Pre-Bankruptcy Executive Pay a New Target for Fairness Advocates

Large companies’ awards of millions in executive bonuses on the eve of bankruptcy are drawing renewed congressional focus.

Bankrupt companies need court approval to award executive bonuses. But there isn’t a similar restriction on pre-bankruptcy bonuses, a loophole that’s been increasingly used by some big-name companies, such as Hertz Global Holdings Inc. and Chesapeake Energy Corp.

Companies argue bonuses are crucial in retaining key employees at a critical time. But extravagant compensation for the executives who may have contributed to their companies’ decline is unfair while creditors and employees are often left holding an empty bag, critics say.

A recently introduced House bill aims to close the loophole, reflecting more attention paid to the issue at a time when headline-grabbing bankruptcies increasingly face creditors and other stakeholders’ complaints about hefty “pre-petition” bonuses.

Hertz paid more than $16 million in bonuses three days before its May 2020 Chapter 11 filing, and just a month after laying off 10,000 workers.

Chesapeake Energy paid $25 million ahead of its June 2020 filing. Sears Holdings Corp., Neiman Marcus Group Inc., and Whiting Petroleum Corp. also handed out hefty executive bonuses shortly before their bankruptcies.

In fiscal year 2020 alone, 42 distressed companies awarded a total $165 million in retention bonuses shortly before filing Chapter 11, according to a recent Government Accountability Office report.

“Workers don’t usually get bonuses when they screw up, but that’s what happens to the executives here,” Rep. Cheri Bustos (D-Ill.), who introduced the bill (H.R. 5554), told Bloomberg Law.

‘Emotional Response’

In the wake of public outcry over bonuses awarded to Enron Corp. and WorldCom senior managers, Congress in 2005 amended the bankruptcy code to require court permission before a bankrupt company could offer such compensation.

“The amendment was an emotional response and never calibrated to deal with the real problem,” said Jared Ellias, a bankruptcy law professor at the University of California, Hastings and visiting professor at Harvard Law School.

Executives who helped drive their companies into bankruptcy—but still in control of the Chapter 11 process—found ways to get around the bonus limits, he said.

They were able to get court approval of proposed bonuses more easily by characterizing them as performance incentives rather than retention measures, Ellias said.

Awarding bonuses ahead of the bankruptcy filing—in some cases just one or two days beforehand—was another workaround they found to avoid court scrutiny.

According to Bustos, pre-bankruptcy executive bonuses—often paid within days, and always less than six months before a Chapter 11 filing—averaged $833,000 in fiscal year 2020, with some as high as $6 million.

J.C. Penney Co. paid its top executives $10 million in bonuses just days before filing Chapter 11, which contributed to massive stores closing and layoffs.

Meanwhile, its creditors received only a fraction of their claims. The retailer’s Chapter 11 plan paid unsecured note holders less than 1% of a total $1.3 billion in claims. General unsecured creditors recovered less than 1% of the more than $700 million they were owed.

Other stakeholders also have been vocal. A group of retired Hertz executives told the bankruptcy court in a filing in September 2020 that the company’s pre-petition bonuses have “inappropriate parameters, potentially squander limited resources without adequate purpose or beneficial result for creditors.”

Seeking Fairness

Bustos, who commissioned the GAO report, is hoping that the bill she introduced last month will put a stop to that workaround.

The No Bonuses in Bankruptcy Act would prevent companies that have declared bankruptcy from handing bonuses to employees earning $250,000 or more.

The bill doesn’t bar pre-bankruptcy bonuses. But it’s intended to authorize the Justice Department’s bankruptcy watchdog to recover similar bonuses paid within 180 days prior to the bankruptcy filing.

The measure has bipartisan support.

“This bill is really about doing what’s fair. The vast majority of people up here would have a hard time voting against it,” said Rep. Tim Burchett (R-Tenn.), a co-sponsor of the measure.

“Everyone I’ve talked to about the bill has given the affirmative nod,” he told Bloomberg Law. “But the devil’s in the details and every other cliché you can think of.”

Purdue’s Chapter 11 case, filed to handle billions in legal claims stemming from the company’s role in the opioid crisis, has drawn congressional attention to how large corporations are handling the bankruptcy system.

Last year, several U.S. senators complained that Purdue CEO Craig Landau was slated to get a $3.5 million bonus despite evidence that he may have presided over “significant criminal activity.” The proposed bonus, part of a total $9.8 million executive bonus package, followed a prior, court-approved executive bonus worth $38 million.

‘Mechanical Restriction’

Some bankruptcy law watchers question whether eliminating bonuses for high-earning employees is the answer.

“A mechanical restriction” on bankrupt companies’ ability to pay executives “could inhibit the ability of those firms to get the best possible talent they need to reorganize,” Ellias said.

Such a no-bonus restriction might lead companies to avoid Chapter 11, which provides tools to restructure debt and operating expenses in order to survive, he said.

“You don’t want to live in a world where companies can’t use the bankruptcy system because it would cripple their ability to get the best talent,” he said.

Instead, an early bankruptcy court hearing on executive compensation may be the better option, Ellias suggested.

The new bill “dovetails with a rising sense that some workers are treated significantly better than others,” said Pamela Foohey, a professor at Cardozo School of Law. “Executives are paid well and will continue to be paid well and shouldn’t need millions to stay with the company.”

“A company in bankruptcy—everyone is in it together,” she said.