The Bottom Line

The Delaware Bankruptcy Court, in In re Old BPSUSH Inc., Case No. 16-12373 (Bankr. Del. June 1, 2018) [Docket No. 1787], upheld provisions in a post-petition key employee retention plan (KERP) that provided for a waiver of pre-petition wages and bonuses under a pre-petition retention plan even if the waiver allegedly violated state labor law. Under California state law, employers are not permitted to require a release for wages due unless paid in full. The court found that even if California state law were applicable, the retention bonuses under the pre-petition retention plan had not become payable because the applicable conditions under that retention plan had not been met. Importantly, the court ultimately determined that federal bankruptcy law, enforced by a court order, pre-empted state law. Therefore, the waiver was enforceable.

What Happened?

This case involved a tale of two retention plans — one pre-bankruptcy and one court-approved KERP.

Prior to filing for bankruptcy, the debtors implemented a two-year retention plan to ensure certain employees remained with the debtors until June 2018. Shortly after filing for bankruptcy, Old BPSUSH Inc. and its affiliated debtors (together, the “Debtors”), lost eight employees, three of whom were critical employees party to the Debtors’ pre-petition retention plan. The Debtors subsequently adopted a new, post-petition KERP that offered bonuses to eligible employees who stayed until the closing of a Section 363 sale. The KERP letter agreement signed by every participant included a waiver of wages and bonuses earned under the pre-petition retention program being superseded by the new KERP.

Despite having signed the new KERP, several California-based employees (the “Claimants”) filed proofs of claim for bonuses under the former pre-petition retention plan. The Claimants asserted that the waiver in the KERP was unenforceable because California labor law provided an employer cannot require an employee to provide a release for wages due unless the wages are paid in full.

First, the Claimants argued the claim waivers in the KERP were not enforceable because the KERP letter agreement was a novation that was not supported by new consideration and was therefore invalid. The court disagreed and found the Claimants received new and valuable consideration under the post-petition KERP because, among other reasons, the new KERP substituted pre-petition general unsecured claims of unknown value that were unlikely to be paid for post-petition administrative priority obligations.

Second, the Claimants argued California labor law prevented enforcement of the waiver of wages/bonuses earned under the pre-petition retention plan. The Claimants asserted California courts have recognized that the public policy of protecting employees’ rights to wages is “unwaivable.” However, the court found that even if California law did apply, the Debtors did not owe any “earned wages” under the pre-petition retention plan because the retention award had not vested. The pre-petition retention plan provided Claimants with a cash incentive award as long as they stayed with the Company for two years (until June 1, 2018), a future date that had not yet occurred at the time the proof of claim was filed. Further, the Claimants’ contention that the retention payments became payable upon the sale date was incorrect. Even though the closing of a sale of substantially all of the Debtors’ assets was a change in control, the incentive bonuses did not become payable upon the sale date because the change of control provision did not provide for automatic vesting of retention awards. Instead, it provided that if an employee is terminated on or within 12 months of the occurrence of a change of control, “the Company’s compensation committee may provide for an award to vest” and has the discretion to accelerate the vesting period and/or waive certain conditions with respect to any pre-petition retention bonus. Old BPSUSH Inc., Case No. 16-12373 [Docket No. 1787], at 9. The KERP letter agreements were not a violation of the California labor code because the bonuses were not due at the time of signing, as it was unclear whether the heavily contested sale would close. In light of this uncertainty, the Debtors’ compensation committee likely would have had the discretion to determine whether an award was warranted.

Lastly, the court found that federal bankruptcy law pre-empts California labor law. The court noted that courts have recognized three categories of federal pre-emption: (1) express pre-emption, (2) field pre-emption and (3) conflict pre-emption. Conflict pre-emption applied in this case, as the court was asked to address a conflict between local law and federal law, such that it is impossible for a party to comply with both, or the local law is an obstacle to the achievement of federal objectives. The court relied upon In re Old Carco LLC, 442 B.R. 196 (S.D.N.Y. 2010), which determined that the “federal Bankruptcy Code, as enforced by orders of the Bankruptcy Court, preempted the state franchise laws.” Id. at 206. Accordingly, the Court found that “federal Bankruptcy law, enforced by the order approving the KERP motion, preempts application of the California Labor Code.” Old BPSUSH Inc., Case No. 16-12373 [Docket No. 1787], at 13. Therefore, the waiver provisions in the KERP are valid and enforceable, notwithstanding contrary state law.

Why This Case Is Interesting

The case is interesting for general and specific reasons. On the general point, principles of federal conflict pre-emption arise in bankruptcy where the court needs to assess state law issues in the context of a bankruptcy policy. This case is an example of the power of a bankruptcy court order to pre-empt state law, even when such law is rooted in state law public policy (here, employee rights). On the specific point, post-petition retention plans are a routine part of complex Chapter 11 cases. Companies often seek to design those plans mindful of the need to re-examining pre-petition retention, bonus or severance policies and related costs. The ability to offer specific bankruptcy awards will be impacted by potential legacy (prefiling) claims. Waivers or modifications of pre-petition claims for wages and bonuses are therefore not uncommon for inclusion in post-petition KERPs. The case provides direction for debtors — and serves as a warning for employees — on the ability of a post-petition KERP to enforce waivers of certain employee-related pre-petition claims.