Since the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, there have been discussions about the impact of Bankruptcy Code Section 503(c) a/k/a the "KERP Killer." As long as there have been KERPs (or key employee retention plans), creditors, creditors’ committees and United States Trustees have argued about executive excesses and abuses.  With the enactment of Section 503(c), Congress took on these perceived abuses by adopting a set of rules that makes traditional KERPs difficult, if not impossible, to approve. In response, counsel for debtors immediately began repackaging KERPs as incentive plans ("produce value for pay") rather than retention plans ("pay to stay"). The hope was that incentive plans would be evaluated through the business judgment lens of Bankruptcy Code Section 363, as opposed to the strict new standard of Section 503(c).

In In re Dana Corporation, Case No. 06-10354 (Bankr. S.D.N.Y. 2006), Judge Lifland held that simply changing the name of a KERP and adding an incentive component to the payment plan does not avoid application of Section 503(c). The Court specifically addressed two provisions of the compensation plan in the Dana case which it identified as having a "retentive effect." These two provisions were the "Completion Bonus" and the "Severance/’Non-Compete’ Payment." The Court found that because the "Completion Bonus" would entitle executives to obtain 66% of their bonus even if the debtors lost 23% of their value, that it was not a success-based incentive bonus, but was more akin to a retention bonus. With respect to the "Severance/’Non-Compete’ Payment," the Court found that the debtors failed to meet their burden of demonstrating that the "non-compete" payments were not "severance" for the purposes of Section 503(c)(2).

The Court left open the idea that a compensation plan could contain "some components that arguably have a retentive effect" but held that the debtors’ compensation plan did not pass muster, notwithstanding its packaging.

Written by Kyle Mathews.

Footnote 3, In re Dana Corporation, Case No. 06-10354 (Bankr. S.D.N.Y. 2006)