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Overview of Limitations on Employee Compensation in Bankruptcy
The filing of a bankruptcy case by a company creates substantial uncertainty for its employees. This uncertainty can translate into employee departures, lack of focus on the business, and diminution in the value of the company. Recognizing these potential consequences, companies in Chapter 11 bankruptcy often try to reduce employee uncertainty by seeking authority from the bankruptcy court to: 1) honor unpaid compensation and benefit obligations to employees; 2) continue severance and benefit plans post-bankruptcy; and/or 3) continue existing bonus programs or establish retention or new incentive programs for employees.
The Bankruptcy Code, however, imposes a variety of limitations on the ability of a debtor-employer to provide certain types of compensation and benefits to "insiders," a term that is broadly defined in the Bankruptcy Code. Moreover, as a general matter, compensation and benefits paid to insiders by a debtor company are closely scrutinized, and incentive programs for insiders often become a focal point for disputes between a company, its creditors, and the United States Trustee. This article, which focuses primarily on Delaware law, provides a high-level summary of several common issues that often arise in bankruptcy related to insider compensation and benefits.
Who Is an Insider?
Under section 101(31) of the Bankruptcy Code, an "insider" of a corporation includes, but is not limited to: a) a "director of the debtor;" b) an "officer of the debtor;" c) a "person in control of the debtor;" d) a "partnership in which the debtor is a general partner;" e) a "general partner of the debtor;" f) a "relative of a general partner, director, officer, or person in control of the debtor;" or g) any "affiliate, or insider of an affiliate as if such affiliate were the debtor." 11 U.S.C. §101(31)(B) & (E). Thus, courts will consider titles, relationships, and general ability to "control" a debtor (as discussed below) in determining whether an individual constitutes an insider. Importantly, individuals who are named officers or directors of a debtor — including named officers or directors of defunct or shell subsidiaries of a debtor — should be wary that, based on such titles, courts may consider them presumptively insiders of the debtor under section 101(31). See, In re Foothills Texas, Inc., 408 B.R. 573, 579 (Bankr. D. Del. 2009) ("Just as there may be non-statutory insiders that fall within the definition of an insider but are outside of the enumerated categories, there may be persons that fall within the enumerated categories but do not meet the definition of the category …. In order to overcome the presumption that a person holding an officer's title is not what he or she appears to be requires submission of evidence sufficient to establish that the officer is, in fact, not participating in the management of the debtor.").
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