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back to index backAMERItalk May,  2005

U.S. bankruptcy bill fails to close loophole

A provision of the new bankruptcy bill aimed at curbing compensation abuses may end up backfiring.

At first glance, the bill appears to hit the compensation issue head on, making it harder for companies to award lavish pay packages to executives while the companies are in bankruptcy. In order to win court approval for a retention bonus, for example, an executive would have to have a "bona fide" job offer from another company and any payouts would be capped.

Yet the new law fails to close a major loophole: Companies can still grant top executives big retention bonuses and other payments ahead of the actual court filing.

"As a policy matter, you want to have everything happen in front of the court, rather than before a case is filed," said Emanuel C. Grillo, a partner in Goodwin Procter LLP's business law department and a member of the firm's insolvency and business reorganization practice. The new law is structured so that "it still encourages them to try to implement these plans and programs pre-bankruptcy," he said.

Many of the most recent compensation scandals involving companies in bankruptcy, like those of Enron Corp. and Kmart Holding Corp., were triggered by lavish compensation packages paid to executives while their companies were on the road to bankruptcy court.

Enron, for example, approved bonuses to select employees within days of filing for Chapter 11 bankruptcy protection in December 2001. Bonuses ranged from $200,000 to $5 million, according to one lawsuit targeting former Enron executives and employees. Yet some of the recipients were only required to remain with the company for 90 days.

Even outside the glare of scandal, companies have increasingly tried to sidestep judicial review of retention bonuses by hammering out plans before entering bankruptcy, experts say. The burden then falls to creditors and other opponents of the plans to fight it out in court.

A bankruptcy attorney working to retrieve eleventh-hour Enron bonuses through the courts also sees the new bill as potentially harmful. "It's my view, and it's shared by many others, that the new law will have potentially disastrous effects," said Ronald R. Sussman, a bankruptcy partner with Kronish Lieb Weiner & Hellman LLP in New York.

"Sure, there's going to be a risk that creditors may come along and sue you for it," said Sussman, speaking of executives who push to lock in payouts pre-petition. "In the meantime, wouldn't you rather have it in your pocket now?"

The bankruptcy bill attempts to address this loophole by tweaking a section of the law that addresses "fraudulent transfers." It expands the definition of fraudulent transfers _ or transfers made to avoid paying creditors _ to include payments made to an "insider" under an employment contract.

This may increase the likelihood that courts will rule the transfers fraudulent, but the process involved will remain complex. Creditors first have to file a lawsuit, prove unreasonable value (an ambiguous concept) and then collect. Executives who plead medical or financial hardship can hamper collection.

The fraudulent-transfers amendment offers a clarification but is really nothing new, said Jonathan Landers, a bankruptcy attorney with Gibson Dunn & Crutcher LLP in New York. Creditors have always been able to target compensation paid to executives prior to bankruptcy with fraudulent-transfer claims. As a practical matter, the clarification "won't make much of a difference," Landers said.

Others, however, question whether companies will really have free rein in the period leading up to a bankruptcy, and exactly how the law will play out in courts, once judges begin interpreting the new provisions in real cases.

"I don't think you can circumvent this by (awarding packages) before the bankruptcy," said Richard A. Lapping, co-chair of Thelen Reid & Priest LLP's bankruptcy and creditors' rights practice in San Francisco, who believes that even payments that are part of pre-bankruptcy plans will still require a judge's review once in court.

Sen. Edward Kennedy, D-Mass., drafter of the amendment to tighten the rules around retention bonuses, acknowledged that the provision isn't a cure-all. "I think Sen. Kennedy firmly believes this bill fails to address the real problem of rampant corporate abuse," said Laura Capps, a spokeswoman for Kennedy. "He was able to get through one amendment to address it. It's just one small part of the problem."

Source: The Washington Post - GAI

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