By: Prof. G. Ray Warner

Robert M. Zinman American Bankruptcy Institute Scholar in Residence

On September 19, 2002, Senator Dick Durbin (D-IL) introduced a substitute amendment to the Employee Abuse Prevention Act of 2002 (S. 2798). The substitute deletes the most controversial provisions of the prior bill, while retaining most of the provisions designed to protect employees and retirees when businesses file bankruptcy. The substitute amendment does not include a venue provision that would have limited Delaware and New York filings, provisions that would have enhanced the trustee’s power to challenge security interests and asset securitization transactions, a provision that would have given claims for ERISA fiduciary breaches a super-priority, lien-priming status, and a provision that would have limited the section 546(e) safe harbor for securities settlement payments to financial intermediaries. Like the original bill, the changes made by the substitute amendment would be effective immediately upon enactment and would apply to cases pending on that date.

Retiree Health Benefits

Several provisions of the bill address employee and retiree issues. First, current section 1114 prevents a Chapter 11 debtor from unilaterally modifying certain retiree benefits, such as retiree health insurance, during the case unless an authorized retiree representative is appointed and agrees to the modification, or the court authorizes the modification as necessary to the reorganization. The bill would amend section 1114 to prevent debtors from evading its requirements by terminating retiree benefit plans on the eve of bankruptcy. The bill would require retroactive reinstatement of retiree benefits that were modified "in contemplation of bankruptcy" within 180 days before filing unless the pre-petition modification was essential to the continuation of the debtor’s business. Modifications made within the 180-day period would be subject to a rebuttable presumption that they were made in contemplation of bankruptcy.

Employee Wage, Severance and Pension Priority

Several provisions are designed to enhance the employees’ recovery on pension and wage claims. The bill would increase the current section 507(a)(3) priority for unpaid wage claims from $4,650 to $13,500, and would extend the time period during which wages could qualify for priority from 90 day to 180 days.

More importantly, unlike the original bill, the substitute would deem severance payments to be earned in full on the day of layoff or termination. Thus, for employees terminated within 180 days before bankruptcy, the entire severance obligation would be subject to the section 507(a)(3) priority, rather than merely that portion deemed to have been earned during the final 180 days. The bill makes a corresponding change to section 503(b) that would give administrative expense priority treatment to the first $13,500 of severance obligations owed to employees who are terminated post-petition. Contra In re Hechinger Investment Co., 298 F.3d 219 (3d Cir. 2002) (“stay-on” benefits apportioned between pre-petition and post-petition periods). The full amount of severance owed would be given administrative expense status if the debtor had assumed the collective bargaining agreement or other contract that included the severance obligation.

Of greater significance, in certain instances the bill would convert employee equity security interests held in pension plans from "interests" to "claims." The bill would amend the section 101(5) definition of "claim" to include equity securities held in an ERISA pension plan if the employee was forced to invest the pension assets in equity securities of the debtor or an affiliate of the debtor. The "claims" thus created would be entitled to priority under the section 507(a)(4) "employee benefit plan contribution" provision. The amount of the section 507(a)(4) priority claim would be set at the market value of the stock at the time it was contributed to, or purchased by, the pension plan. Note that the section 507(a)(4) benefit plan priority is limited to the unused portion of the 507(a)(3) priority times the number of employees. This would remain the case for benefit plan contributions. No dollar limit would apply, however, to the new pension plan stock claim. The effect of these changes would be to elevate covered employee pension plan stock interests from the lowest priority common stock level to a fourth level priority ahead of general unsecured claims. In a case like Enron, where the contributed stock had a high value at the time of the contribution, this provision could divert all of the residual value of the estate from the unsecured creditors to the employees.

Enhanced Avoidance of Fraudulent Transfers and Excessive Compensation

The bill would also enhance the recovery of voidable transfers and impose limits on executive compensation. Two changes would make it easier for the estate to avoid pre-petition transfers. First, the one-year look-back period for fraudulent transfers under section 548 would be extended to four years. Thus, both actual fraudulent transfers and constructive fraudulent transfers (transfers for less than reasonably equivalent value when the debtor is insolvent) could be avoided by the estate if they occurred within four years before bankruptcy. This change would have relatively little impact in most cases since most such transfers already could be avoided under section 544(b) using very similar state fraudulent transfer laws. The provision would enhance the estate’s recovery in those cases where the state law statute of limitations was less than four years or where the state law was less expansive than section 548.

The bill would also expand section 548 to allow the recovery of excessive benefit transfers and obligations made to insiders (including officers and directors) during the four years prior to bankruptcy if the debtor was insolvent or was rendered insolvent by the transaction. This provision would apply even though the transaction was not otherwise fraudulent. A two-part test would be used to determine whether the benefit was excessive, and thus avoidable. If similar benefits were provided to non-management employees during the same calendar year, then the benefit would be excessive if it was equal to or greater than 10 times the average similar benefits provided to non-management employees during the same calendar year. If no such benefits were provided to non-management employees, then the benefit would be excessive if it was equal to or greater than 125% of the amount of any similar benefit provided in the calendar year prior to the year of the benefit transaction. The bill appears to avoid the entire transaction, and not merely the portion deemed excessive. This appears to be intended as a disincentive to engage in such transactions. The bill does not indicate whether the section 548(c) "good faith transferee for value" defense could be used to limit avoidance in appropriate cases. Although the provision appears to be designed to apply to management compensation, nothing in the language of the provision expressly limits it to compensation. Arguably it could be used to avoid non-fraudulent transfers between corporate affiliates if they met or exceeded the 125% threshold.

Limitations on Retention and Severance Programs

The bill also would impose new standards for the approval of retention and severance programs for officers and directors. Retention payments to insiders (including officers and directors) would not be allowed unless the court finds "based on evidence in the record" that the retention benefit is “essential” to the retention of such person and “essential to the survival of the business.” The substitute does not include the original bill’s requirement that the person have a competing job offer. Further, the amount of the retention benefit could not be greater than 10 times the average similar benefit provided to non-management employees during the same calendar year or, if no similar benefits were provided to non-management employees, the retention benefit could not exceed 125% of any similar benefit provided to the same insider during the prior calendar year. It is not clear which benefits would be considered in computing these caps since the bill refers to "similar" transactions "for any purpose". While use of the term "similar" suggests that the comparison is to other retention benefits, the "any purpose" language suggests that the cap is computed on the basis of total compensation. The bill would not limit retention programs for non-management employees.

The bill would also limit severance benefits for insiders (including officers and directors). The severance payment would have to be part of a program that is generally applicable to all full-time employees and could not be greater than 10 times the average severance given to non-management employees during the same calendar year.

Post-Petition Employment of Officers or Consultants

Finally, the bill contains broad language barring post-petition transfers and obligations that are outside the ordinary course of business, unless they are justified by the facts and circumstances of the case. Transfers to, and obligations incurred for the benefit of, officers, managers, or consultants hired post-petition would be deemed to be outside the ordinary course of business. The effect of this provision would be to subject the compensation arrangements for management personnel and consultants hired post-petition to greater scrutiny by the court. While such compensation arrangements are the obvious focus of the provision, the new “justified by the facts and circumstances” standard would apply to all non-ordinary course post-petition transfers and obligations. It is not clear whether this language would impose significant new limitations on the debtor’s ability to use business judgment in entering into non-ordinary course transactions.