Judge Approves $20 Million in Executive Bonuses From Bankrupt Company, Finding That Incentives Weren't "Lay-ups"

| Jason M. Knott

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A bankruptcy can be hazardous to the health of an executive’s bonus check.  Sometimes, however, an executive can survive an attack on a bonus in a bankruptcy, and come out clean on the other side.  For example, we covered here how one executive succeeded in keeping most of his incentive payments based on the timing of those payments. 

Now, we have another lesson in how executives can keep their bonus checks despite a bankruptcy, from Judge Christopher S. Sontchi of the U.S. Bankruptcy Court for the District of Delaware.  The company at issue in the case was Energy Future Holdings Corp. (EFH), a holding company with a portfolio of Texas electricity retailers.  EFH filed for Chapter 11 bankruptcy in April of this year.

As is typical, a trustee is monitoring EFH’s bankruptcy on behalf of the United States government.  The U.S. trustee wasn’t happy when EFH asked the bankruptcy court to allow it to pay more than $20 million in executive bonuses, and she opposed the request.  The trustee argued that the proposed payments were “pay to stay” payments to keep the executives from leaving, and not “pay for value” payments that would incentivize enhanced performance by the execs.  Because the targets for the bonuses were actually “lay-ups” and too easy to meet, she said, they fell within a provision in the Bankruptcy Code  imposing stricter restrictions on bonus payments that aren’t rewards for good performance.  (We previously covered this provision (Section 503(c)) here, in connection with American Airlines’ $19.8 million payout to CEO Tom Horton in its bankruptcy.) 

Meanwhile, EFH contended that the targets were “difficult to achieve, reasonable and fairly incentivize[d] plan participants.”  Further, it noted that none of the company’s creditors had objected to the request to pay the bonuses.

After a three-day trial, Law360 reports, Judge Sontchi sided with EFH against the trustee, finding that the company had presented a “thorough, persuasive and unblemished record” that the bonus plans were indeed incentive plans, because their targets were difficult to obtain.  EFH succeeded in making its case for the bonuses because it showed, with the support of testimony from compensation experts, that the payouts were consistent with historical practice at the company and with standards throughout the energy industry.  EFH also helped its cause by making the targets more difficult to reach in the midyear period after it filed for bankruptcy, which wasn’t its usual practice. 

The lesson from the EFH ruling is that a company can protect its incentive bonuses for its employees, even in bankruptcy, by making sure it sets legitimate targets for those bonuses at the outset.  If the bonuses are truly too easy to meet, as the trustee contended, a bankrupt company may face stricter scrutiny before it is allowed to pay them out.  Involving compensation experts at the bonus-setting stage will help a company make a stronger case that its targets are three-pointers, not lay-ups.