In our last post, we discussed differences between “pay to stay” arrangements, which face stricter scrutiny in bankruptcy cases, and “Produce Value for Pay” plans, which provide incentives for executives based on strong corporate performance.  As promised, we now examine two cases that illustrate acceptable ways for companies to motivate their executives to perform through a Chapter 11 bankruptcy.

The first is the case of Chassix Holdings, Inc., which manufactures parts for approximately two-thirds of automobiles made in North America.  After a sequence of unfortunate financial and operational setbacks during 2014, Chassix found itself a petitioner under Chapter 11 of the bankruptcy code last month.  Included among the operational setbacks was the fact that approximately 1,100 employees voluntarily left Chassix during 2014.  Since it was critical to have a work force with the proper experience, skill, and know-how to manufacture the auto parts, Chassix found itself exploring ways to enhance its compensation options prior to the petition date in order to retain more of its employees.  Unfortunately, it didn’t finish these plans prior to the petition date.

Chassix took a couple of important steps in designing its KERP and seeking authority from the bankruptcy court to implement it.  First, and foremost, it limited its KERP to a pool of employees who were not company “insiders.”  Therefore, the bankruptcy court applied the more liberal standard of business judgment when it evaluated the plan, even though Chassix had not established and regularly implemented the plan before its bankruptcy petition.  Under this standard, and considering the pre-petition employee turnover and the support of the various creditor constituencies, the bankruptcy court approved the KERP. 

Chassix took a couple of important steps in designing its KERP and seeking authority from the bankruptcy court to implement it.  First, and foremost, it limited its KERP to a pool of employees who were not company “insiders.”  Therefore, the bankruptcy court applied the more liberal standard of business judgment when it evaluated the plan, even though Chassix had not established and regularly implemented the plan before its bankruptcy petition.  Under this standard, and considering the pre-petition employee turnover and the support of the various creditor constituencies, the bankruptcy court approved the KERP.

While the Chassix KERP was easily approved without objection, a similar plan brought an objection from the U.S. Trustee in the Standard Register Chapter 11 case currently pending in Delaware.  In that case, the company initially proposed to pay more than $4 Million in incentive pay to a variety of employees, including insiders.  The company claimed that since it was hoping to conduct a bankruptcy sale for its business as a going concern, the ultimate purchaser would assume responsibility for the KERP.  Therefore, Standard Register did not expect to actually make the payments.  The U.S. Trustee objected to the lack of clarity in the motion and to the inclusion of insiders among the pool of eligible participants.  Ultimately, Standard Register acceded to the demands of the U.S. Trustee.  It amended the KERP to exclude the insiders and clarified that the estate would not be responsible for the payments to the employees under the plan.

The moral of this comparison, and, in general, of our two posts on this subject, is that companies should carefully think through their employee compensation practices before and after a bankruptcy petition.  Companies that push for excessive compensation for their insiders will face heightened scrutiny of their plans.  In contrast, companies who focus on their bottom line will be permitted to implement reasonable compensation plans, which will incentivize their employees to achieve the legitimate ends of the corporation.