In the early 2000s, large troubled firms developed a practice of paying retention bonuses to senior managers immediately after filing for Chapter 11 bankruptcy. Congress banned this practice in 2005 with the late Sen. Ted Kennedy (D-Mass.), citing the need to protect public confidence in the bankruptcy courts and fight “glaring abuses of the bankruptcy system by the executives of giant companies.”
But by regulating only bonuses paid during the bankruptcy case, Congress left open the possibility of paying retention bonuses immediately before a bankruptcy filing — and this is exactly what companies are doing. Last week, on the eve of a historic bankruptcy, JCPenney paid $7.5 million in retention bonuses to its senior managers shortly after furloughing more than 80,000 employees. As we confront the early stages of a COVID-19 deluge of bankruptcy cases amidst record unemployment, Congress should ban this straightforward evasion of congressional restrictions on executive pay.
When JCPenney paid these bonuses, it followed the same path as many other firms recently, especially in the just-as-troubled energy industry. For example, Whiting Petroleum paid $14.6 million in bonuses in the days before bankruptcy, including $6.4 million for its CEO.
To be sure, executive pay is a challenging subject for federal regulation. On the one hand, troubled firms need talented managers to turn their businesses around and navigate a bankruptcy process. Any interference with the ability of troubled firms to hire and pay executives could diminish their ability to offer competitive pay packages to attract and motivate the best people for the job.
On the other hand, such practices can be cynical attempts to evade the regulation and pay retention bonuses despite Congress’s law banning them. Executives of bankrupt firms enjoy enormous bargaining power due to their control over the bankruptcy process, raising questions about any amount of pay they receive that goes beyond the normal level of pay in the company or in the industry. There is also an interesting question at the moment about where exactly many senior company managers can go, given the realities of social distancing and a pandemic that has ravaged an already battered retail sector.
Congress’s 2005 attempt to regulate bankruptcy pay was unsuccessful in other ways as well. It left open the possibility of paying “incentive” bonuses that managers earned by accomplishing challenging “stretch” goals, without specifying exactly what that means. While many companies have responded to the new rule by paying bonuses on the eve of bankruptcy, others have chosen to engage in the new process of proving that an executive bonus is a bona fide “incentive bonus” and not a disguised retention bonus.
Some companies have recently sought to pay these “incentive” bonuses through the bankruptcy process, inviting litigation and outrage from creditors. In my research, I have found that Congress’s demand that bankruptcy judges distinguish permissible “incentive” bonuses from banned retention bonuses is an unproductive exercise. The new procedure invites a great deal of litigation that makes the process of approving a bonus plan 60 percent more expensive than it was pre-2005; to make things worse, the litigation rarely provides a judge with much in the way of useful information in determining whether the proposed bonuses are, in fact, bona fide incentive bonuses. And incentive bonuses provoke public outrage no less than retention bonuses did.
Accordingly, Congress should revisit the entire regulatory framework from 2005 and start over. A better approach would move away from distinguishing “incentive” and “retention” bonuses and force Chapter 11 firms to justify all executive compensation with data on historic practice and prevailing market conditions. Unless companies can show some special justification, unusual bonuses paid prior to bankruptcy should be forced to be returned to the firm for the benefit of unsecured creditors. In light of the power that Chapter 11 executives have, post-bankruptcy pay should always be set by the post-bankruptcy board. And firms should be required to disclose the pay contracts of their Chapter 11 managers to the bankruptcy court for two years after bankruptcy in order to avoid simply shifting the timing of large bonuses that are unconnected to the success of the company or out of line given pay practices in the industry.
As Congress considers amendments to bankruptcy law to respond to COVID-19 and record unemployment, cracking down on bankruptcy pay evasion, while not core to how bankruptcy law operates, could go a great deal towards eliminating behavior that only exacerbates a rising sense that Americans are not all in it together, and that some workers are more equal than others.
Jared Ellias is a professor of law and founding faculty director of the Center for Business Law at the University of California, Hastings College of the Law, in San Francisco. He previously was a visiting associate professor at Boston University's School of Law and a teaching fellow at Stanford Law School.