with the debtor, absent a finding that the transfer is essential to retain the insider or that the services provided are essential to the survival of the business. Section 503(c)(2) prohibits paying severance benefits to an insider unless the payment is part of a program that is generally applicable to all full-time employees and the payment is not greater than 10 times the amount of the mean severance pay given to non-management employees. Section 503(c)(3) utilizes the business judgment rule as the measure of an improper transfer to insiders and prohibits those transfers that are outside the ordinary course of business and not justified by the facts and circumstances of the case.

The court ruled that the proposed completion bonus was not an incentive bonus but a retention bonus. The court also found that the language of ' 503(c)(3) did not prevent the use of the business judgment rule. Nevertheless, the debtors failed 'to meet their burden of demonstrating that the payments in exchange for signing a non-compete agreement and other payments do not constitute 'severance' for purposes of section 503(c)(2) ' or that the evidentiary requirements contained in section 503(c)(2) have been satisfied.' The court noted that '[w]hile it may be possible to formulate a compensation package that passes muster under the section 363 business judgment rule or section 503(c) limitations, or both, this set of packages does neither.' The court also did not dismiss the possibility that incentivizing plans with some components that arguably have a retentive effect would necessarily violate ' 503(c)'s requirements.

Executive Compensation Plan Denied under ' 503(c)

The Bankruptcy Court for the Southern District of New York has denied a Chapter 11 debtor's request for an order approving the payment of millions of dollars in executive compensation to the Chief Executive Officer and five other executives, finding that the payments would violate ' 503(c) as amended by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. In re Dana Corp., No. 06-10354 (Sept. 5).

The executive compensation plan proposed to continue paying the CEO his $1.5 million annual salary and the other executives their salaries ranging from $500,000 to $600,000. The proposed plan also called for annual in-centive bonuses ranging from $336,000 to $2 million. The proposed plan also included a two-part completion bonus. Part one awarded the executives between $400,000 and $3.1 million in cash regardless of performance or creditor recovery when the debtor emerges from bankruptcy. Part two of the completion bonus was an uncapped, variable component based on the debtor's 'total enterprise value' 6 months after emerging from bankruptcy, a benefit potentially worth $6.2 million, according to the court. There was also a severance package, which proposed to pay the CEO $166,667 per month for 18 months if he was terminated and agreed to sign a non-compete agreement. Further, the plan retained an existing pre-bankruptcy senior executive retirement program that entitled the CEO to more than $18 million. Under the proposed executive compensation plan, the debtor would have assumed this agreement on the earlier of the CEO's termination or the debtor's emergence from bankruptcy. Objections were filed by creditors and the U.S. Trustee, who claimed that because the executives were hired pre-petition, the proposed plan should be subject to either ' 503(c)(1) or ' 503(c)(2). The debtor argued that the benefits should be reviewed subject to the less burdensome ' 503(c)(3).

Under ' 503(c)(1), a debtor is prohibited from transferring money to an insider as an incentive to remain with the debtor, absent a finding that the transfer is essential to retain the insider or that the services provided are essential to the survival of the business. Section 503(c)(2) prohibits paying severance benefits to an insider unless the payment is part of a program that is generally applicable to all full-time employees and the payment is not greater than 10 times the amount of the mean severance pay given to non-management employees. Section 503(c)(3) utilizes the business judgment rule as the measure of an improper transfer to insiders and prohibits those transfers that are outside the ordinary course of business and not justified by the facts and circumstances of the case.

The court ruled that the proposed completion bonus was not an incentive bonus but a retention bonus. The court also found that the language of ' 503(c)(3) did not prevent the use of the business judgment rule. Nevertheless, the debtors failed 'to meet their burden of demonstrating that the payments in exchange for signing a non-compete agreement and other payments do not constitute 'severance' for purposes of section 503(c)(2) ' or that the evidentiary requirements contained in section 503(c)(2) have been satisfied.' The court noted that '[w]hile it may be possible to formulate a compensation package that passes muster under the section 363 business judgment rule or section 503(c) limitations, or both, this set of packages does neither.' The court also did not dismiss the possibility that incentivizing plans with some components that arguably have a retentive effect would necessarily violate ' 503(c)'s requirements.