Courts stepping in to limit pay-to-stay plans

NEW YORK — The way that some executives have been paid when their companies file for bankruptcy, running a failing business may seem like a profitable proposition.

That’s right, while workers often get fired and shareholders watch the value of their investments sink when companies enter Bankruptcy Court protection, corporate leaders have been known to secure fat “retention” bonuses that pay them big money to stick around while their companies reorganize.

But they won’t be able to get that kind of pay-to-stay cash for long. Not only are the courts cracking down on overly generous retention agreements, but thanks to a new bankruptcy law, such bonuses will become a lot tougher for companies to dole out.

“The money isn’t going to be outlawed, but the new law will cut out lots of the excess and bring some reality and rationality back to the process of how to pay to retain executives during bankruptcy proceedings,” said Anthony Sabino, associate professor at the Peter J. Tobin College of Business at St. John’s University.

Just as executive compensation has soared over the last decade, so have pay packages for corporate leaders to rebuild their bankrupt companies.

In some cases, the money is well spent because it helps stem the exodus of workers who know the business and can speed up the reorganization process. Ironically, those getting the money often happen to be the same people who were in charge when the company stumbled.

At Kmart Corp., for instance, the struggling retailer’s 25 top managers collected more than $28 million in “retention” pay just as the company filed for bankruptcy three years ago. And they weren’t alone: Those leading Enron, WorldCom and others at many other troubled companies secured the same kind of deals.

In most cases, the retention bonuses require executives to stay through at least part of the bankruptcy reorganization process, but there is no standard that specifies for how long.

And there are plenty of examples that show how short their stays can be. In the case of Enron, bonuses ranging from $200,000 to $5 million were given to select employees in the days before the former energy trading giant filed for bankruptcy in 2001. Some recipients of those payouts only had to stay 90 days before they were entitled to the pay.

Already the courts have started clamping down on retention deals. For instance, a bankruptcy court judge in May rejected US Airways Group Inc. request to pay up to $55 million in severance and retention plan to its 23 senior executives and 1,800 managers to prevent an exodus of managers ahead of the airline’s anticipated merger with America West. That request came after the struggling airline sought to cut $1 billion annually in labor costs.

Instead, the court only approved a plan estimated to cost between $20 million and $28 million for its management employees, not its executives.

The new bankruptcy law, which goes into effect in October, will further restrict such payouts as part of sweeping changes to the bankruptcy code.

In order to get a retention bonus under the new law, an executive will have to prove to the court that they are entertaining another job offer that pays as much or more than their current compensation. In addition, there will be a cap on the amount they can make if they were to get one — it can’t be larger than 10 times the average amount given to rank-and-file workers during that calendar year.

The law also extends what is known as the fraudulent transfer provision, which will make it more difficult for companies to hand out the bonuses just before a company enters bankruptcy.

“There are a number of provisions in the amended bankruptcy code designed to protect rank-and-file employees, creditors and investors from the effects of the actual misconduct of senior managers,” said Ira Herman, a partner in the bankruptcy practice group at the law firm Bryan Cave LLP.

Legal experts, however, say that it could take time for cases to work through the courts to see how the new requirements will be applied. For instance, it remains unclear what documentation, if any, executives would have to present when claiming they have another job offer.

There are also worries about the unintended consequences that could come from the new restrictions. What happens if talented managers leave or won’t go work at troubled companies because they can’t get amply paid for their service? What happens if it sparks an exodus of crucial personnel making the reorganization process more difficult?

Still, the downsides can hardly outweigh the good that will likely come from steeper restrictions put on retention pay. It never made sense that executives would get rich at a time when their companies were barely limping along.