Pre-bankruptcy payments under fire from the government’s watchdog

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Dive brief:

  • Companies paid some $ 165 million in executive retention bonuses before Chapter 11 bankruptcies in 2020, according to a Government Accountability Office survey.
  • These bonuses were awarded without any court approval. Retailers make up a significant fraction of 2020 pre-bankruptcy bonuses, with JC Penney, GNC, Neiman Marcus, Ascena Retail Group, Custom brands and Tuesday morning pay premiums before their respective bankruptcies.
  • The GAO recommended that Congress take up the issue and consider including provisions in the US bankruptcy code that would clearly subject these bonuses to court oversight.

Dive overview:

Pre-bankruptcy bonuses have become so common that they often indicate that a Chapter 11 is imminent. Retailing probably accounts for a disproportionate share of these bonuses, for the simple reason that retailing accounts for the most bankruptcies of any other industry except oil and gas, according to data from Debtwire.

The retailers listed above each paid millions in retention bonuses to key executives in the months, weeks, or even days before filing.

JC Penney, for example, paid out $ 10 million in loyalty bonuses to senior executives just days before the company’s filing. That included more than $ 4 million to then CEO Jill Soltau, who would be leaving the company shortly after it was acquired by Simon Property Group and Brookfield Asset Management later in the year.

These bonuses are subject to strict judicial control if they are paid during bankruptcy, after Congress in 2005 imposed strict restrictions on executive bonuses in the Bankruptcy Code.

As the GAO details, for a bankrupt company to pay a retention bonus, the executive must have a real job offer for equal or greater pay, the executive’s services must be essential to the survival of the business. , and the bonus cannot be higher than Average bonus 10 times higher than non-managerial employees. None of these rules apply to bonuses before bankruptcy.

Bonuses are ostensibly paid to keep a management team in place so that a business can survive a restructuring or judicial sale. This assumes that executives would jump ship in the short term without the payments and that their work in the company is essential to its immediate survival.

Aside from the idea of ​​paying millions to executives of a company that cannot meet its financial obligations, bonuses represent money that is not there for creditors during the Chapter 11 process. especially since several retail bankruptcies, including that of Toys R Us, have left salespeople short and employees without jobs or significant severance pay.

Toys R Us executives have been sued by former salespeople for a host of things, including pre-bankruptcy bonuses. According to emails revealed in litigation in early September 2017, Dave Brandon, then CEO of Toys R Us, and his talent director learned from their restructuring lawyers at Kirkland & Ellis that all bonuses and their amounts would be subject to much greater restrictions in the event of bankruptcy. . Their solution was to pay themselves bonuses – including $ 2.8 million to Brandon – just days before Toys R Us filed Chapter 11.

Some experts say these bonuses could be clawed back by unsecured creditors in lawsuits, such as the one against former Toys R Us executives. The GAO report notes that the fraudulent transfer provisions of the Bankruptcy Code could be used by unsecured creditors and other affected parties to limit pre-bankruptcy premiums. But such litigation is expensive, the arguments are difficult to prove, and the results are always uncertain.

This means that, under the status quo, most of the bonuses would likely remain intact. As David Farrell, a partner at law firm Thompson Coburn, told Retail Dive earlier this year: “In the worst case, you may have to return some of it, but probably not all of it. So what’s the downside? I mean, there’s the reputation and public scrutiny that comes with it. But that doesn’t seem like a big inhibition [for] one of the executives so far. “


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