Debtors, creditors, purchasers and lenders continue to carefully monitor employee incentive programs after the 2005 changes to Bankruptcy Code brought on by BAPCA. Although many feared the changes to section 503(c) would eliminate an important tool for creating incentives for employees, courts have consistently approved reasonable and well-thought-out incentive programs.

Factual Background

In re Global Home Products, LLC, 2007 WL 689747 (Bankr. D. Del. 2007) is a recent example of such a practice. There, the Court approved a key employee incentive plan proposed by the debtors over the objection of Union representatives. The debtors, leading manufacturers of branded consumer and specialty products, proposed to implement a management plan (“Management Plan”) that rewarded employees with four quarterly payments (“Quarterly Payments”) based on the company’s performance. Under the Management Plan, eligible employees were entitled to receive Quarterly Payments if the debtors met certain EBITDAR (Earnings Before Interests, Taxes, Depreciation, Amortization and Rent) and/or Cash Flow ratios. The Management Plan contained a six-month target, a third and fourth quarter target and a fiscal year-end target. The two components of the plan, EBITDAR and Cash Flow, were both equally weighted to count for 50% of the potential Quarterly Payment. Employees were required to be employed on the last day of the quarter on which the EBITDAR and/or Cash Flow objective were actually achieved.

The Chief Executive Officer of the Debtors (“CEO”) would not be eligible under the same Management Plan: in lieu of the Quarterly Payments, he would receive amortization of his existing obligation owed to the debtors. The CEO’s incentive thus had limited “upside” with unlimited “downside;” his plan was structured such that full amortization of the CEO obligation may not occur, while the CEO could never receive more than full amortization of his debt.

The debtors estimated that the total cost of the program would range from $890,000 to $2,700,000. The top level of compensation could only be paid out if the debtors consistently achieved 125% or more of its EBITDAR and Cash Flow objectives.

The debtors also sought to implement a sales manager plan (“Sales Plan,” together with the Management Plan, the “Plans”). The Sales Plan entitled these managers to 30% of their annual salaries based on percentage increase of annual sales for their division as of the fiscal year end. The sales managers would also receive a 15% target bonus payment pursuant to the same terms and conditions as the Management Plan.

In support of these programs, the debtors introduced testimony of the debtors’ president, its chief restructuring officer and a compensation expert from Johnson Associates Incorporated. Among other things, the testimony established that the Plans were consistent with prepetition plans, were necessary to create incentives for employees and were market rate plans. In addition, the testimony showed that, due to a continued liquidity concern faced by the debtors, the structure of the CEO’s compensation package was beneficial to the debtors.

Parameters of Incentive Programs

After addressing whether the Plans were Key Employee Retention Plans (“KERPS”), subject to the restrictions of section 503(c) of the Bankruptcy Code, the Court concluded that the Plans were not retention or severance plans. Thus, as incentive plans, they would be subject to “the more liberal business judgment review under § 363.” Id. at 5. The Court added that the “reasonable use of incentive and performance bonuses are considered the proper exercise of a debtor’s business judgment.” Id. In approving the Plans, the Court explained that the changes to the Bankruptcy Code made under BAPCA of 2005 were intended to dispel the notion that executives were entitled to bonuses simply for staying with the company during the bankruptcy process. As a result, strict requirements were established that must be met prior to obtaining approval for a KERP. The Court summarized these changes as follows:

Section 503(c)(1) prohibits payments to “insiders” to induce them to remain with the debtor unless a court finds that the evidence establishes that the payment is “essential” because the individual has a “bona fide” offer from another entity at the same or greater rate of compensation, and the individual’s services are “essential” to the debtor’s survival. The retention bonuses are also limited in amount. Section 503(c)(2) permits severance payments to “insiders” only if they are part of a program which is applicable to all employees and are less than ten times the mean of severance payments given to nonmanagement employees.

The Court noted that while these are high hurdles to clear, the entire analysis changes if a bonus plan has different goals, in other words, if it is designed to provide incentives for management to perform, rather than inducing them to remain with the company. In concluding that the Plans were permissible, the Court discussed the two decisions in In re Dana Corporation. In Dana, the court had originally denied approval of the plan; however, once it was redesigned to be more in the nature of an incentive plan, the court found that adopting the plan was a reasonable exercise of the debtor’s business judgment.

In Global Home Products, borrowing from the factors utilized in Dana, the Court the considered the following before finding the Plans met the business judgment test:

  • The Plans were calculated to achieve performance for the debtors’ benefit.
  • The cost of the Plans was reasonable.
  • The Plans were consistent with industry standards.
  • The Plans were virtually identical to plans the debtors used pre-petition.

The Plans were part of the debtors’ budget that the debtor in possession lenders had approved. In approving the plan, the Court relied heavily on the fact that the Plans had essentially been proposed pre-peti-tion when retention was not a motive. The Court was not dissuaded by the fact that certain performance targets had already been met by the time of the Plans were approved. The Court explained that, because the debtors had informed the employees that they would seek approval for such Plans, “the beneficiaries were performing in response to a financial incentive and not merely to remain with Debtors.” Id. at 8.


Although the Plans in Global Home Products were deemed to meet the business judgment test, an even stronger case might have been made to assure the Plans’ approval. While the Court overlooked the fact that the debtors had not used independent counsel to perform due diligence and authorize the Plans, the use of such counsel would have bolstered the debtors’ case. Because the Plans were designed pre-petition and little change was made post-petition, the Court felt that this factor took on less significance. It also appears that independent consultants may not have been utilized to conduct due diligence regarding the necessity of an incentive plan or to truly design it. While the debtors introduced expert evidence regarding market compensation, independent consultants should ultimately assist in the process of fashioning the plan as well as setting market parameters for such programs.

Although added layers of professionals may seem unnecessary, when issues arise regarding whether an incentive plan is necessary, appropriate, and reasonable, the added safeguard of an “independent” participant will enhance a debtors’ chances of obtaining Court approval for such plans. When a company is facing a liquidity crisis, and employee defection may become a reality, a debtor should avoid being penny-wise and pound-foolish and present the strongest case it can make. An incentive plan should be properly designed and well supported, preferably through independent sources. Thus, so long as the debtor charts the right course, the door should remain open for incentive plans in the post-BAPCA era.