Aralez Pharmaceuticals Inc. ("AP Inc.") and Aralez Pharmaceuticals Canada Inc. ("APC Inc.") (collectively, the "Applicants") brought an application to the Ontario Superior Court under the CCAA concurrently with a United States Chapter 11 proceeding brought by affiliated entities. the Applicants. desired a managed liquidation process.

The Applicants entered into three stalking horse agreements for approximately $240 million. This compared to the secured claim of $275 million of the major secured creditors of the Applicants.

The KERP impacted three employees in Canada, and was designed to provide these three employees with retention bonuses of 25-50% of their salary, for a total remuneration of $256,710.00. The KEIP impacted nine employees of the Canadian debtors which incented those employees to assist in achieving the highest possible cash flow during the bankruptcy process, and the highest sales proceeds. Different levels of bonus were promised depending on the KEIP employees' success ('threshold', 'target', 'stretch' and 'super stretch' bonus levels).

The motion to approve the KEIP was opposed by the Official Committee of the Unsecured Creditors appointed pursuant to the United States Chapter 11 proceedings on the basis that the highest level of bonus was too easy to achieve, and the incentive levels relative to salary were too high. The issue before the Court therefore was whether the KERP and KEIP programs should be approved.

Justice Dunphy found that while there are no solidified rules when reviewing KERP or KEIP plans, there are a number of principles to apply. While the Court reviewed earlier decisions such as Cinram International Inc. (RE), 2012 ONSC 3767 and Grant Forest Products Inc. (RE), 2009 CanLii 42046 (ON SC), and distilled the a number of considerations from those decisions, the Court went on to reformulate those considerations into three criteria that it felt encapsulated the previously articulated considerations, and provided a framework to consider the extent to which appropriately objective business judgment underlies the Employee Plan proposals:

1)       Arm's length safeguards. The Court found that the greater the input into the design, scope and implementation of the Employee Plan from parties who were independent of the plan's beneficiaries, the better. The Court highlighted two possible sources of that input: the Monitor, and creditors whose interests are affected by the costs and benefits of the program.

2)      Necessity. The Court found that the existence of Employee Plans must be justified on a case by case basis, which means that the moving party should demonstrate that the Employee Plans are necessary under the circumstances having regard to the following factors:

  1. employees who are working to protect their own long-term job security are already well-aligned with creditor interests and therefore may not require a KERP or KEIP, while employees who have critical responsibility in the company but with no chance of an ongoing role with the company may necessitate the creation of Employee Plans;  
  2. employees with high-demand skills are more likely to require an Employee Plan than those employees who could be relatively easily replaced; and
  3. Overbroad Employee Plans are more likely to be found to be inappropriate and overreaching.

3)      Reasonableness of Design. The Court found that the targets and incentives in an Employee Plan must be reasonably related to the goals that the applicant(s) pursue, and those goals must be of demonstrable benefit to the objects of the restructuring process. The Court cautioned that payments made before the desired results are achieved are often less defensible.

The Court then used the newly formulated criteria to determine that AP Inc. and APC Inc.'s Employee Programs were appropriate under the circumstances on the basis that:

1)      There were sufficient arm's length safeguards. The Applicants engaged a financial advisor to formulate the KEIP and KERP plans, along with legal counsel and the AP Inc. Board of Directors, none of whom are beneficiaries of either program. Additionally the Monitor was consulted on the programs and the major secured creditors did not object to either program.

2)      The Court found that the KEIP and KERP plans were not overly broad, and were sufficiently necessary under the circumstances due to the scope of both programs (3 employees and 9 employees for the KERP and KEIP programs, respectively), as well as the employees' impact on the business during the period.

3)      The Court found that both the KERP and KEIP were reasonably designed. Despite the fact that the employees subject to the KEIP would comfortably achieve the highest bonus bracket, the Court determined that the Employee Programs were designed prior to the initial Court filings, and as such, there was a great deal of uncertainty regarding what sort of cash flow and sale proceeds were going to be possible. Accordingly, the Court found that it is only with hindsight, and the efforts of the KEIP employees themselves that made the achievement of the goal look relatively easy.