Validity of Bonus Plan for Insiders Turns on Difficulty of Performance Targets, New Hampshire Federal Court Rules

By Peter D. DeChiara

pdechiara@cwsny.com

Posted September 2015

Chapter 11 debtors often ask the bankruptcy court to approve a bonus plan for “insiders” like corporate officers and top management.  These proposed bonus plans frequently meet opposition, particularly in cases where the debtor also seeks to cut the pay and benefits of its unionized workforce.  Whether a bonus plan for “insiders” passes muster generally depends on its purpose.  Section 503(c)(1) of the Bankruptcy Code all but outlaws insider plans aimed at keeping the top corporate executives on the job.  On the other hand, courts have interpreted Section 503(c)(1) to permit bonus plans aimed at inducing the insiders to achieve financial targets or other corporate goals.  In the decade since Section 503(c)(1)’s enactment, the courts have  struggled to divine the true nature – retentive versus incentive – of  proposed insider bonus plans.  The recent decision of the New Hampshire federal district court in GT Advanced Technologies, Inc., Case No. 15-cv-069 (D.N.H. July 21, 2015), reversing a bankruptcy court’s rejection of an insider plan, is one of the latest additions to this developing case law.

In GT Advanced, a technology company filed for Chapter 11 protection and proceeded to lay off seventy percent of its workforce.  It then moved for approval of a bonus plan, of up to approximately $3.3 million, for nine senior management employees.  Payment of the bonuses depended under the plan on the executives’ performance toward achieving certain goals, such as maximizing the value received for certain assets or minimizing the cost of “deinstalling” certain equipment.  Objections to the proposed insider plan were filed by a shareholder and by the U.S. Trustee (the U.S. Justice Department official assigned to monitor bankruptcy cases).

The bankruptcy court denied the debtor’s insider bonus plan motion, finding the proposed plan to be nothing other than a “disguised retention agreement.”  Bankruptcy judge Henry Boroff explained that during the hearing on the motion, whenever he inquired about the plan, the debtor’s witnesses testified only about how damaging it would be to the company if the top management team quit.  The bankruptcy judge also concluded that the executives would not work any less diligently without the promise of the bonuses.

On appeal, the district court ruled that the bankruptcy court had erred, and remanded to the bankruptcy court for further consideration.  District judge Landya McCafferty held that the “key question” in determining whether an insider bonus plan is retentive or incentive is whether it incorporates performance targets that are difficult to achieve.  Quoting prior case law, she wrote that  “[a] plan that does not require affirmative action beyond that contemplated prepetition is not incentive, but is retentive and cannot be approved under the more lenient standards for incentive plans.”  The judge noted that while cases evaluating proposed insider bonus plans typically contain detailed analyses of the plan, here the bankruptcy court’s ruling relied exclusively on statements from debtor witnesses about the importance of the executive team to the debtor’s reorganization.  The district judge instructed the bankruptcy court on remand to determine whether the debtor’s proposed plan had “sufficiently stringent metrics” to qualify as an incentive plan.

On a separate issue, the district court in GT Advanced ruled that the bankruptcy court also failed to apply the proper analysis in evaluating the debtor’s second proposed bonus plan, this one for a group of non-insider employees.  Judge McCafferty explained that such a plan required application of the “facts and circumstances” test of Section 503(c)(3) of the Bankruptcy Code, not Section 363(b)(1)’s “business judgment” test.  Moreover, although some courts have found the two tests to be equivalent, Judge McCafferty endorsed the better view, expressed by some courts, that the “facts and circumstances” test requires more scrutiny of the proposed plan than would the deferential “business judgment” test.

Cases like GT Advanced show that in opposing insider bonus plans, unions or employee benefit funds should focus their attack on the performance metrics in the plan.  They should focus on holding the debtor to its burden of demonstrating that the targets require the executives to “stretch” in performing their duties.