SOUTHEASTERN BANKRUPTCY LAW INSTITUTE: THIRTY-SECOND ANNUAL

SEMINAR ON BANKRUPTCY LAW

KEY EMPLOYEE RETENTION PROGRAMS UNDER BAPCPA

Presented by

Paul Steven Singerman Douglas Alan Bates

Berger Singerman, P.A. 200 S. Biscayne Boulevard

Suite 1000 Miami, Florida 33131

Telephone: (305) 714-4343 Telecopier: (305) 714-4340

singerman@bergersingerman.com

Grand Hyatt Atlanta Hotel Atlanta, Georgia

April 6-8, 2006

Thirty-Second Annual Southeastern Bankruptcy Law Institute Atlanta, Georgia April 6-8, 2006

Key Employee Retention Programs Under BAPCPA

Paul Steven Singerman

Douglas Alan Bates Berger Singerman, P.A.

I. Introduction

The sounds of Washington, D.C. in the year 2006:1

“Our purpose here today is to help investors keep an eye on how much of their money is being paid to the top executives who work for them….It’s high time we updated the rules on executive compensation.” - SEC Chairman Christopher Cox “Many investors think ‘payment for performance has been replaced by payment for pulse.’” – SEC Commissioner Roel Campos.

Nearly thirty years ago, in an essay entitled “Is Executive Pay Excessive?,” management guru

Peter Drucker predicted that executive compensation would spur a revolt among Americans, stating “I very much fear that it will come soon.”2 During the three decades following Drucker’s prediction, the United States has watched executive compensation grow at an astonishing pace. In the face of seemingly limitless executive compensation, perks, and benefits and the concurrent frontal attack on pension and health care benefits for non-executive employees, Congress has, until recently, maintained a laissez faire attitude with regard to private business, allowing businesses to create and maintain their own compensation systems and pay scales. Some simple facts reported in a 2006 Wall Street Journal article entitled “Are CEOs Worth Their Weight in Gold?” shed light on the extraordinary executive compensation that Drucker warned against. For example, in the United States, the average CEO’s salary is 475 times greater than the average worker’s salary.3 By way of comparison, “[i]n Japan, it is 11 times greater; in France, 15 times; in Canada, 20; in South Africa, 21, and in Britain, 22.” No matter your politics, it is also interesting to note that “[i]n 1960, the ratio of the average Fortune 500 CEO’s pay to the U.S. president’s salary was 2-1. Today, it is 30-to-1.”4 Perhaps it is this vast separation between executive and non-executive compensation that drove the federal government’s hands-off approach to an end in the form of the April 2005 enactment of certain executive compensation related provisions in the Bankruptcy Abuse Prevention Consumer Protection Act (the “BAPCPA”).

1 See, Lauren Etter, Are CEOs Worth Their Weight in Gold?, Wall Street Journal Weekend Edition, January 21-22, 2006. 2 See, generally, Peter Edmonston, Foot in the Door; Article posted on December 15, 2005 at www.thedeal.com. 3 See, note 1, supra. 4 Id.

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Before BAPCPA, bankruptcy courts frequently allowed Chapter 11 debtors to adopt Key Employee Retention Programs (“KERPs”). Generally, the courts accepted the debtor’s argument that a KERP was necessary to stabilize a debtor’s operations and motivate key employees who were expected to make substantial contributions to the success of the Chapter 11 debtor’s ongoing business or restructuring efforts. A typical pre-BAPCPA KERP provided for bonuses and other incentives to encourage executives and other employees to remain with a bankrupt entity as it reorganized or liquidated. As the popularity and frequency of KERPs increased, so too did criticism of them by organized labor, academics, the Office of the United States Trustee, creditors’ committees, individual creditors, media and regulatory observers.5 For years, the concerns of most bankruptcy constituencies fell on deaf ears in Congress. But, late in the eight-year debate over bankruptcy amendments, Senator Edward Kennedy (D. Mass.) proposed an amendment to 11 U.S.C. § 503, which was enacted into law by the BAPCPA. Senator Kennedy’s amendment severely restricts the maximum amount of permissible KERP payments and imposes new and difficult evidentiary hurdles for the approval of KERPs.

In support of Senator Kennedy’s proposed amendment, Dave McCall, a director with the

United Steel Workers of America, AFL-CIO, testified before the U.S. Senate Committee on the Judiciary, categorizing KERPs as nothing more than corporate abuse.6 Apparently, that was all that the Senate needed to finally weigh in and limit KERPs. With Senator Kennedy’s amendment and the political peril of opposing it, the genre of rich KERPs seems to have come to an end with the passage of BAPCPA. The manner in which the BAPCPA addresses the perceived abuses wrought by overgenerous executive retention packages raises serious practical issues for bankruptcy professionals. There is little question that the BAPCPA will challenge the continued viability of KERPs, but like any new statute, the amendments to KERPs will require bankruptcy professionals to concentrate on developing creative solutions to the BAPCPA’s apparent KERP roadblocks. This article will address the practical problems with KERPs that are certain to arise post-BAPCPA, and will explore creative solutions for dealing with executive compensation and employee retention under the new law.

II. Pre-BAPCPA KERP Considerations A. Typical Features of Pre-BAPCPA KERPs

Various commentators have referenced the types of payments and the bankruptcy vernacular used to identify them that are included in a typical KERP.7 A typical KERP may include some or all of the following types of payments triggered by certain milestones or events during the bankruptcy case:

5 See, e.g., In re Georgetown Steel Co., LLC, 306 B.R. 549 (Bankr. D. S.C. 2004) (approving implementation of key employee retention program over objections of union employees). 6 See, Bruce Grohsgal, New Law Deals Severe Blow to KERPS, Severance Programs, posted August 1, 2005 at www.turnaround.org. 7 The factors listed below derive from a review of various articles, including the following: 1) Gary Kaplan, Executive Compensation Issues Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, August 2005 Benefits Practice Center Journal Reports: Law and Policy, posted at www.howardrice.com; and 2) Robert J. Keach, The Case Against KERPS, April 2003, posted at www.abiworld.org.

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1. Retention payments to eligible employees who remain employed by the debtor company through a particular date or through a certain event (e.g., the filing or confirmation of a reorganization plan or completion of an asset sale). Occasionally, KERPs will provide for payments on an interim basis, setting a schedule of milestones for the reorganizing debtor to reach and providing compensation to the key employees who assist in reaching those milestones. Some constituencies argue that retention payments do little to foster the successful reorganization of the debtor, and little to actually incentivize the employees, as retention payments generally do not contain performance hurdles. This argument is seen in the Campos quote, supra, noting that retention payments are tantamount to “payment for a pulse” instead of pay based on performance. 2. Success bonuses payable to eligible employees upon the occurrence of one or more specified events (such as achievement of a targeted dividend to creditors, confirmation of a plan, sale of assets or emergence from bankruptcy). Success bonuses may also be paid to employees if the reorganizing debtor is able to achieve pre-determined financial targets, often gauged by EBITDA8 or EBITDAR9 levels or target sale prices for certain company assets. 3. Severance payments to eligible employees whose employment is involuntarily terminated without cause; and 4. “Golden parachutes” payable to eligible employees in the event of employment termination or a specified loss in status after a defined change in control of the company.

B. The Good, the Bad and the Ugly: Pros and Cons of KERPs Prior to BAPCPA 1. PROS – KERPs Can’t Be That Bad, Can They?

At the American Bankruptcy Institute Annual Spring Meeting in April of 2003, Robert J. Keach delivered a powerful presentation based on his article entitled The Case Against KERPs.10 In the article, Keach served up the following ten arguments often advanced by debtors’ counsel when lobbying constituencies or seeking court approval of KERPs: a. Retaining the covered executives is critical to the success of the reorganization/liquidation due to their familiarity with the business, experience, knowledge, and/or specialized skill, as well as the need for "strong leadership" as the debtor deals with the chapter 11 process;

b. The debtor’s industry is competitive, and the debtor’s competitors or headhunters will aggressively recruit qualified candidates and/or are actively "targeting" the covered key employees; if the executives are not compensated for the risk of staying on, they will leave;

c. Turnover is occurring at the debtor’s business, with some employees leaving the debtor’s employ;

8 EBITDA refers to Earnings Before Interest, Taxes, Depreciation and Amortization. 9 EBITDAR refers to Earnings Before Interest, Taxes, Depreciation, Amortization and Reorganization Costs. 10 See, Keach, note 6, supra. The 10 arguments included herein come directly from the Keach article.

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d. Stock options held by the covered executives (or which could be issued to them) have been rendered worthless by the chapter 11 filing, thus causing the executives’ overall compensation package to "trail the market" (placing the debtor at a disadvantage in trying to retain the executives);

e. Due to the chapter 11, the debtor’s employees (including, presumably, the covered executives) are subject to employment demands and burdens that persons in comparable positions at other, non-debtor companies are not;

f. Due to its fragile state, the debtor cannot afford to lose members of the current management team or other key employees;

g. The loss of key employees will cause the debtor to incur search and headhunter fees, signing bonuses, relocation expenses, etc., all of which will be necessary to attract comparable talent to a company that is attempting to restructure its financial affairs;

h. The KERP is the product of consultation with an expert on KERPs retained by the debtor who has determined that the KERP is necessary to retain the selected executives, is designed to accomplish that goal, and is in line with similar KERPs for comparable companies in comparable chapter 11 cases;

i. KERPs are approved in other chapter 11 cases (and in "most large chapter 11 cases"); and

j. Retaining the executives will benefit the estates and maximize creditor recoveries.

2. CONS - Reasons for Reigning in KERPs

After listing the most frequently cited arguments in favor of KERPs, the Keach article then attempts to establish the fatal flaws with the pre-BAPCPA KERP standards. Keach offers another “top-ten” list, but this time listing the reasons why KERPs should be banned outright, stating that “[t]op-heavy KERPs, in particular, are more of a detriment to the bankruptcy system than their highly speculative benefits, if any, would seem to justify.”11 The con “top-ten” list is as follows: a. KERPs don’t work. There is no evidence that bonus payments actually result in the retention of employees who would otherwise leave, and considerable anecdotal evidence in cases with KERPs suggests that they made no material difference. In Kmart, 19 of 25 covered executives were gone within six months [of the bankruptcy court’s approval of the KERP].12 In Enron, prior to the implementation of a pricey KERP, the Debtor was losing 30 employees a week. At the time the Debtor sought approval of an additional KERP, the rate was still 9-10 per week, but the Debtor had ten times fewer employees. On a percentage basis, the outflow was greater after approval of the KERPs. Moreover, since the last employees were either the most loyal or the least mobile, the KERP was 11 See, Keach, note 6, supra. The “top-ten” list comes directly from the Keach article. However, all supplementary footnotes have been supplied by the authors. 12 While the media, labor and various commentators made it common practice to blast the Kmart KERP, it is worth emphasizing that Kmart’s share price certainly has not suffered. In fact, in an article posted on retailtraffic.com on January 30, 2002, some 8 days after Kmart filed for Chapter 11 protection, Joel Groover noted that when Kmart filed bankruptcy, its stock price “plummeted” from a 52 week high of $13.55 to 66 cents a share practically overnight. Interestingly, in an article entitled Kmart Stock Price Skyrockets, posted on theoaklandpress.com in March 2005, good news was reported for Kmart shareholders, with stock traveling through the roof – up 53% to $127 per share. The article noted that “Kmart stock has been a Wall Street success story, rising more than 700 percent since it emerged from bankruptcy in May 2003.”

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hardly successful by any standard. A number of human resource or "human capital" experts openly question whether money is ever a critical factor in retaining employees;

b. KERPs don’t work better than cheaper alternatives. The best "glue" is a well-run employee communication program; keeping employees informed and having them invested in the problem-solving process is more likely to retain them than money. The "lie" of KERPs is exposed by the majority of middle-market chapter 11 cases in several jurisdictions which operate perfectly well without KERPs and yet the key employees do not leave. In these cases, management and other employees – at all levels – are kept aware of the progress of the case through successful communication and since they know the status of the case, they can make an informed judgment to stay on, and usually do;13

c. KERPs are often unnecessary. Employees who have remained through the run-up to chapter 11 are unlikely to leave just because the petition was filed. In many cases, the state of the industry and/or the state of the employment market will not permit employee mobility, and most employees have other factors causing them to stay put. Moreover, as Kmart suggests, often the "critical executives" turn out not to be as essential as advertised;14

d. The prototypical, top-heavy KERP is "upside down." Often, the senior-most executives are the most replaceable employees, with the least to contribute to the process, not to mention the lack-of-credibility baggage they may bring.15 Yet they get the most money. The growth of a professional class of CRO’s makes retention of the prepetition CEO, and his immediate top-level team, less important;

e. Most KERPs, despite favoring senior management, are over-inclusive. Can it really be true, as with the last KERP in Enron, that 900 of about 1100 employees are truly critical?;

f. KERPs contribute significantly to the risk of administrative insolvency, particularly in smaller cases, and may contribute to keeping cases in chapter 11 beyond when it is reasonable to do so just so that KERP milestones are met;

g. KERPs have a negative impact on employee morale among the rank and file employees not blessed to be included in the KERP. As noted above, this fact was recognized in Geneva Steel,16 where the court criticized the debtor for not discussing the KERP with the union. This is also one reason some debtors seek to keep the details of KERPs “secret,” with particulars kept “under seal,” as

13 Successful communication, while important, does not always carry the day. Query how communication alone could serve to maintain the critical employee base of a company that makes a strategic decision, for the benefit of unsecured creditors, to cease operations and pursue a liquidating chapter 11 plan, such as the decision made by FLYi, Inc., discussed in detail, infra. 14 Again, as referenced in note 11, supra, one must consider Kmart’s post-confirmation share price when evaluating the effectiveness of the KERP. 15 There can be little argument that “bad apples” who steer their companies into bankruptcy while pilfering company assets and disguising less than perfect financial performance should not be able to share in bonus features intended to retain their services. In fact, when Senator Orin Hatch proposed limiting Senator Kennedy’s proposed KERP Amendment, he made sure to note that Enron-types would not be allowed to receive retention benefits. However, 11 U.S.C. § 503 paints with a broad brush, and instead of isolating corporate wrongdoers, it effectively deprives all of the benefits under a KERP for the actions of a few. 16 In re Geneva Steel Co., 236 B.R. 770 (Bankr. D. Utah 1999).

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the morale of those “left off the list” is almost always negatively impacted. This can be particularly true of rank and file employees who will tend to see the KERP as just another example of executive self-enrichment while their benefits are cut and layoffs occur. As the Geneva Steel court recognized, union and other employees who see the KERP as too generous may also withdraw support for the debtor’s reorganization effort, making competing plans more likely and confirmation more difficult;

h. KERPs breed a lack of faith in, and a lack of respect for, the bankruptcy system among creditors and rank and file employees who cannot grasp how the folks who drove the bus off the road get bonuses while vendors go unpaid, retiree benefits are slashed, and other wage-related, pension and severance claims remain unsatisfied. A quick review of the press surrounding attempts to implement top-heavy KERPs while curtailing employee and retiree benefits reveals what damage can be done to the public’s perception of the integrity and fairness of the bankruptcy system, whether or not that perception is correct;

i. KERPs raise serious questions of business ethics, given the timing of most KERP-approval motions, early in the case at the same time as motions are filed or actions taken to curtail other employee and retiree benefits or reject labor agreements; and

j. If practitioners and their debtor clients do not limit the use of overly-generous, top-heavy KERPs, Congress will happily perform the task, leading to legislation resembling more the axe than the scalpel, as Congress nearly did with section 104 of the “Employee Abuse Prevention Act of 2002.”17

C. Case Law Helps Define KERP Boundaries

Decisional law relating to KERPs consists almost entirely of pre-BAPCPA opinions. Due to the recent enactment of the BAPCPA, as of the date of this writing, minimal decisional law exists with regard to KERPs post-BAPCPA. However, an analysis of critical points from pre-BAPCPA case law may be useful when analyzing and predicting the future of KERPs under the new law. Generally, pre-BAPCPA courts faced with the decisions of whether to approve, disallow or modify a debtor-in-possession’s proposed KERP examine the facts and circumstances of the case, paying particular attention to the following list of factors:18 1. Employee Loss: Whether there is an immediate danger of losing key employees because those employees have already been approached by competitors, or because the debtor has reason to believe that it is likely those employees are exploring other employment options,19 as well as the post-petition turnover rate of employees;20

17 The Employee Abuse Prevention Act of 2002 (the “Employee Act”) provided for pre-BAPCPA 11 U.S.C. § 503 to be amended to include the exact KERP limiting language that is now embedded in 11 U.S.C. § 503 by virtue of the BAPCPA. The Employee Act, standing alone, did not make it through Congress. However, Senator Kennedy’s late amendment to the BAPCPA essentially made the relevant provisions of the Employee Act law. In any event, the Keach article proves to be sage in its prediction that Congress was not far from taking KERP matters into its own hands. 18 See, Kaplan, FN 6, supra. The list of factors comes directly from the Kaplan article. 19 Id. (citing In re Montgomery Ward, 242 B.R. 147, 150 (Bankr. D. Del. 1999) (noting that the debtor's employees were being targeted at an unusually high rate by other organizations and competitors); Geneva Steel Co., 236 B.R. at 772 (noting that the debtor “contends that there is a real danger that key employees will be enticed away by other companies if a retention plan is not implemented”); see also In re Aerovox, 269 B.R. 74,76 (Bankr. D. Mass. 2001) (“[Creditors] expressed

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2. Replacement Costs: The anticipated costs associated with replacing key employees who are in danger of leaving, including “headhunter” and recruitment expenses, and the time associated with bringing new employees “up to speed;”21 3. Retention Period: How long the KERP requires employees to stay with the company. (While there is no fixed time period that courts have mandated, the case law suggests that courts have approved plans that require employees to stay for a fixed period of time ranging from six months through plan confirmation.);22 4. Industry Comparison: Whether the proposed compensation under the KERP is sufficiently in line with compensation paid to similarly situated employees in the comparable industry;23

5. Broad or Narrow: Whether the plan takes a broad or narrow approach to employee compensation, i.e., whether the plan covers highly paid executives, or all employees and, if the plan covers only key or essential employees, how the plan defines “essential;”24 6. Overall Cost: The overall cost of the KERP, and whether the potential expenses appear reasonable and are transparent and fairly predictable;25 7. Pre-Bankruptcy Pay Cuts: Whether employees were forced to take pay cuts or whether their benefits were decreased before the company filed for bankruptcy (e.g., through stock or stock options that have become worthless);26

concern about binding the estate to potential administrative claims, without first providing any evidence that any `key' personnel have either threatened to leave or are planning to leave prior to the Debtor's submission of a prospective sale ....”) (internal citation omitted). 20 Id. (citing Montgomery Ward., 242 B.R. at 150 (asserting employee attrition rate of 20 percent); cf. Geneva Steel, 236 B.R. at 772 (considering anecdotal evidence of employee attrition based on the debtor's statement that “the loss of key employees often leads to the resignation of other key employees”)). 21 Id. (citing Aerovox, 269 B.R. at 78-81). 22 Id. (citing Montgomery Ward, 242 B.R. at 150 (requiring employees to remain for period amounting to 15 months according to proposed plan); In re Interco, 128 B.R. 229, 231 (Bankr. E.D. Mo. 1991) (requiring employees to remain for duration of Chapter 11 proceeding pursuant to proposed plan). 23 Id. (citing Montgomery Ward, 242 B.R. at 150 (relying on evaluation of third-party consultant in determining that compensation package was in line with others in industry); Geneva Steel, 236 B.R. at 773-74). 24 Id. (citing Montgomery Ward, 242 B.R. at 150; In re America West Airlines, 171 B.R. 674, 677-78 (Bankr. D. Ariz. 1994)). 25 Id. (citing Interco, 128 B.R. at 232 (evaluating the threshold, target, and maximum amounts of the proposed plan)). 26 Id. (citing Aerovox, 269 B.R. at 78, 80 (expressly recognizing that employee benefits were suspended prior to the debtor's bankruptcy filing)).

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8. Waiver of Claims: Whether employees agree to waive potential claims against the debtor under pre-petition employment contracts, such as claims based on a “change in control” agreement;27 9. Severance Benefits: Whether the program provides for reduced severance benefits if the terminated employee obtains employment during the relevant time period;28 and 10. Process Utilized: The process that the board of directors used in approving the retention or severance program, including whether the board hired an outside consultant to advise it on the need to implement the program;29

III. Who’s Idea Was This Anyway: Legislative History of BAPCPA

A. Senator Kennedy’s “Hail Mary” That Became the Law of the Land

It is now obvious that the opponents of pre-BAPCPA KERPs did not believe that usual tensions in the Chapter 11 process, the Office of the United States Trustee and the judiciary were doing an effective job policing KERPs and insuring that they were being utilized only when and to the extent necessary to satisfy legitimate bankruptcy goals and objectives. On February 17, 2005, the Senate Judiciary Committee marked up S. 256 and ordered the bill, as amended, to be favorably reported by a vote of 12 to 5.30 Over the course of the markup, five amendments were passed. One of the amendments, reproduced below as proposed by Senator Edward Kennedy, would become the basis for BAPCPA’s quite severe restrictions on KERPs.

“an amendment by Senator Kennedy limiting retention bonuses, severance pay, and other

payments to insiders of the debtor, under certain circumstances;”31

In fact, the amendment proposed by Senator Kennedy did not differ substantively from the Employee Act discussed above. As noted above, the Employee Act met with limited success in the halls of Congress as soon as 3 years before the BAPCPA amendment proposed by Senator Kennedy. Nearing the end of a tortured 8 year battle to pass some form of bankruptcy legislation, beleaguered members of Congress on both sides of the aisle were anxious to be done with the dreaded BAPCPA - 27 Id. (citing Interco, 128 B.R. at 232 (considering two executives' waiver of “change in control” claims under their current employment agreements in exchange for payments under the proposed retention plan)). 28 Id. (citing Geneva Steel, 236 B.R. at 773-74 (refusing to approve severance plan that would pay either six or nine months salary as severance payments unless plan reduced amount of payment if employees obtained other employment during the relevant time period)). 29 Id. (citing Montgomery Ward, 242 B.R. at 150-51 (expressly relying on significant discussions among directors, and lengthy consultations with financial advisors in determining the need for, and fashioning, a retention plan); Aerovox, 269 B.R. at 78-81 (noting that the debtor's board of directors met five times before submitting the retention plan proposal to the court and had many serious discussions regarding the cost-benefit analysis, and indicating that this “established that the Board utilized sound business judgment”); America West Airlines, 171 B.R. at 677 (finding significance in the board's use of outside professional services consultant in designing an employee bonus plan)). 30 See, 109th Congress, 1st Session, House Report 109-31 Part 1 (2005). 31 Id.

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one way or another. Republicans wanted to tout a victory against bankruptcy abuse, and perhaps Democrats just wanted to be done.

Indeed, limited Congressional testimony following the February 2005 Kennedy Amendment

does exist, but it is clear from the testimony (and from the end result) that Republicans were not going to hold up bankruptcy reform another year to settle KERP issues. At least one constituency, the Association of Insolvency and Restructuring Advisors (“AIRA”), expressed great concern over the Kennedy Amendment, and sent an open letter to Senator Arlen Specter which was read into the Congressional record on two separate occasions in opposition to the Kennedy Amendment.32 But the AIRA letter had little effect on Congress.33

Given the outcome on the KERP amendment, it is clear that the Senate testimony of Dave

McCall, reproduced in part below, reverberated through the halls of Congress with greater force than the AIRA letter. With obvious angst towards what he described as “notorious KERPs,” McCall testified as follows:

“‘[t]hese are ‘golden parachutes’ payable to executives of a reorganizing company and

rewarding them handsomely, often after they have cut workers’ pay,34 reduced or eliminated retiree benefits, shuttered plants, and sold them off….When workers learn of a KERP or a massive fee award [paid to professionals], it puts our bankruptcy system in a bad light and often makes the difficult choices required in bankruptcy even harder to achieve.’”35

With the AIRA letter matched up against organized labor as the only substantial pieces of testimony relating to KERPs, and as the BAPCPA neared the finish line in its ultra-marathon through Congress, on March 1, 2005 Senator Orin Hatch made the following comments regarding Senator Kennedy’s KERP amendment:

“We have language in this issue which would mitigate what I believe are unintended effects of this amendment. Under this modified language, all payments where “misconduct, fraud, or mismanagement” is present are prohibited. This language also keeps the burden on chapter 11 companies to prove that retention bonuses are “necessary, fair and reasonable,” and “likely to enhance a successful reorganization.” This seems like a reasonable fix to me and I hope we include this language in the bill. I appreciate any help my friend from Massachusetts would give on that particular issue because if we are interested in doing what is right, this will do what is right.”36

32 The AIRA letter is attached hereto as Exhibit “A.” 33 From a conversation with Sam Gerdano, Executive Director of the American Bankruptcy Institute, we learned that consistent with the ABI’s internal policy regarding pending legislation, the ABI did not take a formal position regarding the proposed KERP amendment. 34 Consider Delphi’s initial KECP plan described in detail, infra, wherein workers’ hourly wages would be cut in half at the same time that executives were to receive large bonuses. 35 See, Grohsgal, note 5, supra. 36 See, 151 Cong. Rec. S 2306, 109th Congress, 1st Session (2005). Note the the standards referred to by Senator Hatch are substantially lower than the standards proposed by Senator Kennedy.

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Despite this last plea from Senator Hatch, Senator Kennedy’s KERP amendment remained unaltered, and President Bush signed the BAPCPA into law in April of 2005. As a result, new 11 U.S.C. § 503 focuses not only on the bad actor types who were the catalyst for the Kennedy Amendment and who would have been excluded under the more narrow revisions alluded to by Senator Hatch, but instead indiscriminately on nearly all employees of a debtor.

IV. The New Statutes: 11 U.S.C § 503(c) and 11 U.S.C. § 548(a)(1)(B)(ii)(IV)

A. 11 U.S.C § 503(c) As noted in note 16, above, BAPCPA’s restrictions on KERPs are not new. Instead, they are recycled from previous failed legislation. BAPCPA’s 11 U.S.C. § 503(c), provides as follows:

(c) Notwithstanding subsection (b), there shall neither be allowed, nor paid-- (1) a transfer made to, or an obligation incurred for the benefit of, an insider of the debtor for the purpose of inducing such person to remain with the debtor's business, absent a finding by the court based on evidence in the record that-- (A) the transfer or obligation is essential to retention of the person because the individual has a bona fide job offer from another business at the same or greater rate of compensation; (B) the services provided by the person are essential to the survival of the business; and (C) either-- (i) the amount of the transfer made to, or obligation incurred for the benefit of, the person is not greater than an amount equal to 10 times the amount of the mean transfer or obligation of a similar kind given to nonmanagement employees for any purpose during the calendar year in which the transfer is made or the obligation is incurred; or (ii) if no such similar transfers were made to, or obligations were incurred for the benefit of, such nonmanagement employees during such calendar year, the amount of the transfer or obligation is not greater than an amount equal to 25 percent of the amount of any similar transfer or obligation made to or incurred for the benefit of such insider for any purpose during the calendar year before the year in which such transfer is made or obligation is incurred; (2) a severance payment to an insider of the debtor, unless-- (A) the payment is part of a program that is generally applicable to all full-time employees; and (B) the amount of the payment is not greater than 10 times the amount of the mean severance pay given to nonmanagement employees during the calendar year in which the payment is made; or (3) other transfers or obligations that are outside the ordinary course of business and not justified by the facts and circumstances of the case, including transfers made to, or obligations incurred for the benefit of, officers, managers, or consultants hired after the date of the filing of the petition.

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B. 11 U.S.C. § 548(a)(1)(B)(ii)(IV) While some may view hefty employment agreements with big signing bonuses executed on the eve of bankruptcy as an “end around” to the troublesome KERP restrictions outlined in § 503(c), the drafters of BAPCPA attempted to foreclose such planning tools through 11 U.S.C. § 548(a)(1)(B)(ii)(IV), which reads as follows:

(a)(1) The trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debtor in property, or any obligation (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily--

(A) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted; or (B)(i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and (ii)(I) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation; (II) was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital; (III) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor's ability to pay as such debts matured; or (IV) made such transfer to or for the benefit of an insider, or incurred such obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business. The new provisions of 11 U.S.C. § 548 are intended to backstop 11 U.S.C. § 503, and to discourage troubled companies and their managers from seeking to avoid the restrictions of section 503 by entering into employment agreements with large signing bonuses on the eve of bankruptcy. The new provisions of § 548 create a statutory basis to sue and recover such payments and thus give the recipients of them concern over whether they will get to hold onto the eve of bankruptcy type payments. The question remains whether this prospect of being sued will give managers of troubled companies pause when considering tantalizing employment agreements at a time when their companies are facing financial hardship.

V. Trouble for Troubled Companies: Issues Under the New Statutes

A. Thoughts About Retention Programs:

In the days leading up to the passage of the BAPCPA, and in the few months since, practioners and commentators alike have worked to analyze the practical impact of the new KERP law and employee compensation structures and legal arguments to avoid it. In an article published by Bruce Grohsgal

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entitled New Law Deals Severe Blow to KERPs, Severance Programs,37 Grohsgal did an excellent job of articulating issues that troubled companies will face under the BAPCPA KERP provisions, including:

1. Who qualifies as an officer or a non-director control person under the new Section 503(c) for determining whether such person is an insider, and who qualifies as a non-management employee in determining the group used in calculating the 10 times cap?;

2. Strictly speaking, who, if anyone, is “essential” to the debtor’s survival? ; 3. What constitutes a transfer or obligation of a similar kind in a calendar year for

determining whether the 10 times or 25 percent cap applies, and for determining the transfers or obligations against which the 10 times cap will be measured?; and

4. Can a debtor that had no pre-petition retention program and made and incurred no pre-

petition transfers or obligations to officers, directors or any other employees find any basis under Section 503(c)(1) to make a post-petition retention payment to an officer or director? If no similar transfer or obligation was made in the preceding calendar year, then 25 percent of that amount is zero, and accordingly, a court could interpret the statute to bar any post-petition payment to an insider.

B. Thoughts About Severance Programs:

In addition to the foregoing regarding retention programs, the following issues are likely to arise in respect of severance programs:

1. Who qualifies as an officer or non-director control person for purposes of determining whether such person is an insider, and who qualifies as a non-management employee in determining the group to be used in calculating the 10 times cap?;

2. Does the term “severance payment” include payments to employees who are terminated

involuntarily? Does it include employees who voluntarily terminate their employment upon a sale or change in control of the company or under a similar provision of the severance agreement or program? Does it include employees who terminate their employment for no reason if none is required under the agreement or program?; and

3. To what extent, if any, are equal participation rights necessary for a severance program

to be “part of a program that is generally applicable to full time employees?”38

37 See, Grohsgal, note 5, supra. The list included herein comes directly from the Grohsgal article. 38 See also, Grohsgal, note 5, supra (stating “It should be emphasized that the ‘obligations incurred’ language used in the retention provisions of Section 503(c)(1) is not used in the severance provisions of Section 503(c)(2) of the new law. Thus, prospective promises made under the severance agreements or programs will not be considered in calculating the 10 times cap of Section 503(c)(2)(B) applicable to severance payments. Accordingly, because only actual payments are considered in calculating the 10 times cap and because the time of termination of an employee entitled to a severance payment may not always be within a company’s control, the opportunity for pre-bankruptcy planning may be more limited with respect to severance plans than for retention plans.”).

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C. Additional Considerations for Counsel Under BAPCPA

1. No Discretion For Bankruptcy Judges - under the pre-BAPCPA law, bankruptcy judges had nearly unlimited discretion in adjudicating KERP motions and in determining whether a proposed KERP represented a proper exercise of the debtor’s “business judgment.” Under the BAPCPA, judicial discretion is all but gone. 11 U.S.C. § 503(c) prescribes specific (and substantial) evidentiary hurdles that debtors-in-possession must clear before a court can approve a KERP. In cases where debtors-in-possession cannot muster the evidence necessary to satisfy the rigorous requirements of section 503(c), a strict reading of the statute would prohibit the exercise of judicial discretion or the consideration of special or extraordinary circumstances to approve a KERP - even in the absence of objection or with the affirmative support of the economic stake holders.

2. BAPCPA Wants Deals Done Right – And Quickly – If anything, executives will be asked to work harder, and under more intense pressure, given the new exclusivity limits imposed by BAPCPA.39 Essentially, the combination of new 11 U.S.C. §§ 503(c) and 1121(d) results in management of debtors who stick around being forced to work harder and faster for less upside. Will management stick around?

VI. KERPs in Real Life

A. Delphi – Just before the Bell

“it is imperative that the Debtors' key personnel are appropriately incentivized to maximize the financial performance of the Debtors' operations”40

1. In the News – Is $518.5 Million Excessive?

In a December 10, 2005 article entitled, Delphi to Revise Proposal to Union,41 the Wall Street

Journal placed the microscope over on Delphi’s large proposed Key Employee Compensation Program (“KECP”),42 which has received much negative media attention as well as harsh criticism from Delphi’s largest union, the United Auto Workers (“UAW”). As noted in the article, “[f]aced with sharp criticism from his largest union, frustration from his largest customer and opposition by investors…Delphi Corp. Chairman and Chief Executive Officer Robert S. “Steve” Miller says he is crafting a new contract proposal to the United Auto Workers union. He also opened the door to changing the controversial executive-pay proposal.”43 The article went on to note that Delphi’s 39 See, 11 U.S.C. § 1121(d)(2)(A). 40 See, Motion for Order Under §§ 105 and 363 Authorizing Debtors to Implement a Key Employee Compensation Program (“Delphi KECP Motion”) at ¶ 16. 41 See, Jeffrey McCracken and John D. Stoll, Delphi to Revise Proposal to Union, Wall Street Journal Weekend Edition, December 10, 2005. 42 It is important to note Delphi’s strategic use of the word “Compensation” as opposed to “Retention.” There is little doubt that this language was carefully crafted and was formulated in anticipation of objections from labor and the United States Trustee given the restrictions in the BAPCPA. The Executive Summary of the KECP that Delphi filed with the United States Bankruptcy Court for the Southern District of New York is attached hereto as Exhibit “B.”

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proposed KECP, which has yet to be approved by the bankruptcy court, “seeks to set aside $518.5 million in cash bonuses, severance packages and future stock for about 600 executives, managers and other key employees,” and “is one of the most lucrative critical-employee compensation and retention plans ever proposed in bankruptcy….”44 Furthermore, the article compared Delphi’s proposed KECP to other KERPs in recent mega-cases, emphasizing that:

“[i]t far outstrips the $25 million approved for 325 senior employees at World-Com, Inc., or the

$140 million that failed energy company Enron Corp. first sought in its bankruptcy for 1,700 key employees. Bankrupt retailer Kmart Corp. sought $150 million for 9,500 mid-level executives and managers.”

In stark contrast to Delphi’s proposed KECP for management, Delphi’s first proposal to the

UAW “called for wages to be cut from an average of about $25 an hour to $9 to $10. A second proposal provided for hourly wages of approximately $12.50.”45 As you might expect, such disparity resulted in a hue and cry from many major constituencies, particularly the UAW. However, the fight is just beginning to heat up, as Delphi seeks bankruptcy court approval of its proposed KECP, the KECP faces the objections from major constituencies such as bondholders, pension funds, the United States Trustee and the Pension Benefit Guaranty Corporation. Each of these constituencies filed objections to Delphi’s proposed KECP which were set to be heard by the bankruptcy court on January 27, but then continued to February 10, 2006.

2. Creditors Press BAPCPA Arguments; Will Courts Entertain Them?

It is yet to be seen whether the bankruptcy court will entertain objections to KERPs in pre -

BAPCPA cases based on the provisions of the new §503(c) law in cases such as Delphi that were filed on the eve of the effective date of the new KERP law, presumably at least in part to avoid the application of some of BAPCPA’s harsh amendments. One thing is certain: major constituencies who vigorously oppose KERP programs such as Delphi’s KECP will argue that courts ought take note of new BAPCPA provisions and the clear intent of Congress to reign in KERPs. The following are examples of the objections Delphi is facing from certain of its major creditor constituencies:

a. From the UAW: “Amidst threats of plant closures and declarations that its hourly workers must accept dramatic cuts in wages and benefits, Delphi asks the Court to approve a rich package of bonus, incentive and severance payments and stock grants for selected executives that would commit the estate to $42 million a year in payouts for the duration of the bankruptcy case and cash emergence payments of $89 million. Severance commitments, including enhanced severance for some 21 executives, could add payments of up to $145 million. In addition, without even a proposed business plan, and before any meaningful participation by creditors and key stakeholders in the reorganization process, the KECP would grant 10% of the equity in reorganized Delphi to 600 chosen executives on emergence, a component of the program valued at an astonishing $400 million. An up-front grant of this scope and magnitude is clearly inappropriate and may well be unprecedented.”46 43 Id. 44 Id. 45 Id. 46 See, Objection And Memorandum Of UAW In Opposition To Debtors’ Motion For An Order Authorizing Debtors To Implement A Key Employee Compensation Program (the “UAW Objection”) at ¶ 2.

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“The Debtors are apparently tone deaf to the effects of implementing a generous bonus and severance program for a select group on the remainder of the workforce. At a time when Delphi is proposing deep cuts in wages and benefits, and contemplating a severe contraction of its domestic operations that could leave tens of thousands of employees (both hourly and salaried) without jobs, deep resentment and anger over a program valued at over $500 million can neither be understated nor should it be ignored. Delphi is critically dependent on the participation of the UAW and UAW-represented employees for the success of its reorganization. The parties’ ability to reach a consensual restructuring agreement is already significantly challenged. Delphi scheduled its Section 1113 proceedings as part of its first day motions and is less than one month away from the date it intends to file labor contract rejection motions absent a consensually modified labor agreement. The company could not have picked a less hospitable time to seek approval of a rich payment package for its executives.”47 b. From Indenture Trustee Wilmington Trust Company: “The Debtors Annual Incentive Plan, which is estimated to cost $21.5 million every six months, and relies on EBITDAR (Earnings before interest, taxes, depreciation, amortization and restructuring costs) targets in evaluating executive performance rewards the Debtors’ executives for labor and related cost savings which will result from the Bankruptcy Code imposed Section 1113 and 1114 processes, as well as from the sale of underperforming assets and the rejection of burdensome executory contracts, rather than from other, more relevant, performance metrics, such as top line revenue growth. Moreover, the proposed EBITDAR targets, which have not even been determined yet by the Debtors’ compensation committee, would provide no incentive to the Debtors’ executives to control reorganization or interest costs that will have a substantial impact on the recoveries enjoyed by the Debtors’ creditors.”48 “Although this newly added provision49 applies to cases filed on or after October 17, 2005, it certainly reflects the disfavor into which not only retention plans, covered in subsection (1), but other transfers or obligations outside the ordinary course of business covered in subsection (3), have fallen in the eyes of Congress. Accordingly, the Debtors’ Motion, and particularly its comparison to programs approved in other large bankruptcy cases, should be viewed in the context of a Congressional determination that such programs should be prohibited.50 c. From the Lead Plaintiffs: “The KECP Motion fails to provide evidence demonstrating that the proposed KECP is the result of sound business judgment. Indeed, the proposed KECP is (i) not supported by sufficient facts; (ii) unconscionable because many of the senior executives who were involved in the fraud are still managing the Company and stand to profit under the KECP; and (iii) not specific regarding key details of the plan, including the identity of the executives covered under the KECP and the specific performance levels that trigger the KECP.”51 47 See, UAW Objection at ¶ 17 (emphasis added). 48 See, Objection of Wilmington Trust Company, as Indenture Trustee, to Debtors' Motion for Order Under Sections 105 and 363 Authorizing the Debtors to Implement a Key Employee Compensation Program (the “Wilmington Objection”) at ¶ 3. 49 Referring to amended 11 U.S.C. § 503(c). 50 See, Wilmington Objection at ¶¶ 23-24 (emphasis added) (also see comment to note 53).

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“The KECP Motion fails to supply even the barest specificity regarding fundamental aspects of the program, including the executives covered under the KECP, the methodology used to select covered executives, the maximum dollar amount that can be paid to any one participant, the performance targets and the allocation methodologies contemplated by the KECP. Even if one were to ignore the accounting scandal (as the KECP Motion does), the absence of any detail makes it impossible to evaluate the reasonableness of the KECP.”52 It remains to be seen whether the objections citing to the BAPCPA and the legislative intent underlying it will be given weight by the bankruptcy court when it considers Delphi’s proposed KECP, but the objections are powerful and it appears safe to say that the prospects of getting the Delphi KECP approved are substantially greater than had the Delphi case been filed after October 17, 2005.53

B. Post-BAPCPA KERPs

1. FLYi, Inc. – A Post BAPCPA Liquidation Case54

“The Wind-Down Employee Plan is designed to assure that employees are incentivized to complete the important task of properly winding down the Debtors’ [airline] operations.”55

a. Background

On November 7, 2005, FLYi, Inc., et al., commenced their cases under Chapter 11 in the United States Bankruptcy Court for the District of Delaware. FLYi, Inc., through its operating subsidiary Independence Air, Inc., formerly operated a low-cost airline providing all-jet service to various United States destinations. Like many airlines in today’s marketplace, the FLYi debtors suffered mounting operating losses and filed Chapter 11 “to conserve their cash and to use the Chapter 11 process to continue their efforts to find an investor, strategic partner or purchaser.”56 As noted in the Wind-Down Motion, “[a]fter an intensive evaluation of all of their alternatives, the Debtors 51 See, Lead Plaintiffs’ Objection To Debtors’ Motion For Order Under §§ 105 And 363 Authorizing Debtors To Implement A Key Employee Compensation Program (the “Lead Plaintiff’s Objection”) at ¶ 17 (The Lead Plaintiffs are involved in consolidated securities class action entitled In re Delphi Corp. Securities Litigation, Master File No. 1:05-CV-2637 (NRB)(SDNY)). 52 See, Lead Plaintiffs’ Objection at ¶ 27. 53 On the date this article was submitted to the SBLI (February 10, 2006), Delphi’s KECP was set to be heard in bankruptcy court. Further evidencing the passion with which the KECP was being opposed by labor, on February 9, 2006, just one day before the KECP trial, rank and file employees renewed threats to strike if Delphi’s KECP were to be approved by the bankruptcy court. See, generally, Jeffrey McCracken, GM-UAW Negotiations Stall Over Restructuring at Delphi, Wall Street Journal, February 9, 2006. 54 See, In re FLYi, Inc., et al., Case No. 05-20011 (MFW) (Jointly Administered). 55 See, Emergency Motion Of The Debtors For An Order (I) Authorizing Them To Discontinue Their Scheduled Flight Operations And Take Certain Actions In Connection Therewith; (II) Approving A Wind-Down Employee Plan; (III) Approving The Payment Of Certain Severance Vacation And Other Benefits And Amounts To Terminated Or Furloughed Employees; And (IV) To The Extent Necessary, Authorizing The Modification Of Collective Bargaining Agreements Pursuant To Section 1113(E) Of The Bankruptcy Code In Connection Therewith (the “Wind-Down Motion”) at ¶ 31. 56 Id. at ¶ 5.

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concluded that the value of their estates would be maximized by discontinuation of their scheduled flight operations and liquidation of their assets pursuant to one or more sale or other transactions that did not contemplate the continued operation of Independence Air as a going concern.”57

b. Relief Requested

Through the Wind-Down Motion, the Debtors sought the entry of an order authorizing, inter alia, the following:

“…the implementation of the Wind-Down Employee Plan58 for those employees that will remain with the Debtors post-discontinuation of operations to implement the wind-down of the Debtors’ operations and the administration of these cases…”59

The Wind Down Employee Plan, as contemplated by the Debtors, requested authorization for the estates to pay total compensation through the plan of up to $5.5 million.60 In the words of the Debtors, “implementation of the Wind-Down Employee Plan…is designed to ensure that the Debtors can wind down their operations properly, prudently and as efficiently as possible by encouraging individuals to complete specified wind down tasks.”61 As further jusification, “[t]he Debtors believe that this plan is critical to winding down their operations successfully and in a manner that maximizes the values of the Debtors’ estates.”62 The Wind Down Motion cites to pre-BAPCPA case law, noting that the “[p]ay and benefits to be provided under the Wind-Down Employee Plan have been developed by the Debtors in their business judgment based upon the Debtors’ planning efforts, and are based upon the Debtors’ estimates of the expected periods of employment needed of each employee to complete the wind-down tasks.”63

However, the Debtors’ did not stop with business judgment, but went on to explain that “[t]he Wind-Down Employee Plan is designed to assure that employees are incentivized to complete the important task of properly winding down the Debtors’ operations. The Debtors believe that these employees are necessary to wind down their operations and to assist in the administration of these Chapter 11 cases. Accordingly, the Wind-Down Employee Plan is a vital tool to ensure that the Debtors can achieve these goals.”64

57 Id. at ¶ 8 (emphasis added). 58 The specifics of the Wind Down Employee Plan, which are described in detail in ¶ 28 of the Wind Down Motion, are attached hereto as Exhibit “C.” 59 Id. at ¶ 21. 60 Id. at ¶ 30. 61 Id. at ¶ 27. 62 Id. 63 Id. at ¶ 31 (emphasis added). 64 Id. (emphasis added).

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c. Arguments in Favor of Wind Down Employee Plan

In support of the relief they were seeking, the Debtors focused the bankruptcy court on 11 U.S.C. § 363(b) as their statutory authority for the implementation of the Wind-Down Employee Plan, stating that “[s]ection 363(b) of the Bankruptcy Code permits a debtor to use property of the estate outside the ordinary course of its business where the use of such property represents an exercise of the debtor’s sound business judgment.”65 After citing 11 U.S.C. § 363(b) as the primary authority allowing the implementation of the Wind Down Employee Plan, and in anticipation of objections from various constituencies based on BAPCPA, the Debtors argued “the Wind-Down Employee Plan does not conflict with newly enacted section 503(c)(1) of the Bankruptcy Code. The debtors argued that Section 503(c)(1) only applies to payments that are meant to induce insiders to ‘remain with the [debtors’] business’ by requiring, among other things, that a debtor demonstrates that the insider (a) has a bona fide job offer from another business and (b) is ‘essential to the survival of the business.’”66 Moreover, the Debtors argued that the following two principal rationales support their proposition that section 503(c) does not apply to their plan, even in respect of insiders of the Debtors:

1. “…as of January 6, 2006, there will not be a ‘business’ of the Debtors, as that term in used in section 503(c)(1). Section 503 precludes payments to insiders to induce such insiders to remain with the debtor’s business unless certain conditions are met. One condition, set forth in section 503(c)(1)(B), is that the services provided by that person are ‘essential to the survival of the business.’ If ‘business’ in section 503 were construed to mean something other than a viable commercial enterprise, no retention payments could ever be made to insiders in a liquidating chapter 11 case. A liquidation, by definition, means that ‘business’ will not survive, and hence the employee’s service cannot be essential to the survival of the business. Thus, for purposes of section 503(c), a business should mean a viable commercial enterprise.”67

2. “…even if the Debtors still were a ‘business’ for purposes of section 503(c)(1) after

they discontinue scheduled flight operations, the Wind-Down Employee Plan is not intended to ‘induce’ anyone to ‘remain with the Debtors’ business.’ Instead, the Wind-Down Employee Plan is intended to create incentives for employees to wind down the Debtors’ affairs, liquidate their assets, and efficiently administer their bankruptcy estates.”68 The Debtors’ emphasized their “inducement” argument, adding that “while base compensation, performance bonus, and the prospects of future employment may be sufficient to induce employees to remain with the going concern business that the insider willingly joined (arguably in certain cases making retention bonuses potentially appear superfluous absent a bona fide job offer), such considerations do not apply when there are no prospects of future employment and a fundamental change in job description because the debtor has discontinued operations. Accordingly, the Debtors submit that section 503(c)(1) simply does not apply in the

65 Id. at ¶ 32 (citing In re Martin, 91 F.3d 389, 395 (3d Cir. 1996)). 66 Id. at ¶ 33. 67 Id. at ¶ 34 (citing, Official Comm. Of Unsecured Creditors of United Healthcare System, Inc. v. United Healthcare System, Inc. (In re United Healthcare System, Inc.), 200 F.3d 170 (3d Cir. 1999) (finding that a debtor that had ceased operations was no longer an “employer” for purposes of the WARN Act, and thus was not subject to the Act’s notification requirement when it terminated its employees)). 68 Id. at ¶ 35.

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circumstances presented here because the Wind-Down Employee Plan is not an inducement to remain with a going concern business.”69

d. FLYi’s Proposed Wind-Down Plan Structure

In anticipation of objections from the United States Trustee and organized labor, and potential bankruptcy court rejection of the Wind-Down Employee Plan with respect to insiders as violative of the provisions of new section 503, the Wind-Down Motion presented the following alternative scenarios in which the Debtors proposed certain insider compensation issues could be resolved pursuant to section 503:

1. The Debtors would consider seeking authority to “enter into postpetition employment

agreements with insiders otherwise covered by section 503(c)(1) at a base salary equal to the amounts payable under the Wind-Down Employee Plan,

2. Terminate the employment of such insiders and enter into consulting agreements with

such parties as independent contractors, 3. Demote such persons so that they are no longer “insiders” covered by section 503(c), or 4. Establish incentive-based bonuses (on the assumption that they do not fall within the

ambit of section 503(c)) that can be satisfied by such insiders.70 e. Objections to the Wind-Down Plan

1. Objection by the Association of Flight Attendants.

The Association of Flight Attendants (“AFA”) filed an objection to the Wind Down Motion,71 stating as follows:

“The AFA objects to the Emergency Motion and the proposed Wind-Down Plan to the extent

that the Debtors seek to provide bonuses to Wind-Down Employees while more than 2,000 employees are terminated. The AFA believe that extended employment at regular pay rates is reward enough for the Wind-Down Employees. Providing those employees with bonuses is a “slap in the face” to employees who will not be retained, an improper use of estate assets and contrary to the basic notions of fairness and equity.”72 69 Id. at ¶ 36. 70 Id. at ¶ 37 (The Debtors go on to state that they “believe that any of these alternatives may pass muster under section 503(c) for ‘insiders.’ However, such arrangements may be less effective and/or more costly to the Debtors’ estates to achieve the Debtors’ wind down goals.”). 71 See, Objection of Association of Flight Attendants to Emergency Motion Of The Debtors For An Order (I) Authorizing Them To Discontinue Their Scheduled Flight Operations And Take Certain Actions In Connection Therewith; (II) Approving A Wind-Down Employee Plan; (III) Approving The Payment Of Certain Severance Vacation And Other Benefits And Amounts To Terminated Or Furloughed Employees; And (IV) To The Extent Necessary, Authorizing The Modification Of Collective Bargaining Agreements Pursuant To Section 1113(E) Of The Bankruptcy Code In Connection Therewith (the “AFA Objection”). 72 Id. at ¶ 7.

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The AFA Objection underscores the passionate opposition of organized labor to KERPs almost

regardless of structure, form or name. In addition to protesting the inequity and unfairness of the proposed Wind-Down plan, the AFA hammered on the limitations on KERPs under BAPCPA:

“Additionally, the newly enacted Section 503(c)(1) should be applied to the Wind-Down

Employee Plan. The Debtors attempt to avoid the effects of the new law by arguing that as a liquidating case, the ‘survival of the business’ is not at stake. This interpretation cannot be reconciled with Section 1108 of the Bankruptcy Code.73 Certainly, the debtors-in-possession in liquidating Chapter 11 cases are still deemed to ‘operate their business.’ Therefore this Court should approve the Wind-Down Employee Plan only to the extent that is [sic] complies with Section 503(c)(1).”74

2. Objection by the United States Trustee

The United States Trustee took strong objection to the Wind-Down Employee Plan, and focused its objection more heavily on the statutory underpinnings of 11 U.S.C. § 503 rather than the emotional arguments advanced by the AFA. The salient features of the UST Objection are:

i. The UST Objection broadly attacked the Wind-Down Motion, referencing BAPCPA’s new heightened evidentiary burden, stating that:

“The Motion improperly seeks to avoid or circumvent the restrictions and evidentiary burdens

enacted by Congress as part of the Bankruptcy Abuse and Consumer Protection Act (BAPCPA) under 11 U .S.C. § 503(c)(1) and seeks to retain certain members of senior management during the wind-down without indicating how senior management will carry out their fiduciary obligations to the Debtors and their creditors.”75 “Section 503(c)(1) prohibits the payment to or for the benefit of insiders of retention bonuses unless the court can make three findings: first, that the “...individual has a bona fide job offer from another business at the same or greater rate of compensation;” second, that the person’s services are essential to the survival of the business, and; third, that either the amount of the proposed transfer does not exceed 10 times any similar compensation paid to nonmanagement employees during the calendar year in which the transfer is made, or that the amount of the transfer or obligation is not greater than 25% of any similar transfer made to the insider during the calendar year preceding the transfer. To the extent that the Motion proposes to pay retention bonuses to senior management, the Debtor has presented no facts whatsoever that might enable the Court to make any of the necessary findings required to be made to approve the proposed bonus. In fact, the Motion to Shorten Time indicates only that employees may look for alternative employment and may accept it if they find it, not that any employee actually has an offer equal to or better than the employment with the Debtors.”76

73 11 U.S.C. § 1108 provides as follows: “Unless the court, on request of a party in interest and after notice and a hearing, orders otherwise, the trustee may operate the debtor’s business.” 74 Id. at ¶ 8. 75 See, UST Objection, at ¶ 4. 76 See, UST Objection, at ¶ 11.

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ii. In addition to its emphasis on the BAPCPA’s heightened evidentiary standards, the UST Objection responded to the Debtors’ argument that 11 U.S.C. § 503(c) does not apply to the Debtors as they will no longer be a “going concern” as follows:

“Although it requests, in essence, that the Debtors’ operations be allowed to continue in this

chapter 11 proceeding as opposed to being converted to a case under chapter 7, the Motion indicates the Debtors’ belief that § 503(c) does not apply because the operations are not a going concern business. Furthermore, although the chapter 11 cases are proposed to continue, the Motion does not indicate which member of management will be responsible for the Debtors’ continued operations during the wind-down and what corporate governance is in place to supervise those members of management who remain.”77

“Section 503(c) is an entirely new provision to the Bankruptcy Code and has no prior antecedent. According to Collier on Bankruptcy, its intent is to “...limit the scope of ‘key employee retention plans’ and other programs providing incentives to management of the debtor as a means of inducing management to remain employed by the debtor.” (4 Collier on Bankruptcy, 15th Ed. Revised 2005, p. 503-80 emphasis added). Nothing in the statute and nothing in Collier on Bankruptcy would indicate that the statute is limited only to a business that is a going concern. The plain language of the provision prohibits the payment to insiders of retention bonuses (503(c)(1)), or severance bonuses (503(c)(2)), except under the conditions prescribed by the statute. Section 503(c)(3) prohibits transfers not in the ordinary course of business and not justified by the facts and circumstances of the case, for the benefit of officers, managers or consultants hired after the filing date of the case. These provisions fundamentally alter the approach debtors and bankruptcy courts should take in reviewing postpetition incentive payments to insiders for cases filed after October 17, 2005.”78

iii. Furthermore, the UST Objection focused closely on the actual language used in the court papers filed by the Debtors. The UST Objection stated: “The Debtors’ Motion to Shorten Time and Approve Notice of Emergency Motions of the Debtors Relating (I) to the Discontinuation of Scheduled Flight Operations and Employee Matters and (II) Aircraft Rejection and Abandonment Matters (the “Motion to Shorten Time”) states, “The employees identified in the wind -down employee plan are necessary to wind down the affairs of the Debtors in an orderly period. Unless such plan is approved expeditiously, the Debtors’ employees in such plan, facing uncertainty about their compensation and with knowledge that there [sic] jobs will exist for a limited time, may very well seek, and if they find may accept, alternative employment prior to approval of the wind down plan.” Motion to Shorten Time, page 3, ¶1.”79 iv. As a way to keep management on board without offering any compensation, the UST Objection offered up a rationale that does not emanate from the BAPCPA, but instead is premised upon potential exposure insiders may face relating to their fiduciary duties. The UST Objection stated as follows:

77 See, UST Objection, at ¶ 7. 78 See, UST Objection, at ¶ 10. 79 See, UST Objection, at ¶ 8.

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“Because members of senior management owe fiduciary duties to FLYi and its creditors under Delaware law and the Bankruptcy Code, it is unlikely that they would precipitously leave prior to the winding down of the Debtors’ business, and if senior management were to precipitously leave the Debtors’ employ without the proposed bonuses, other management could be appointed for a limited period of time, or alternatively, the Court could appoint a chapter 11 trustee whose 3% commission would be significantly less than the bonuses proposed to senior management.”80 “The Motion fails to indicate how senior management will carry out their fiduciary obligations to the Debtors and their creditors. It does not indicate who will be responsible for running the company in its wind-down phase and to whom that person will report. The Debtors must tell parties in interest who is going to be responsible for the operations of the Debtors and whether the Board of Directors that existed prior to the wind-down will be the one to whom that responsible person reports.”81 v. Last, but certainly not least, the UST Objection focused on the overall necessity of the Wind-Down Plan, and the payments included therein, suggesting that the Wind-Down Motion failed to included important information, and that the Wind-Down Employee Plan was excessive in its allocation of bonuses. The following portion of the UST Objection is important and will no doubt be seen again in post-BAPCPA KERP litigation: “Even excluding payments to senior management as a violation of §503(c), the payments contemplated by the Wind-Down Plan are extravagant. For example, employees who remain employed by the Debtors for one to twelve weeks will receive double their base salary. (Those who stay from one week to four weeks also receive an additional two weeks’ pay. Those who stay from four to twelve weeks do not receive the additional two week’s pay, but are paid at the higher pay scale that was in effect prior to the date of filing.) Those who remain for six months or more receive a bonus equal to one year’s base salary at the higher pay scale. The Debtors contemplate retaining 180 employees. Given that this case is winding down and that unsecured creditors are not contemplated to receive full recovery, these bonuses are excessive. In addition, the Motion fails to inform parties-interest what tasks the employees will perform, why it is necessary to employ 180 to do the tasks, and what level employee is proposed to be retained.”82 vi. The UST Objection took a final shot at the proposed Wind-Down Employee Plan: “Enactment into the Bankruptcy Code of Section 503(c) places prohibitions and limitations upon the making of payments to insiders not in the ordinary course of business except in compliance with the statute. To the extent that these provisions are inconsistent with prior practice based primarily upon exercise of the so-called business judgment rule, the statutory provisions supplant prior practice. Notwithstanding the semantics of the Motion, it is clear that what the Debtor seeks is the payment of retention bonuses to senior management. The Debtor has produced no evidence that would satisfy the requirements of new Section 503(c). Rather, the Debtor seeks to ignore the provision altogether and instead advocates a position that would render the entire section meaningless. In addition the Debtors

80 See, UST Objection, at ¶ 13. 81 See, UST Objection, at ¶ 14. 82 See, UST Objection, at ¶ 15 (emphasis added).

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have failed to inform parties in interest who will be the responsible officer during the wind-down process and to whom that person will answer as well as who the remaining employees are and what tasks they are to perform.”83 The UST Objection is important because it presents many of the arguments likely to be seen in KERP litigation until the law is more fully developed. f. Bankruptcy Court Approves Wind Down Employee Plan in Part Despite intense objections from multiple constituencies, including the AFA and the United States Trustee, the Court in FLYi entered an Order84 approving a substantial portion of the Wind-Down Employee Plan, but adjourning the hearing with regard to the portion of the plan relating to certain insiders. The key portions of the Wind-Down Order relating to the Wind-Down Employee Plan are reproduced in full as follows: 1. The Court found that “The Debtors have articulated a sound business purpose for the approval and payment of the Wind-Down Employee Plan and have sought such approval in their sound business judgment. The approval of the Wind-Down Employee Plan to the extent set forth herein is in the best interests of the Debtors, their creditors, their estates and other parties in interest.”85 2. The Court Ordered that: “The Wind-Down Employee Plan, as modified herein, is hereby approved, pursuant to section 363(b) of the Bankruptcy Code, and any amounts due and owing to employees covered by the Wind-Down Employee Plan as so modified shall be paid as and when due. The Debtors’ estates are authorized and directed to take any and all actions that are necessary or appropriate to implement the Wind-Down Employee Plan as so modified. The Debtors, in consultation with the Committee, may modify the Wind-Down Employee Plan described in the Motion and as further modified on Schedule 1 hereto, provided that the total compensation paid under the Wind-Down Employee Plan shall not exceed $4.4 million.”86 As noted above, the six “insiders” were not included in the $4.4 million Wind-Down Employee Plan approved by the Court. Instead the Court elected to hold a separate hearing to consider approval of the payments to the six “insiders,” as proposed by the Wind-Down Employee Plan (the “Insider Hearing”). At the Insider Hearing, Judge Walrath allowed the payments to insiders, subject to modification in amount so that the payments met the “10-times” standard provided in 11 U.S.C. § 503(c)(2)(B).87 Pursuant to an agreement between the debtor and the United States Trustee that was

83 See, UST Objection, at pg. 8 (emphasis added). 84 See, Order (I) Authorizing the Debtors to Discontinue Their Scheduled Flight Operations and Take Certain Actions in Connection Therewith; (II) Approving a Wind-Down Employee Plan; (III) Approving the Payment of Certain Severance, Vacation and Other Benefits and Amounts to Terminated or Furloughed Employees; and (IV) To the Extent Necessary, Authorizing the Modification of Collective Bargaining Agreements Pursuant to Section 1113(e) of the Bankruptcy Code in Connection Therewith (the Wind-Down Order). 85 See, Wind-Down Order, ¶ I. 86 See, Wind-Down Order, at ¶ 4. See pg. 26. 87 The “10-times” standard also appears in 11 U.S.C. § 503(c)(1)(C)(i), but in somewhat different form.

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reached prior to the Insider Hearing, the United States Trustee agreed to treat four of the insiders under Section 503(c)(2) of the Bankruptcy Code, which is the provision related to severance.88 Without decisional law or legislative history to guide the debtors’ interpretation of the section 503(c)(2) “10-times” calculation, the debtors calculated the severance payments with respect to the 171 employees provided for in the Wind-Down Employee Plan, 166 of which were non-insiders. Accordingly, the debtor concluded that the section 503(c)(2) “cap” was $118,800, and that only two insider payments sought were above the “cap.” As such, the debtors agreed to limit the severance payments to the additional two insiders to the “cap,” as calculated by the debtors, using only those 171 employees provided for in the Wind Down Employee Plan. Although the debtors’ method of calculation of the “cap” drew some criticism from the United States Trustee, the Court approved all six of the insider severance payments, subject only to the “cap” as calculated by the debtors. Specifically, the Court held that section 503(c)(2) contemplates a new severance program, and therefore calculation of the “10-times” cap does not require a debtor to look back beyond the payments proposed in the severance plan. In so holding, the court noted that since section 503(c)(2) does not include language referencing payments made by the debtor during the previous calendar year, as section 503(c)(1)(C) does, section 503(c)(2) “does contemplate creating a severance payment for remaining employees after the debtor has gone through its cost cutting and does not mean that because you’re now proposing to do severance payments for employees you have to go back and retroactively give severance payments for terminated employees…I think this contemplates a new severance program…”89

Overall, the FLYi case is a great study of post-BAPCPA executive compensation issues. Even though the Debtors received multiple objections, proper planning and attention to detail allowed for the Wind-Down Employee Plan included in the Wind-Down Motion to say all it needed to say, without saying too much. Of course, FLYi’s agreement with the United States Trustee to treat the insiders under section 503(c)(2) proved sage, as the Court recognized the severance provisions under section 503(c)(2) to be more loose than the retention provisions under section 503(c)(1). Most of all, the FLYi case demonstrates that although traditional KERPs may be seriously impaired post-BAPCPA, reorganizational professionals and their clients will succeed in finding ways to pay management.

VII. Litigating KERPs post BAPCPA: Practical Concerns

A. BAPCPA’s Evidentiary Requirements of “Essential to Reorganization”

How will debtors adduce the evidence required by the 11 U.S.C. § 503(c)’s new requirement that the transfer in question is “essential to the retention of the person?” Furthermore, how will debtors prove that “the services provided by this person are essential to the survival of the business?” Who will offer the testimony that a particular manager is “essential” and that the payments are “essential?” Is this expert testimony or fact testimony? Could this heightened requirement foster a cottage industry

88 The focal point of the test under section 503(c)(2) is that the severance payment to an insider cannot be more than 10 times the severance payment for non-management employees. 89 See, Transcript of Continuation of Hearing on Wind-Down Employee Plan, p. 11.

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of witnesses, ready to play the age old game of “You scratch my back, I’ll scratch yours” regarding a particular manager being essential?

And how do objectors rebut such testimony if a debtor can adduce it? Can objectors argue that

the BAPCPA requires a “mini trial” on the feasibility of a then yet to be filed plan of reorganization. If so, how will this affect negotiations throughout the tenure of the reorganization if debtors are forced to tip their hands early in their case at the risk of losing the key executives who will ensure the survival of the business. How will courts be able to adequately assess the prospects for the survival of a bankrupt debtor at the outset of the debtor’s case, before the bankruptcy process is allowed to take effect?

B. Nobex Corporation – Analysis of 503(c)(3)’s “Catch All” Provision

On December 1, 2005, Nobex Corporation filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the District of Delaware.90 Soon after filing bankruptcy, on December 9, 2005, Nobex filed a Motion for Order Authorizing Payment of Sale Related Incentive Pay to Senior Management Pursuant to 11 U.S.C. §§ 105, 363(b) and 503(c)(3) (the “Incentive Pay Motion”). Through the Incentive Pay Motion, Nobex sought bankruptcy court approval of certain incentive payments to senior level management who were necessary to implement the sale of Nobex’s assets.

As could be expected, the United States Trustee91 and the Official Committee of Unsecured

Creditors92 objected to the Incentive Pay Motion, arguing that the payments described in the Incentive Pay Motion amounted to nothing more than “retention” payments to executives. Furthermore, the United States Trustee and the Committee insisted that the Incentive Pay Motion did not provide the type of information necessary to meet the statutory predicate for “retention” payments under the BAPCPA. For example, the Committee Objection stated as follows:

“…the Incentive Pay Motion does not state what specific duties or contributions they will

perform to add value to the asset sale justifying the incentive payments. The Incentive Pay Motion also does not address whether the senior management have other job offers or whether they received retention compensation in the last calendar year….Thus, the Incentive Pay Motion wholly fails to address the requirements of section 503(c) of the Bankruptcy Code.”93

After noting the deficiencies in the Incentive Pay Motion, the Nobex Committee Objection

went on the emphasize that the Committee was “not adverse to the allowance of true, forward-looking incentive payments to senior management to the extent that they are related to value provided by an open value maximizing sale of the Debtor’s assets or to a successful plan of reorganization.”94

90 See, In re Nobex Corporation, Case No. 05-20050 (MFW). 91 See, Objection by United States Trustee to Debtor’s Motion for Order Authorizing Payment of Sale-Related Incentive Pay to Senior Management Pursuant to 11 U.S.C. §§ 105, 363(b) and 503(c)(3) (the “Nobex UST Objection”). 92 See, Objection by the Official Committee of Unsecured Creditors to Debtor’s Motion for Order Authorizing Payment of Sale-Related Incentive Pay to Senior Management Pursuant to 11 U.S.C. §§ 105, 363(b) and 503(c)(3) (the “Nobex Committee Objection”). 93 See, Nobex Committee Objection, ¶ 10. 94 Id. at ¶ 11.

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Reference to an “open value maximizing sale” was merely a continuation of the Committee’s objection to the Debtor’s Bid Procedures Motion, and evidenced the Committee’s concerns regarding the Debtor’s proposed asset sale. Ultimately, the Committee sought justification for the Debtor’s proposed payment of 9% of the proceeds of the asset sale to senior management in the case of “a transaction with an insider who, potentially, was in a position to write its own deal.”95

After an extensive hearing, the Court approved the Incentive Pay Motion in part, allowing the

Debtor “to pay an aggregate incentive bonus, allocated in the discretion of management of the Debtor, to the three non-insider employees that comprise the Marketing Team…”96 The hearing transcript is particularly instructive with regard to 11 U.S.C. § 503(c)(3). Judge Walrath explained section 503(c)(3) as follows: “And (c)(3) was meant to provide a standard, albeit not as clear, for any other transfers or obligations outside the ordinary course of business. I agree that the including transfers made to officers, managers or consultants hired after the petition date is not exclusive. That's clear from other provisions in the Bankruptcy Code. So I do read (c)(3) to be the catch-all and the standard under (c)(3) for any transfers or obligations made outside the ordinary course of business are those that are justified by the facts and circumstances of the case. Nothing more -- no further guidance being provided to the Court by Congress, I find it quite frankly nothing more than a reiteration of the standard under 363 and -- well, 363 under which courts had previously authorized transfers outside the ordinary course of business and that is, based on the business judgment of the debtor, the court always considered the facts and circumstances of the case to determine whether it was justified. And I'll do the same in this case. I think in this case it is clear that from structure of the plan that this is not a retention plan. It is not providing payment to the employees or senior management solely for being retained, staying on the job. In fact, they can stay on the job all they want if the criteria are not met. That is, the sale does not produce sufficient funds, they will not get anything. Similarly, they can leave the day after the sale and get the incentive if in fact the sale produces more than the minimums required under this. So I see it as not a retention plan and therefore not subject to the (c)(1) strictures. The question is whether or not, based on the evidence that was presented, whether this incentive plan or the transfers contemplated by it are justified by the facts and circumstances of the case. And I think that burden has been met here. I do place great weight in the fact that the plan has been presented and negotiated with the creditors committee, who, as well as the debtor, has a fiduciary duty to all creditors, but has a particular interest in assuring that general unsecured creditors get some recovery. I think it's significant that the plan provides no incentive or no payment for simply achieving a sale already contemplated by the stalking horse bid. And I think providing such would not have been justified under the circumstances of this case since that bid is already in hand. I think it is designed to assure that senior management and the marketing team go above and beyond the -- what they are required to do as fiduciaries. Gives them an incentive to come up with additional recoveries for the general unsecured creditors. And in that sense, I think it is

95 Id. 96 See, Order Authorizing Payment of Sale-Related Incentive Pay to Non-Insider Employees Pursuant to 11 U.S.C. §§ 105 and 363(b) (the “Nobex Order”) at ¶ 2.

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reasonable.”97 Judge Walrath’s explanation presents a clear standard under 11 U.S.C. § 503(c)(3) where application of the Debtor’s business judgment under a facts and circumstances test will set the stage for authorizing incentive based bonus payments. In fact, Judge Walrath’s words should give some comfort to bankruptcy professionals, as she directly linked the requirements under section 503(c)(3) to the current standards applied by courts under 11 U.S.C. § 363 as it relates to transfers outside the ordinary course of the Debtor’s business.

As Nobex makes clear, incentive-based, performance guided packages will generally be acceptable under the BAPCPA as long as the proposed incentive package represents an exercise of the debtor’s sound business judgment. To this end, pre-BAPCPA wisdom still applies: debtors are well-served to negotiate with creditors’ committees and other constituencies prior to seeking court approval of expenditures that are outside the ordinary course of business.

C. CALPINE Presents the “Hire Don’t Retain” Option

Poised to lead the charge in the largest chapter 11 corporate bankruptcy filed post-BAPCPA, Calpine Corp.'s new chief executive officer agreed to a two-year employment contract with the bankrupt U.S. power producer that will pay him a base salary of $1.5 million, plus millions more in bonuses.98 Robert May, a highly regarded turnaround CEO, is no stranger to corporate restructuring in chapter 11, making his name known in the restructuring industry as a turn-around expert by helping lead restructurings at HealthSouth Corp. and Charter Communications, Inc. Calpine chose May as CEO on December 12, 2005, and promptly filed for Chapter 11 bankruptcy protection in the Southern District of New York on December 20, 2005.99

Under an employment deal entered into by Calpine on December 20, 2005, May will receive

his base salary of $1.5 million during his initial two-year tenure, which ends December 31, 2007, and during any subsequent terms deemed necessary. His salary will be reviewed by Calpine's board at least once a year and may be increased at any time. In addition, Calpine reported that May will receive minimum bonuses of $2.25 million for the fiscal year ending December 31, 2006, and $1.5 million for the fiscal year ended December 31, 2007. Lastly, May will receive a one-time signing bonus of $2 million which is payable Dec. 27, 2005.

May's hiring followed Calpine’s board's removal of the company's founder, chairman and chief

executive, Peter Cartwright, two weeks earlier after a Delaware judge ruled the company had improperly used proceeds from asset sales. In addition to a wide-array of bonuses discussed above, May will be eligible to receive a ‘success fee’ of $12 million if and when a plan of reorganization is confirmed by the bankruptcy court during May's tenure as CEO, or within 12 months after the termination of his employment.

97 See, Transcript of Hearing on Incentive Pay Motion, pp., 86-88. 98 The information contained within this section was derived from a December 27, 2005 webpost on CNNMoney.com entitled, Calpine Names Turnaround CEO; Hopes Robert May Can Steer the Energy Firm Out of Bankruptcy; Will Get Millions, Success or No. 99 In fact, multiple Calpine related entities filed on December 20, 2005, while others filed on December 21, 2005. See, In re Calpine Corporation, Case No. 05-60200 (BRL), Jointly Administered.

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May’s selection, which occurred pre-petition, is an excellent example of how chapter 11

debtors can avoid the KERP restrictions of new 11 U.S.C. § 503 by hiring executives from outside the company, even though such industry expertise or turnaround experience demands top dollar. Quite simply, Calpine is not seeking to retain May, it sought to employ him.

E. Other BAPCPA KERP End Arounds

With lots of money at stake, the restrictions imposed by Congress will now face the challenge of restructuring professionals whose creativity and ingenuity should not be underestimated. While many submit that post-BAPCPA KERPs are dead, most restructuring professionals would agree that until the law develops, KERPs are at least severely wounded. Potential end arounds used in the early post-BAPCPA cases that have given rise to lots of gossip include :

1. Substantially higher base pay for executives.

2. The formation of pre-bankruptcy compensation trusts.

3. Funding of KERPs from outside interested parties, including potential purchasers.

4. Delay of implementation or payment of KERPs until confirmation of plan.

5. KERP experts offering whatever testimony is considered necessary to allow a debtor to

carry its burden.

6. Hiring high powered CROs post bankruptcy.

7. Pre-bankruptcy incentive based compensation tied to well-defined future performance

that is assumed post -bankruptcy.

8. The resignation of executives at the inception of the bankruptcy case only to be hired by

turnaround firms that are then retained and put the old executives back behind their old desks.

9. Gerrymandering of severance plan groups in order to increase the “10-times” cap.

VIII. Conclusion

Drucker was right: the revolt against executive compensation is well underway. Indeed, the

first major battles regarding the boundaries of executive compensation for bankrupt companies have started in the bankruptcy courts as judges get cases of first impression regarding the meaning and implications of the BAPCPA KERP provisions. With the BAPCPA available to sharpen the swords of labor, creditors’ committees and the United States Trustee, corporate debtors can expect more strenuous objection to any motion that seeks to provide compensation to any of the debtor’s senior management. The thought that the radical limitations on KERPs emanate from a last minute amendment to the BAPCPA is surprising, especially given the fact that substantially similar legislation was soundly rejected 2 years prior to the final passage of the BAPCPA. Apparently, timing is everything. But as the early post-BAPCPA KERP cases show, executive compensation is by no means dead. If properly structured, executive compensative to management of corporate debtors is alive and

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well, despite the aggressive objections of most major constituencies. Incentive bonus structures are alive, receiving court approval pursuant to 11 U.S.C. § 503(c)(3) in Nobex. In addition, severance packages can be effectively structured to get the most from the “10-times” cap, as shown by the court’s approval of the severance package proposed by the debtors in Flyi pursuant to 11 U.S.C. § 503(c)(2). Even with the small victories in Flyi and Nobex, the largest battles still remain to be fought. The compensation packages approved in Flyi and Nobex are peanuts compared to the amount of executive compensation sought in mega-cases such as Delphi. Will any corporate debtor in a post-BAPCPA mega-case feel comfortable proposing an executive compensation package as large as Delphi’s current proposal? Going further, will a corporate debtor brave the challenges posed by section 503(c)(1) and actually propose a “retention” based program, or is the word “retention” forever a memory in Chapter 11 practice? When the standards under the BAPCPA are more fully defined, and enough executive compensation programs have been adjudicated under 11 U.S.C. § 503, bankruptcy professionals will know exactly how to get KERPs approved. Perhaps then we will learn what constituencies, if any, benefited from the last-minute Kennedy KERP Amendment.