Associated Press
04.27.2005, 02:49 PM
A provision of the new bankruptcy bill aimed at curbing compensation
abuses may end up backfiring.
At first glance, the bill appears to hit the compensation issue head
on, making it harder for companies to award lavish pay packages to
executives while the companies are in bankruptcy. In order to win
court approval for a retention bonus, for example, an executive
would have to have a "bona fide" job offer from another company and
any payouts would be capped.
Yet the new law fails to close a major loophole: Companies can still
grant top executives big retention bonuses and other payments ahead
of the actual court filing.
"As a policy matter, you want to have everything happen in front of
the court, rather than before a case is filed," said Emanuel C.
Grillo, a partner in Goodwin Procter LLP's business law department
and a member of the firm's insolvency and business reorARnization
practice. The new law is structured so that "it still encourages
them to try to implement these plans and programs pre-bankruptcy,"
he said.
Many of the most recent compensation scandals involving companies in
bankruptcy, like those of Enron Corp. and Kmart Holding Corp., were
triggered by lavish compensation packages paid to executives while
their companies were on the road to bankruptcy court.
Enron, for example, approved bonuses to select employees within days
of filing for Chapter 11 bankruptcy protection in December 2001.
Bonuses ranged from $200,000 to $5 million, according to one lawsuit
targeting former Enron executives and employees. Yet some of the
recipients were only required to remain with the company for 90
days.
Even outside the glare of scandal, companies have increasingly tried
to sidestep judicial review of retention bonuses by hammering out
plans before entering bankruptcy, experts say. The burden then falls
to creditors and other opponents of the plans to fight it out in
court.
A bankruptcy attorney working to retrieve eleventh-hour Enron
bonuses through the courts also sees the new bill as potentially
harmful. "It's my view, and it's shared by many others, that the new
law will have potentially disastrous effects," said Ronald R.
Sussman, a bankruptcy partner with Kronish Lieb Weiner & Hellman LLP
in New York.
"Sure, there's going to be a risk that creditors may come along and
sue you for it," said Sussman, speaking of executives who push to
lock in payouts pre-petition. "In the meantime, wouldn't you rather
have it in your pocket now?"
The bankruptcy bill attempts to address this loophole by tweaking a
section of the law that addresses "fraudulent transfers." It expands
the definition of fraudulent transfers - or transfers made to avoid
paying creditors - to include payments made to an "insider" under an
employment contract.
This may increase the likelihood that courts will rule the transfers
fraudulent, but the process involved will remain complex. Creditors
first have to file a lawsuit, prove unreasonable value (an ambiguous
concept) and then collect. Executives who plead medical or financial
hardship can hamper collection.
The fraudulent-transfers amendment offers a clarification but is
really nothing new, said Jonathan Landers, a bankruptcy attorney
with Gibson Dunn & Crutcher LLP in New York. Creditors have always
been able to target compensation paid to executives prior to
bankruptcy with fraudulent-transfer claims. As a practical matter,
the clarification "won't make much of a difference," Landers said.
Others, however, question whether companies will really have free
rein in the period leading up to a bankruptcy, and exactly how the
law will play out in courts, once judges begin interpreting the new
provisions in real cases.
"I don't think you can circumvent this by (awarding packages) before
the bankruptcy," said Richard A. Lapping, co-chair of Thelen Reid &
Priest LLP's bankruptcy and creditors' rights practice in San
Francisco, who believes that even payments that are part of
pre-bankruptcy plans will still require a judge's review once in
court.
Sen. Edward Kennedy, D-Mass., drafter of the amendment to tighten
the rules around retention bonuses, acknowledged that the provision
isn't a cure-all. "I think Sen. Kennedy firmly believes this bill
fails to address the real problem of rampant corporate abuse," said
Laura Capps, a spokeswoman for Kennedy. "He was able to get through
one amendment to address it. It's just one small part of the
problem."
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