Bankruptcy Reform: A Necessary Component of Economic Recovery

Edward NeigerEdward E. Neiger is the founder of Neiger LLP, a creditor’s rights and bankruptcy law firm. Neiger LLP leads efforts on behalf of creditors and creditors’ committees to help them recover as much money as possible. Neiger LLP also publishes the Avoidance Action Report, which is a quarterly publication reporting the latest developments and case law in connection with bankruptcy avoidance actions. Prior to Neiger LLP, Edward was an attorney in the Business, Finance & Restructuring department of Weil, Gotshal & Manges LLP. For more information please visit or contact the author directly at

By Edward Neiger

Many American companies will likely file for bankruptcy protection in the next few years. It is, therefore, important that Congress act to protect the interests of creditors and shareholders of bankrupt corporations. Unfortunately, one systemic cause of corporate failure – overcompensation of bad management – is all too often allowed to recur after a company files for bankruptcy protection. Reforming certain aspects of the bankruptcy code will go a long way to revive America’s sick corporations by re-instilling public and creditor confidence in corporate America – an important step in reviving the economy. Particularly, Congress must ensure that there is a genuine correlation between a bankrupt company’s performance and its executive’s compensation.

Congress had good intentions when it enacted Bankruptcy Code section 503(c) as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Essentially, section 503(c) limits compensation to insiders (such as officers and directors) if the compensation is “for the purpose of inducing such person to remain with the debtor’s business.” In addition, section 503(c) prohibits executive severance packages that are disproportionately larger than other non-management employees’ severance. While many bankruptcy courts have indeed limited executive compensation, debtors’ attorneys have become increasingly creative in getting courts to approve excessive compensation for executives of bankrupt companies; sometimes for the very executives that were at the helm when the company sank into insolvency.

In some cases lawyers used one of the oldest tricks in the lawyers’ handbook: ask for the sun, settle for the moon. For example, in the Delphi bankruptcy case, the debtor originally asked the court to approve an $80 million executive compensation package. When all the dust settled, the court approved a still-handsome $16.5 million payout. In the New Century bankruptcy, the debtors proposed an “incentive plan” that would entitle high level employees and executives to bonuses equaling $6.3 million upon the successful sale of the company. The United States Trustee and other parties objected, stating that obtaining a floor bid for the sale of the company doesn’t constitute and achievement worth rewarding, especially for a company that is under criminal investigation. In the end, the court approved a scaled back bonus plan of $3.2 million to 116 top employees, many of whom were in charge of the company as it entered into its now-famed crisis.

Another possible end run around the bankruptcy code is to set aside money for bonuses and condition a sale of the bankrupt company on the retention of current management and the payment of bonuses to them. When Barclays bought certain of Lehman Brothers’ assets in a bankruptcy court-approved sale, over $2.5 billion was set aside for employee bonuses, some of whom were executives at Lehman during its crashing and burning. Unfortunately, many of Lehman’s investors were not as protected.

In the Calpine bankruptcy, the bankruptcy court approved an “emergence incentive plan” which provided bonuses to top management upon Calpine’s successful emergence from bankruptcy, notwithstanding the company’s long-term success after emerging. According to Calpine’s 10-k for 2007, Calpine’s then CEO was to reap approximately $29.6 in combined benefits under the emergence incentive plan. This after receiving over $4 million in combined benefits in both 2006 and 2007. Calpine’s shareholders received warrants to purchase up to 10 percent of the reorganized company.

In the Airway Industries bankruptcy case, executives received handsome bonuses (some at least $500,000) upon the completion of the sale of the company. The court approved the bonuses over the objection of the unsecured creditors notwithstanding that the bonuses were paid by the secured creditors who were the primary beneficiaries of the sale.

In Nellson Nutraceutical, after executives failed to meet the goals set forth in the “executive incentive plan,” the debtor proposed a revised plan that lowered the targets retroactively thus allowing the executives to achieve their “benchmarks” for bonuses. As justification for this move, the debtor argued that it had similarly tinkered with the bonus targets in the past when benchmarks were not met. The bankruptcy judge approved the plan over the objection of several interested parties. The creditors’ committee appealed this ruling but withdrew the appeal upon the confirmation of the debtor’s plan of liquidation.

The current system allows executives to tie their compensation to short-term, myopic goals (sale of the company, liquidation of the company, or emergence from bankruptcy), thus allowing executives to circumvent bankruptcy code section 503(c)’s protections. This article does not advocate over regulation of executives of bankrupt corporations, nor does it promote caps on these executives’ salaries; such restrictions would undoubtedly deter talented and creative executives from taking positions with bankrupt companies – companies where talent and ingenuity are needed most. Rather, Congress should tie any kind of compensation for executives of bankrupt corporations−whether as part of a retention plan or incentive plan, whether paid for by the debtor or by other parties−to the long term health of the company and/or creditor recovery. As such, an executive of a bankrupt corporation would have to make a strategic and personal commitment to the company to either propose a plan that would provide a significant recovery to creditors, or otherwise stay with the company for a period of time following its emergence from bankruptcy and receive compensation upon the achievement of post emergence milestones.

Another important bankruptcy reform that Congress should seriously consider is to shorten or eliminate the debtor’s “exclusive period” to propose a plan of reorganization. Parties in interest, and even non-parties in interest, should have the right to propose competing plans of reorganization. The plan that provides the best overall outcome for the debtor, its estate and its creditors (to whom the debtor owes fiduciary duties) should be voted on and approved by the court. The benefit of this is threefold. First, managers will be keen to keep their companies healthy and solvent if they know that bankruptcy would likely mean the loss of their position and accompanying lavish compensation packages. Second, the healthy competition that would result from this would foster liquidity in the debt markets and bolster the balance sheets of companies with distressed debt on their books. Finally, a foundation of capitalism is that competition and consumer choice results in the best overall value; this is also true for plans of reorganization. The proposition of competing plans of reorganization will result in more choice which will ultimately lead to the best economic outcome for all parties in interest.

Sadly, bankruptcy is the next frontier for many American corporations. So long as the problems forcing companies into bankruptcy continue to percolate while in bankruptcy, the chambers of the bankruptcy courts will likely be these companies’ final frontier.

About Carl Icahn 29 Articles

Carl Icahn is an American billionaire financier, corporate raider, and private equity investor.

Mr. Icahn is the Chairman of Icahn Enterprises, a diversified holding company engaged in a variety of businesses, including investment management, metals, real estate, and consumer goods. He has been the Chairman of American Railcar Industries since 1994 and a Director of Blockbuster since May 2005. He became Chairman of ImClone Systems in 2006. In January 2008, he became the Chairman of Federal-Mogul.

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