Some recent high profile restructuring debtors made multi-million dollar retention bonuses on the eve of bankruptcy filings. The U.S. Government Accountability Office (GAO) took notice of these pre-petition payments and, in September 2021, published a report with data showing that debtors may be “working around the [Bankruptcy] Code’s restrictions” by paying bonuses prior to filing bankruptcy. The GAO Report recommends that Congress amend the Bankruptcy Code to “bring pre-bankruptcy bonuses under court oversight” and “specify factors the court should consider before approving them.” And Congress listened and acted.

Historically, chapter 11 debtors routinely sought Bankruptcy Court approval to pay significant retention bonuses to key members of senior management pursuant to Key Employee Retention Plans or KERPs. Such “pay to stay” plans were essential, debtors argued, to retain key personnel to guide them through the restructuring. While KERPs were mainstream in large chapter 11 cases, creditor committees and other parties objected to these payments on the grounds that such payments (i) were unnecessary considering management’s ongoing fiduciary duties to creditors and shareholders, (ii) were inequitable considering the workforce reductions and wage and benefit sacrifices affecting the rank-and-file employees and (iii) enriched the very executives who drove the company towards chapter 11. Congress took notice and, in 2005, passed the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) to impose strict limitations on such payments and to narrow the circumstances under which such payments could be made. (See Bankruptcy Code Section 503(c).)

While Congress took steps to restrict post-petition executive compensation, it took no action to restrict pre-petition executive compensation, creating a perceived loophole many recent large debtors sought to exploit. Indeed, the GAO Report found that in fiscal year 2020, $165 million in bonuses were paid to 223 executives across 42 companies shortly before they filed for bankruptcy.

In October 2021, Rep. Cheri Bustos (D-IL-17), proposed the No Bonuses in Bankruptcy Act of 2021 (the “Act”) which, as the name suggests, proposes amendments to the Bankruptcy Code to prohibit certain bonus payments. The Act proposes two categories of changes: First, the Act would add a subsection (d) to section 503 prohibiting bonuses for (i) individuals whose annual salaries exceed $250,000, (ii) insiders of the debtor, or (iii) any individuals to the extent that a bonus would cause that individual’s annual salary to exceed $250,000. The Act defines bonus to include “retention, incentive, or reward related services” provided to a debtor, but excludes sales commissions and obligations under collective bargaining agreements. The Act specifies that the term “individual employed by the debtor” includes, but is not limited to, employees, consultants, and contractors of the debtor. Second, the Act directly targets companies who wish to award pre-filing bonuses by revising Bankruptcy Code Section 547 to allow avoidance of any transfer made within 180 days before the bankruptcy petition is filed “if such transfer is the payment of a bonus of the kind that would be disallowed under subsection (c) or (d) of section 503.”

Whether a practitioner believes Section 503 unduly restricts executive compensation or does not restrict executive compensation enough, the GAO Report and the Act indicate that significant changes may be forthcoming. As with the Bankruptcy Venue Reform Act of 2021, which also proposes robust changes to the Bankruptcy Code for corporate debtors, Herrick will continue to monitor this legislation.

The GAO’s report may be accessed here: September 30, 2021 GAO Report.

The text of the Act may be found here: No Bonuses in Bankruptcy Act of 2021.