Chapter 11 Bankruptcies and discretionary bonuses
A May 2019 Delaware Bankruptcy Court opinion provides a detailed analysis of why the Judge dismissed fraudulent conveyance claims. Claims were filed in numerous adversary proceedings by the post-confirmation liquidation trustee. They were filed against former employees who had received bonuses paid in accordance with the company’s employee handbook and policies.
This is a meaningful decision to all chapter 11 debtor management teams. Carefully considering whether to pay discretionary bonuses in times of financial distress is key. Also, to consider bonuses on the eve of a possible bankruptcy filing is important as well.
Often brought late into a chapter 11, “avoidance” actions (also sometimes called “clawback” litigation) can be taken. They are often brought on the eve of the two year statute of limitations. The statute runs two years from the date of the case filing. Everyone who got payments prior to the filing of the case is at risk. This is the case, even if the claims may be defensible. Many such claims are settled since it is costly for each recipient to litigate. Everyone who has ever received one of these demands is usually angry to learn that someone who still owes them money is also asking for money back.
Guidance for Management and A Win for Employees of Insolvent Companies
Hindsight is 20/20. It is difficult in the days leading up to a possible chapter 11 business filing to determine how to best allocate limited dollars. The well-known mantra “Cash is King” could be applicable. However, so is keeping the employee team together so that the business may seek to remain as a going concern. There is no simple black/white answer in most settings.
In the F-Squared decision, 600 B.R. 294 (Bankr. D. Del. 2019), the trustee argued that discretionary bonus payments made at a time when the debtors were allegedly insolvent were per se constructive fraudulent transfers and/or preferences. The Court ultimately dismissed the fraudulent transfer counts, but refused to dismiss the preference claims, on the issue of whether certain employees were “insiders,” a fact- intensive issue. The Court stated in part:
It seems self-evident that the awarding of a bonus in these circumstances may confer value to the employer for purposes of Section 548. Rewarding your best employee(s) with a discretionary bonus undoubtedly helps to build the loyalty of the employee and increase morale. Failure to award the bonus, even if discretionary, could cause a company’s best employee to seek employment elsewhere. Id. at 307.
While not controlling in our jurisdiction, the F-Squared decision is worth holding onto. The “avoidance actions pools” are often large, deep and murky at best, and certainly costly to all involved in the process.
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