The new amendments to the Bankruptcy Code change business as usual for key employees at companies entering bankruptcy. Prior to this year’s amendments, companies in bankruptcy had wide discretion to offer retention bonuses in order to entice key employees to stay on board and guide the business through Chapter 11. Pursuant to the new amendments, the breadth of those incentives has been considerably reduced. So considerably reduced, in fact, that the effect may be that top executives start job hunting at the first sign of trouble and no longer stay with a company in bankruptcy.
Revised Bankruptcy Section 503(c)(1) states that an “insider” of a debtor, such as a corporate officer, cannot be paid a retention bonus unless the court makes a finding that (A) the transfer or obligation is essential to the retention of the person because the individual has a bona fide job offer from another business at the same or greater rate of compensation; (B) the services provided by the person are essential to the business; and (C) the person is not paid more than 10 times what the average nonmanagement employee received or, if no similar transfers were made to nonmanagement employees, the person is not paid more than 25% of the amount of any similar payment made to the insider in the past year. At least initially, these restrictions are likely to be welcome news for the creditors of insolvent companies.
The revised law, however, creates a disincentive for key employees to remain to shepard their companies through bankruptcy. The new requirement of a “bona fide job offer” forces even those key employees who are committed to staying with the company to actively solicit alternate employment. And if they are able to secure a lucrative job offer, the new amendments then cap the amount they can be paid to incentivize them to stay on board. The result is likely to be a systematic exodus of the most talented management from companies in bankruptcy, which could create additional opportunities for the turnaround management professionals who are likely to be called on to fill the void. Developing creative strategies to minimize the impact of this new legislation on employee morale and turnover will be a key challenge for debtors and their professionals under the new Bankruptcy Code.