The Push and Pull of Executive Bonuses and Bankruptcy


by Dayna Harris

What types of bonuses make sense prior to a bankruptcy filing, and how should companies manage the optics with stakeholders?

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Nothing makes media headlines faster than jaw-dropping executive incentive payouts and/or retention bonuses paid prior to a company’s bankruptcy filing. Within this context, the impact of COVID-19 has been uneven across sectors and has contributed to poor performance across various industries. Some sectors, like retail, were already challenged; J.C. Penney, Neiman Marcus, J. Crew and more teetered on the edge of solvency. With almost six months of the pandemic behind us, other casualties include airlines, hotels, car rentals, movie theatres, theme parks, and any other business that brings people together in crowds. Many companies are in survival mode. Some will live. Some will die. But prior to filing for bankruptcy, and as companies prepare to emerge from bankruptcy, there is an important consideration: the ultimate restoration of shareholder value. The retention of key executives is of paramount importance during this extraordinary period. But the real question is, what types of bonuses make sense prior to a bankruptcy filing, and how should companies manage the optics with stakeholders?

A recent Reuters analysis of securities filings and court records identified 32 of 45 companies that paid out bonuses in the six-months prior to filing for bankruptcy, with nearly half making the payouts within two months. Several companies made large bonus payments, often while furloughing or laying off employees, before their bankruptcy filings.

For example,

  • J.C. Penney Co., Inc. approved close to $10 million in payouts just before its May 15 filing while furloughing approximately 78,000 of its 85,000 employees
  • Hertz Global Holdings, Inc. paid executives $1.5 million after having terminated over 14,000 employees before its May 22 filing
  • Whiting Petroleum Corp. paid $14.6 million in extra compensation to executives before its April 1 filing
  • Chesapeake Energy Corp. paid $25 million to executives and other employee in May, about two months before its filing

To Pay or Not to Pay: Paying Bonuses Before Filing Chapter 11

Is the payout of a large bonus appropriate when so many people have lost their jobs, creditors go unpaid and shareholders lose money? Companies often pay bonuses before filing for bankruptcy due to the legal constraints on how executive compensation may be paid once the company is in bankruptcy (e.g., negotiations with creditors and the court, court approval, etc.) (See sidebar on “Key Provisions of Bankruptcy Law.”) The merits of bonuses often go beyond lining the pockets of executives and may instead be tied to short-term incentive bonuses for the prior year based on actual performance achieved, or long-term performance awards that happen to vest in the year of the downturn. There may even be retention bonuses that encourage executives with the right skillsets to remain with the company, help get the company back on the road to survival, and ultimately realign executive and shareholder interests.

Will They Stay or Will They Go? Retention Bonuses: Bankruptcy and Other Disruptions

Very few people want to be associated with a “sinking ship.”  Keeping executives engaged during a bankruptcy can mean the difference between success and failure. It may seem illogical that executives from a company in bankruptcy proceedings would be in demand from other companies. However, such demand is a reality in situations where certain skills are highly sought, or the company downturn results from an environment outside the executives’ control. Retention bonuses have been around for a long time and are used to ensure that the executive team stays in place and is committed to restructuring the business. Boards need a motivated, capable group to get the company back to solvency and profitability.

Bankruptcy is not the only scenario where retention bonuses have a role in overall compensation. Retention bonuses can also be effective in retaining and motivating talent during other periods of disruption. (See the chart below for situations where retention bonuses may be appropriate for executives, as well as other employees.)

Since a wide variety of stakeholders always scrutinize any type of executive retention bonus, the payouts are more likely to be embraced by investors and proxy advisors when they meet the following criteria:

  • Pay out or vest after a defined period of time (e.g., two to three years)
  • Consider awards within the context of normal pay for the recipient (e.g., up to 0.5x to 1x salary, delivered in cash and/or equity, or up to 0.5x annual equity)
  • Include performance measure(s) and/or a minimal performance hurdle before payout or vesting
  • Focus awards only on executives and employees whose departure would have a significant impact on the company’s performance

Same Story, Different Year

Paying bonuses to executives prior to filing for bankruptcy is not new. What is new is the extraordinary focus by stakeholders on Environment, Social and Governance (ESG) issues. This has now become a headline-grabbing, optics challenge that falls squarely on the “S” in ESG. While companies have blamed COVID-19 as a major contributor to their companies’ performance challenges, COVID-19 has really been the catalyst that continues to highlight the many social issues affecting the most vulnerable in our society. From health risks to pay inequality, the pandemic has provided a new lens for all stakeholders to opine on executive pay and to encourage a more holistic look at how all of a company’s stakeholders are being treated, including employees, suppliers, communities where the company does business, and shareholders.

KERPs and KEIPs

As a result of the restrictions and limitations above, retention programs under bankruptcy that only require service from employees based on a time period are only used for “non-insiders.” These plans are known as Key Employee Retention Plans (KERPs). For “insiders,” Key Employee Incentive Plans (KEIPs) are used, and like the name implies, they pay bonuses based on performance criteria. All bonus payouts are subject to court approval.

Dayna Harris is a partner with Farient Advisors.