August 6, 2021
With diminishing pushback, executive bonuses in bankruptcy veer toward ‘entitlement’
By Maria Chutchian
Earlier this year, some of Mallinckrodt’s creditors balked at the prospect of rewarding top executives of the bankrupt pharmaceutical company with bonuses when management was facing accusations of misconduct. But their complaints didn’t persuade the judge overseeing the case, who ruled that the 12 executives could collect about $30 million in performance bonuses if they met certain goals.
Denouncing bonuses for high-ranking officers of companies that are in bankruptcy is not uncommon. But it often has little sway with judges, who must approve the incentive plans. In fact, what made the Mallinckrodt situation stand out was that creditors even bothered to challenge the payments in court. These days, corporate debtors tend to arrange a deal with their creditors behind the scenes in order to fend off a public fight when a bonus plan is presented publicly.
Mallinckrodt’s bankruptcy was precipitated by widespread litigation accusing it of helping to fuel the national opioid epidemic, which has resulted in the deaths of hundreds of thousands of Americans, by downplaying the risks of its drugs. But in April, U.S. Bankruptcy Judge John Dorsey in Delaware concluded that “mere allegations” of senior management misconduct in the years leading up to the bankruptcy was not enough to justify denying them bonuses.
Mallinckrodt said the bonuses were a matter of “appropriately compensating and incentivizing” the executives, in response to the objections. A representative for the company declined to comment.
Mallinckrodt is just one of many bankrupt companies – including OxyContin maker Purdue Pharma – that have sought and received court approval of executive bonus plans in recent years, even as many have opted to pay bonuses before they file for Chapter 11 protection.
Waiting to seek approval of a bonus plan during a bankruptcy offers more transparency for creditors and the general public and provides opportunities for those who have questions about the payments to have their say. Still, opposition to such executive bonuses appears to have waned recently compared with five or six years ago, when it was common to see labor unions or junior creditor challenges to additional payments for top brass in bankruptcy court.
And even the COVID-19 pandemic did not have any obvious effect on bonus plans approved by bankruptcy judges. Since March 2020, Neiman Marcus Group was approved to pay up to $10 million to eight executives, Intelsat was approved to pay up to $22 million to eight executives, SpeedCast International was approved to pay up to $7.6 million to six executives, and offshore driller Valaris was approved to pay up to $11 million to 12 executives. Those are just a handful of examples. None of those bonus plans prompted opposition from junior creditors.
SOUNDING THE ALARM SOLO
These days, the lone opponent of this type of plan in court has often been the bankruptcy arm of the U.S. Department of Justice, the U.S. Trustee Program (USTP), which serves as the government watchdog on various aspects of a Chapter 11 proceeding.
One of the USTP’s many roles in a bankruptcy involves policing these bonus plans – called “key employee incentive plans,” or KEIPs, in bankruptcy lingo. The companies’ lawyers must be careful to ensure that the bonus plans they present to a bankruptcy judge for approval are not actually “retention” plans, because those are not permitted for high-ranking executives under bankruptcy law. (Lower-level employees may collect retention bonuses during a bankruptcy, however.)
Proponents of the bonuses say they’re beneficial to the company as a whole, as well as to its creditors, because they encourage executives to work their hardest to achieve the best possible outcome and the highest possible value for the company. But the USTP believes the KEIPs are getting out of hand.
“Overall, we are concerned that bonuses are considered an entitlement,” USTP Director Clifford White III said in an interview with Reuters.
The best his office can do, he said, is to force the bankrupt company to be as transparent as possible about the potential bonuses and ensure that the goals executives must meet to collect their money are genuinely difficult. Basically, the U.S. Trustee is making sure the executives aren’t being paid extra just for showing up to work.
BEHIND THE SCENES
In the not-too-distant past, KEIPs may have inspired opposition from junior creditors. But now bankrupt companies often work with their various creditor constituencies behind the scenes before they file their bonus plan publicly in the hope of keeping any drama out of the public eye.
Unsecured creditors’ committees, whose constituents are likely to see substantial discounts to their recoveries in a bankruptcy, will sometimes ask for modifications to a KEIP but ultimately won’t put up much of a fight in court because they want to see the case move forward and achieve some sort of return for them, as quickly as possible.
“As unsecured creditors, they’re relying on management to get them the best result possible in a bankruptcy case,” Richard Kanowitz of Haynes and Boone said. “So if [the company is] saying these people are imperative and necessary to reorganization, you don’t want to fight to just fight.”
During the rash of bankruptcies among coal companies around 2015 and 2016, it was more common to see pushback to executive bonus plans from labor, with the United Mine Workers of America often arguing that it was inappropriate to reward executives while miners didn’t know whether they’d have jobs or pensions by the end of the case. But as coal bankruptcies have faded and Chapter 11s in the retail and oil and gas sectors – which generally don’t have a unionized workforce – have increased, workers are heard from less than they once were.
Acceptance of executive bonuses has grown, especially as union influence has diminished, according to Jack Cohen, who chairs the Association of BellTel Retirees. One of the association’s areas of focus is “runaway” executive compensation.
“People become numb to it,” Cohen said. “Unions have lost some of their power, what they had years ago.”
RESOURCE IMBALANCE
Judges who must sign off on these bonus plans are largely limited to the evidence the company and other interested parties present, U.S. Bankruptcy Judge Marvin Isgur in Houston said in an interview with Reuters. But often the company is the only one presenting evidence.
Isgur, who has presided over an array of high-profile Chapter 11 cases in recent years, noted during a December hearing for offshore driller Valaris that while the U.S. Trustee’s attorney made good arguments questioning bonuses for the top brass, he didn’t offer evidence to counteract what Valaris provided in favor of them. Isgur signed off on the plan.
Sometimes, Isgur said, he feels the frustration he assumes the U.S. Trustee lawyers must experience when they make good legal arguments but don’t have the resources to put on evidence that would back up their position. But in approaching these bonus plans, he added, it’s important for a judge to only weigh the evidence that’s been presented and keep personal views on the executive compensation out of the picture.
“They know what they’re confronting and facing because they’re very fine lawyers, and I’m happy to have them make the arguments and I want them to ask the questions,” he said. “But in the end, I’ve got the evidence.”
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