NASPP Webcast Bankruptcy 101 for Compensation Professionals

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This presentation provides an overview of what happens to typical compensation elements in a bankruptcy and walks through some of the basics of bankruptcy from a compensation professional's poitn of view.

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NASPP Webcast Bankruptcy 101 for Compensation Professionals

  1. 1. National Association of Stock Plan Professionals Webcast<br />Bankruptcy 101 for Compensation Professionals<br />June 23, 2009<br />
  2. 2. Key Executive Compensation Issues in a Bankruptcy<br />When a company files for bankruptcy, a number of question arise with respect to compensation and benefit matters. For example:<br />What happens to salaries of management and rank-and-file employees?<br />What happens to management bonus programs?<br />What happens to tax-qualified retirement plan benefits?<br />What happens to nonqualified retirement plan benefits?<br />What happens to severance and other employment contract obligations?<br />The answers to these questions depend on a number of factors, such as:<br />Whether the compensation/benefits were earned pre-petition or post-petition;<br />Whether the debtor is liquidating or restructuring;<br />Whether collective bargaining agreements are being renegotiated; and<br />Whether pre-petition equity holders will retain any value, etc.<br />
  3. 3. Chapter 7 vs. Chapter 11<br />Whether a company is liquidating (i.e., Chapter 7) or restructuring (i.e., Chapter 11) has a significant impact on the bankruptcy process and its purpose.<br />Chapter 7 requires the debtor to sell off assets and liquidate the company—thus, the number of employees required to wind down the company and the corresponding pay structure for those who remain is geared toward obtaining the greatest value for the assets at the least expense for the debtor.<br />Chapter 11 allows the debtor to restructure the company to reduce costs and/or renegotiate debt—thus, the debtor must be allowed to continue to operate the business while in bankruptcy.<br />This material is meant to be a very brief primer on key executive compensation issues that may be applicable in the event that a bankruptcy restructuring is required with a focus on a Chapter 11 filing.<br />
  4. 4. First Day Orders<br />As previously noted, the purpose of a Chapter 11 filing is to allow the debtor to continue operating its business while the capital structure is modified in bankruptcy. <br />One of the first steps in the process is to obtain a “first day order” allowing the debtor to continue to pay all salaries and provide ongoing benefits for services rendered after the bankruptcy filing.<br />Note, unique to bankruptcy is the demarcation of whether liabilities were incurred before or after filing.<br />Post-Petition Claims: Generally, the first day order preserves compensation and benefits earned post-petition and treats them as high-priority administrative expenses.<br />Pre-Petition Claims: Generally, claims for pre-petition wages (including benefits such as accrued vacation) are limited to a specific priority amount. However, in a Chapter 11 filing, this typically allows employees to receive all unpaid pre-petition salary in the ordinary course, i.e., employees generally will not miss a paycheck and will experience no change in the terms and conditions of their employment—note, however, that this issue oftentimes causes companies to file immediately after a payroll period is completed.<br />
  5. 5. Decision-Making Process<br />In a Chapter 11, the presumption is that the reorganization is most likely to be successful and creditors and the public are most likely to benefit from continued operation of the business by existing management. <br />As a result, corporate management oversees the reorganization (this is distinct from a Chapter 7 liquidation where a trustee is appointed).<br />Management may be removed “for cause, including fraud, dishonesty, incompetence, or gross mismanagement.” As a result, all of its operations may be subject to the court’s oversight.<br />In practice, the court holds hearings only for those activities that are outside of the ordinary course of business or for those actions requiring a court authorization by statute, such as asset sales or the assumption or rejection of executory contracts. <br />As such, non-routine post-petition payments are generally subject to review by the court and are oftentimes heavily scrutinized. These oftentimes include:<br />Traditional incentive payments (such as annual incentives);<br />Key employee retention plan payments or KERPs (see next page); and<br />Post-emergence equity grant allocations.<br />Courts generally apply a two-pronged test for determining whether to approve these programs, requiring that:<br />A sound business purpose justifies the program; and<br />The program is “fair and reasonable.”<br />Given the scrutiny applied by the court, most debtors seek creditor agreement in advance of presenting the program to the court to avoid significant conflict.<br />
  6. 6. KERPs and Severance<br />Historically, KERPs (cash retention payments not tied to performance) were implemented in most bankruptcy restructurings. In effect, the KERPs oftentimes replaced the equity grants that otherwise would have been awarded but for the bankruptcy.<br />As a result of a number of high-profile bankruptcy filings (e.g., United Airlines, Worldcom, Enron, etc.), the bankruptcy code was changed to put statutory limits on KERPs as well as severance benefits.<br />KERPs<br />For bankruptcy filings after October 17, 2005, retention payments to “insiders” (generally a director or officer) may only be made under the following circumstances, subject to court approval:<br />When essential to retain an individual because he or she has a bona fide job offer from another business at the same or greater salary; and<br />The individual’s service is essential to the survival of the business; and<br />The payment is less than 10 times the average amount paid to similar non-management employees in the current year or, if none, then no more than 25% of any similar benefit provided the insider in the preceding year.<br />In essence, this has forced companies to establish programs that are performance-based as opposed to pure time-based to avoid the three-pronged test—of course, what qualifies as something that is not a “retention payment” is a developing issue, subject to the facts and circumstances of each particular case.<br />
  7. 7. KERPs and Severance<br />Severance<br />Similarly, for post-October 2005 bankruptcy filings, severance is also limited to situations where:<br />It is part of a program applicable generally to all full-time employees; and<br />It is limited to 10 times the average amount of severance payments made to all employees.<br />
  8. 8. Pre-Packaged Bankruptcies<br />Definition: A reorganization under Chapter 11 that has been negotiated and agreed to by creditors in advance of the bankruptcy filing. Pre-packaged filings can shorten and simplify the bankruptcy process and can result in significant cost savings to the debtor. Reorganization plans can be confirmed in 30 to 45 days from filing.<br />Given the speed with which pre-pack plans take place, the impact on typical compensation programs in bankruptcy can be significant.<br />Generally, the first day order would preserve all salary and benefit programs of the debtor.<br />Given the short time in bankruptcy, there is much less need to develop a KERP-like program. <br />However, equity awards post-emergence become a high priority.<br />
  9. 9. Summary of Key Compensation Elements<br />
  10. 10. Equity Compensation Programs<br />Probably the most critical issue for management in a pre-pack bankruptcy is long-term compensation (i.e., equity compensation) post-emergence.<br />Pre-Petition Equity Awards<br />Typically, pre-petition equity holders are wiped out in a bankruptcy and, as a result, employees’ grants are also wiped out.<br />However, where value is preserved for equity holders, employees’ awards similarly will be preserved.<br />Generally, awards will get adjusted to reflect any stock splits that take place as a result of the reorganization.<br />As such, pre-petition awards will generally be worthless. <br />Under these circumstances, companies may want to consider accelerating the expense associated with the pre-petition awards into the quarter in which the restructuring occurs by vesting up prior option and RSU awards and/or canceling prior PSU awards.<br />
  11. 11. Equity Compensation Programs<br />Emergence Awards<br />As part of the confirmation plan, the equity program available upon plan confirmation should be established. This would include:<br />Shares available for grant to all employees and directors; and<br />Details of initial equity grants, including:<br />Participation;<br />Vehicles awarded;<br />Award sizes and key terms; and<br />Timing of grants.<br />Overall, the two most critical issues are:<br />The total number of shares available for grant; and<br />The total number of shares awarded upon emergence or shortly thereafter.<br />
  12. 12. Lessons Learned<br />It can happen <br />Diversification<br />You can have too much at stake <br />Limit ownership of company stock in your 401K<br />Communication is key<br />Communicate right away – don’t wait<br />Take the time to review your documents/contracts:<br />Plan Documents - Is bankruptcy mentioned? Is it specific enough?<br />Service Providers – Are you protected? Is there a clause in your current contract? If there is work – get the money up front before any work is done.<br />Voice at the table<br />Valuable historical data – who should own it?<br />
  13. 13. Speakers<br />Siri Pannell, former Manager of Stock Plan Operations for Washington Mutual, Inc.<br />E-mail: siripannell@verizon.net<br />Daniel A. Zazove, Perkins Coie LLP<br />Phone: (312) 324-8605<br />E-mail: Dzazove@perkinscoie.com<br />Edward Hauder, Exequity LLP<br />Phone: (847) 996-3990<br />E-mail: edward.hauder@exqty.com<br />

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