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KEIPs v. KERPs: Court Shows Deference to Chapter 11 Companies to Defend Their Bonus Plans Under BAPCPA

By: Sumaya Restagno

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

        Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”), Congress imposed strict limitations on payments made specifically to retain key employees of companies in chapter 11 bankruptcy and narrowed the circumstances under which these payments could be made through the addition of section 503(c).[1] Under section 503(c)(1), chapter 11 debtors may pay a bonus to certain employees under a Key Employee Retention Plan (“KERP”) upon approval of the court and after a showing that certain required factors have been satisfied.[2] Under section 503(c)(3), chapter 11 debtors may pay a bonus under a Key Employee Incentive Plan (“KEIP”)  to certain employees after they attain certain measurable, difficult-to-reach milestones.[3] Payments under a KEIP are described as being outside the ordinary course of business and are statutorily prohibited unless justified by the facts and circumstances of the case.[4] Many courts have held this standard to be synonymous with the “business judgment” standard that governed KERPS prior to the BAPCPA which is not as strict as the test under 503(c)(1).[5]

        In In re American Eagle Energy Corporation, American Eagle Energy Corporation (the “Debtor”), sought approval of a purported KEIP.[6] The Office of the United States Trustee (the “UST”) joined by parties with first priority lien interests in the Debtor’s assets, objected asserting the Debtor’s proposed KEIP was actually a disguised KERP that did not meet the requirements under 503(c)(1).[7] According to the UST, the Debtor’s proposed KEIP does not require bona fide performance-based incentives.[8] In other cases, the UST objected when the KEIP bonus would be earned by the completion of transactions that are bound to occur unrelated to the employee’s specific actions.[9] The UST has also objected when the KEIP bonuses compensate participants for work that was done prior to the filing of the bankruptcy petition.[10] Courts have recognized that incentive bonuses can have a retentive purpose, but where the other strict standards are met, this retentive purpose does not preclude the plan to be deemed an acceptable KEIP.[11]

        The United States Bankruptcy Court for the District of Colorado held that the proposed KEIP plan met the statutory requirement as to two high-level employees, and was not a prohibited KERP.[12] In reaching this conclusion, the court adhered to an analysis of the nine factors articulated in In re Alpha Natural Resources, Inc. to determine whether the plan is a KEIP.[13] In analyzing each factor, the Court found (1) the scope of the bonus plan was reasonable, (2) suitable due diligence was undertaken for adoption of the plan (3) the two insiders receiving the payments were performing a myriad of new functions, (4) the plan was targeted to maintain operations to provide reports and data to maximize value in a sale, (5) the cost of the plan was reasonable in the context of the Debtor’s assets, liabilities and earning potential, (6) the Plan was properly designed to achieve performance standards, (7) the plan was consistent with industry standards, (8) the plan was not a disguised KERP, and (9) the plan was justified by the facts and circumstances of the case.[14]

        The KEIP/KERP distinction is important because each provides a different framework through which a Chapter 11 debtor may seek approval of a bonus plan. KERPs have straightforward, well-articulated, and stricter requirements; when companies are unable to meet this standard, they can use the KEIP framework, which through use of the Alpha factors are more deferential to the business and highly dependent on the court’s analysis of the evidence provided by the business. Here, the first factor to satisfy a finding of a KERP was not met: the employees were not offered a job elsewhere. However, the Debtor wanted to compensate certain employees in order to retain them and accomplish certain goals. Failing to meet this higher standard, the company then sought to characterize their plan as a KEIP. Courts may be willing to defer to the evidence provided by a debtor rather than to compel a debtor to meet the higher standard of proving a KERP.



[1] Letter from Ronald Weich, Assistant Att’y Gen., U.S. Dep’t. of Just., Off. of Legis. Aff. to Senator Charles E. Grassley regarding restrictions on retention and incentive bonuses paid to executives of companies seeking chapter 11 bankruptcy relief at *2 (Mar. 5, 2012), as reprinted in Wall Street J. (Mar. 13, 2012), http://online.wsj.com/public/resources/documents/Letter031312.pdf.

[2] 11 U.S.C. § 503(c)(1). The following factors have to be shown: that the employee has a bona fide job offer from another employer at the same or greater rate of compensation, the employee performs functions that are essential to the survival of the company, and the bonus amount is not greater than ten times the amount of bonuses given to non-management employees and not greater than 25 percent of the bonus paid to the employee in the previous calendar year.

[3] Letter form the Assistant Att’y Gen. to Senator Charles E. Grassley at *1-2.

[4] 11 U.S.C. § 503(c)(3).

[5] Letter form the Assistant Att’y Gen. to Senator Charles E. Grassley at *1; In re Dana Corp., 351 B.R. 96, 100 (S.D.N.Y. 2006); In re Residential Capital, LLC, 478 B.R. 154, 167 (S.D.N.Y. 2012).

[6] In re Am. Eagle Energy Corp., No. 15-15073, 2016 WL 3573952 *2, (D. Colo. 2016).

[7] Id.

[8]In re Am. Eagle Energy Corp., 2016 WL 3573952 *3-7.

[9] In re Hawker Beechcraft, Inc., 479 B.R. 308, 313 (S.D.N.Y. 2012).

[10] In re Residential Capital, 478 B.R. at 164.

[11] In re Patriot Coal Corp., 492 B.R. 518, 533 (E.D.Mo. 2013).

[12] In re Am. Eagle Energy Corp., 2016 WL 3573952 *2.

[13] Id.; In re Alpha Nat. Res., Inc., 546 B.R. 348, 356 (2016).

[14] In re Am. Eagle Energy Corp., 2016 WL 3573952 *3-7.