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Key Employee Retention under BAPCPA
In 2005, Congress purported to address the hot-button issue of executive compensation in bankruptcy by severely limiting Key Employee Retention Programs ('KERPs') that were then common in reorganization cases. These limitations on KERPs were set forth in Bankruptcy Code ' 503(c), added by the Bankruptcy Abuse and Consumer Protection Act of 2005 (the 'Act'). Although billed as a response to recent abuses of the bankruptcy system by executives of corporate giants like Enron Corporation, the amendment as drafted applied absent any Enron-type fraud or mismanagement, prompting concern that it would impede successful reorganizations by preventing necessary retention payments to debtors' executives. As post-Act case law shows, the Act in practice has not had the dramatic effect on executive compensation in bankruptcy that was perhaps intended. This is good news, however, for companies facing reorganization, which need to provide appropriate compensation to their employees in order to negotiate the difficult terrain of Chapter 11 and emerge successfully.
Background: Pre-Act Use of KERPs
Prior to the Act, KERPs were used routinely by debtors in Chapter 11 cases in an effort to retain key employees, principally senior management, who might otherwise seek employment at another, more financially stable, company. Underlying the widespread use of KERPs was the premise that the retention of knowledgeable and experienced personnel, particularly at senior levels, is often critical to enabling a troubled company to reorganize successfully, ultimately maximizing value to creditors. Although compensation packages varied from case to case depending on the debtor's needs, typical components of a KERP included: performance-based incentive bonuses; retention bonuses; success bonuses upon meeting bankruptcy benchmarks; discretionary bonuses for rank and file employees; severance benefits; and assumption of existing employment or severance agreements. Because no Bankruptcy Code provision specifically addressed KERPs, bankruptcy courts considered whether to approve a KERP against the standards for non-ordinary course use of property of the estate under ” 105(a), 363(b) and 365(a) of the Bankruptcy Code: whether the program was fair and reasonable and within the debtor's sound business judgment. This standard afforded a debtor substantial flexibility in formulating a KERP.
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