Employees Appointed by Board of Directors are Insiders Ineligible to Receive KERP Payments

Perry Chresomales

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

            A key employee retention plan (“KERP”) is a payment plan established by a company to retain upper management.[1] In In re LSC Communications, Inc., the United States District Court for the Southern District of New York reversed a bankruptcy court’s decision and held that six employees were ineligible to receive payment from a KERP during a bankruptcy case because they were board-appointed officers.[2] After experiencing liquidity problems, LSC Communications, Inc. (“LSC”), a corporation with 19,500 employees, announced it would fire 1,242 employees, and filed a voluntary petition for relief under Chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”).[3] In its Chapter 11 case, LSC sought bankruptcy court approval of a KERP that would pay a total of $1.8 million to 190 employees.[4] Of those 190 employees, six of the employees were elected officers at LSC.[5] The Bankruptcy Court held that the 190 employees were eligible for KERP payments because they were not statutory corporate insiders.[6] The United States Trustee then appealed, arguing that LSC provided insufficient information for the Bankruptcy Court to conclude that the six of the 190 employees were not corporate insiders and eligible to receive KERP payments.[7]

            As an initial matter, the district court analyzed whether the Trustee’s appeal was equitably moot.[8] A bankruptcy appeal should be dismissed as equitably moot (1) “when an unstayed order results in a comprehensive change in circumstances” or (2) “when a reorganization is substantially consummated.”[9] Here the court concluded that neither requirement was satisfied because (1) effective relief could still be ordered, (2) the parties had notice of the appeal and their interests were represented, and (3) the Trustee’s failure to obtain a stay does not render reversal inequitable.[10] Finding that the appeal was not equitably moot, the court analyzed whether the employees were insiders, who are not eligible for KERP payments under section 503(c) of the Bankruptcy Code.[11] The court began its analysis by rejecting the functional test from In re Borders Group, Inc. that the Bankruptcy Court applied to this case.[12] The functional test was rejected because unlike the employees at issue in this case, the employees in Borders were not appointed by the board.[13] The court was persuaded by the United States District Court for the District of Maryland’s decision in Off. of U.S. Tr. v. Fieldstone Mortg. Co. that when an employee was elected or appointed by the board as an “officer,” it made that person an officer for purpose of the Bankruptcy Code.[14] The court also took note that in Fieldstone, the court noted that it was unnecessary to inquire into a board elected or appointed officer’s duties within the corporation.[15] The court was also persuaded by In re Foothills Texas, Inc. where the Delaware Bankruptcy Court noted that the definition of officer should be based on the “plain meaning of the word officer.”[16]  The Southern District of New York concluded that the Bankruptcy Court erred by inquiring beyond the employees’ appointment by LSC’s board.[17] The employees’ appointment by the board was “dispositive, at least absent a strong showing that they do not perform any significant role in management.”[18] LSC failed to make a showing that the six employees did not perform any significant role in management, and as a result the employees were deemed officers of the company, ineligible to receive KERP payments.[19]

            Insiders, including officers, are generally not eligible to receive KERP payments.[20] Absent a showing that a board-appointed employee did not perform a significant role in management, a court may find that an employee is an officer.[21]