Court Focuses on Policy Rather Than Formality in Approving Key Employee Plans

American Bankruptcy Institute Law Review Staff

 

 

Rejecting the technical arguments of the United States Trustee (the “UST”), the Bankruptcy Court focused on the policies behind the restrictions on employee retention plans to approve the debtor’s key employee incentive plan (“KEIP”) in In re Velo Holdings[1].  The Velo Holdings Court approved the KEIP because it was incentive-based rather than retentive-based and was a valid exercise of the debtor’s sound business judgment.[2]

 

After filing for Chapter 11 bankruptcy, Velo Holdings Inc. (the “Debtor”), and its first lien lenders sought approval of a jointly designed KEIP that included earnings performance targets that were separately tailored to the sale plans of the Debtors’ subsidiary businesses.[3]  The United States Trustee (the “UST”) objected to the to the KEIP on two grounds.  First, the UST claimed that the portion of the KEIP applicable to one group of the debtor’s subsidiary businesses, collectively referred to as the ACU Business, was retentive-based and not incentive-based.  The UST that the requirement under the plan that ACU Business employees comply with the DIP budget as well as provide additional transitional services specifically tailored to the bankruptcy process was not sufficient to qualify the plan as incentive based.[4]  Second, the UST objected to the portion of the plan involving another of the debtor’s subsidiary businesses, Neverblue Communications Inc., and its non-debtor affiliates.  The UST claimed that the bonus to be paid to Neverblue’s president, Hakan Lindskog, was not an incentive bonus because the portion of the KEIP relevant to Neverblue did not specify what performance targets Mr. Lindskog had to hit in order to receive his bonus.[5]

 

The first step in deciding whether to approve a KEIP is to consider whether or not the covered employees are insiders within the meaning of section 101(31) of the Bankruptcy Code (the “Code”).[6]  This is because “[t]he intent of section 503(c) is to limit the scope of ‘key employee retention plans’ and other programs providing incentives to [insiders] of the debtor as a means of inducing [those insiders] to remain employed to the debtor.”[7]  If the plan is found to be retentive-based then the insider employee must meet one of section 503(c)(1)’s statutory exceptions.[8]  However, plans that are incentive-based may be approved if justified by the “facts and circumstances of the case.”[9]  The “facts and circumstances of the case” standard of section 503(c)(3), according to this Court, is no different than the business judgment standard under section 363(b).[10]  Both tests require the court to consider the reasonable expectations of creditors and standards within the industry.[11]

 

Because the participating employees were insiders, the Court analyzed whether the KEIP was retentive-based or incentive-based.[12]  The KEIP was found to be incentive-based because ACU “Executive Employees are required to do more to meet the wide-scale goals outlined in the KEIP as they must address concerns that are unique to the bankruptcy proceeding”[13] and, Hakan Lindskog was incentivized to obtain the highest possible price for Neverblue.  After finding that the KEIP was incentive-based, rather than retentive-based, the Court then considered whether it was justified by the facts and circumstances of the case.  It concluded that it was justified because the KEIP was consistent with industry standards, and was within the reasonable expectations of the creditors because it was similar to other approved KEIPs.[14]

 

The restrictions on incentive and retentive plans under the Code were put in place in order to prevent debtors from favoring insiders during the reorganization process at the expense of the creditors.[15]  Thus the Court noted that if creditors do not object to the proposed plan then this issue of little concern.  In this case, the creditors in fact approved of the KEIP.  The UST objections appear to be only on technical grounds, essentially asserting that the UST would have structured the plan differently.  The Court was faced with a decision to either approve the plan because the concerns underlying the Code’s restrictions were satisfied or to disapprove the plan based on merely formalist concerns.  Judge Martin Glen in this case and a subsequent case appears to be focusing on policy, rather than the technicalities raised by the UST.  In In re Dewey & LeBoeuf LLP, the Court approved a KEIP over the UST objections because the Court said “[t]he UST may not substitute its business judgment for that of the Debtor’s.”[16]  The judges in the Southern District of New York seem inclined to allow businesses to make decisions for themselves during the bankruptcy process as long as they comply with the spirit of the Code.

 

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