Approval of Key Employee Retention Plans: Did Global Aviation Get It Right?

by Cadwalader, Wickersham & Taft LLP
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[author: Christopher J. Updike]

We recently commented here on the standard for reviewing key employee incentive plans (KEIPs) and the approval of the KEIP in the Velo Holdings chapter 11 cases pending in the Southern District of New York. On July 24, Bankruptcy Judge Carla Craig of the Eastern District of New York approved a KERP (a key employee retention plan) in the Global Aviation bankruptcy cases aimed at retaining five employees deemed critical to the consolidation of the debtors’ U.S. headquarters in Peachtree City, Georgia by August 31, 2012. In re Global Aviation Holdings, Inc., 2012 WL 3018064 (Bankr. E.D.N.Y. July 24, 2012).

KERPs are distinct from KEIPs in that the former rewards employees for staying with the debtor for a certain time period, while the latter rewards employees for reaching certain performance targets. As discussed in our prior post, the analysis of any key employee bonus plan begins with a determination as to whether eligible employees are insiders of the debtor and whether the plan is primarily retention-oriented, in which case the plan must satisfy the strict standards of section 503(c)(1) of the Bankruptcy Code enacted to limit “pay to stay” bonuses for executives. As KERPs are retention-oriented by nature, the primary issue regarding their approval is the insider status of the eligible employees.

In Global Aviation, the KERP was not directed at the debtors’ most senior employees. The five employees eligible to receive payments under the KERP included a “Director of Safety,” the “Vice President of Operations,” the “Chief Pilot,” the “Senior Director of Maintenance,” and the “Chief Inspector” – all certainly important positions. The debtors, the official creditors’ committee, and the U.S. trustee disagreed as to whether these employees were in fact insiders, and while the court likely reached the correct outcome, its analytical flight-path encountered some turbulence.

Who is an Insider?

Per section 101(31)(B) of the Bankruptcy Code, “[t]he term ‘insider’ includes—if the debtor is a corporation— “(i) director of the debtor; (ii) officer of the debtor; (iii) person in control of the debtor; (iv) partnership in which the debtor is a general partner; (v) general partner of the debtor; or (vi) relative of a general partner, director, officer, or person in control of the debtor.” These types of relationships give rise to a conclusive presumption that the person or entity commands preferential treatment by the debtor. Rupp v. United Security Bank (In re Kunz), 489 F.3d 1072, 1079 (10th Cir. 2007) (citations omitted).

The use of “includes” in the definition of “insider” means that the list is illustrative rather than exclusive, and therefore certain individuals can fall within the definition but outside of the enumerated categories. Schubert v. Lucent Tech., Inc. (In re Winstar Commc’n, Inc.), 554 F.3d 382, 395 (3d Cir. 2009); Anstine v. Carl Zeiss Meditec AG (In re U.S. Med., Inc.), 531 F.3d 1272, 1276 (10th Cir. 2008); Kunz, 489 F.3d at 741.

These so-called “non-statutory insiders” have been described to generally include anyone who has a close relationship with the debtor and was not dealing with the debtor at arm’s length. Winstar, 554 F.3d at 396-97; U.S. Med., 531 F.3d at 1277; In re Krehl, 86 F.3d 737, 741-42 (7th Cir. 1996); see also H.R.Rep. No. 595, 95th Cong., 1st Sess. 311-314 (1977) (“An insider is one who has a sufficiently close relationship with the debtor that his conduct is made subject to closer scrutiny than those dealing at arms [sic] length with the debtor.”).

Notably, many courts hold that actual control of the debtor is not necessary for an entity to be a non-statutory insider. Winstar, 554 F.3d at 396; U.S. Med., 531 F.3d at 1277 n.5. Indeed, to hold otherwise would render section 101(31)(B)(iii) superfluous and contradict Congress’s decision to provide a non-exhaustive list of specific categories that includes any “person in control of the debtor” as well as categories that don’t require actual control at all. Winstar, 554 F.3d at 396. The Tenth Circuit has added that “[a]ny interpretation of ‘control’ within the non-statutory-insider context as anything like the ability ‘to order, organize or direct’ the debtor’s operations is simply incorrect.” U.S. Med., 531 F.3d at 1277 n.5. Instead, an ability to coerce or unduly influence the debtor together with evidence of any transactions not conducted at arm’s length may be sufficient to qualify a person or entity as a non-statutory insider. Winstar, 554 F.3d at 397; U.S. Med., 531 F.3d at 1276-78; In re Bayonne Medical Center, 429 B.R. 152, 175 (Bankr. D.N.J. 2010).

The Global Aviation Decision

The Global Aviation court acknowledged that an employee does not need to hold a position enumerated in section 101(31)(B) to constitute an “insider” and that “[i]insider status can also be determined on a case-by-case basis based on the totality of the circumstances, including the degree of an individual’s involvement in a debtor’s affairs.” Global Aviation, 2012 WL 3018064, *4. However, the court cited Judge Glenn’s decisions in Velo Holdings and Borders for the proposition that in order to find that a person is a non-statutory insider, “a court must determine that such a person has ‘at least a controlling interest in the debtor or . . . exercise[s] sufficient authority over the debtor so as to unqualifiably dictate corporate policy and disposition of corporate assets.’” Id. at *4 (citing In re Velo Holdings Inc., No. 12-11384, 2012 2015870, at *5 (Bankr. S.D.N.Y. Jun. 6, 2012) and In re Borders Group, Inc., 453 B.R. 459, 469 (Bankr. S.D.N.Y. 2011)). The decisions in Velo Holdings and Borders pulled this language from a 1986 decision by the U.S. Bankruptcy Court for the Northern District of Ohio, In re Babcock Dairy Co., 70 B.R. 657, 661 (Bankr. N.D. Ohio 1986), that was actually analyzing what type of control was sufficient to render someone a “person in control of the debtor” pursuant to section 101(31)(B)(iii). The Third Circuit has previously rejected reliance on Babcock Dairy when determining the nature of non-statutory insiders. See Winstar, 554 F.3d at 395. And, while the standard set forth in Velo Holdings, Borders, and now Global Aviation sounds similar to that espoused by the majority of courts analyzing non-statutory insider status, the standard sets a higher bar for determining who is an insider. As a result, more employees with closer ties to the debtor could qualify for payments under KERPs if this approach is adopted by subsequent courts.

In approving the KERP, the Global Aviation court held that none of the eligible employees were insiders.  Judge Craig eschewed simple reliance on employee’s titles to determine insider status and instead focused on the specific facts regarding each employee’s job. The court found that the record – based upon a declaration and testimony of the debtors’ Executive Vice President and CFO, as well as an evidentiary hearing held on July 11 – showed that (i) none of the employees was a member of the board of directors or participated in corporate governance, (ii) none of the employees attended board meetings, and they generally did not report to the board, (iii) the board did not appoint or elect the employees to their positions, (iv) the pay grades of the employees fell below the pay grades of the debtors’ senior executives, (v) none of the employees receive equity in the debtors as part of their compensation, (vi) none of the employees have discretionary control over substantial budgetary amounts, and (vii) none of the employees had any role in the development of the KERP, nor did they have any authority to do so.

Each of these findings is relevant when determining whether the KERP employees were insiders, the last two being particularly insightful as to whether they are non-statutory insiders. In short, Judge Craig held that none of the eligible employees were insiders “[g]iven their intermediate positions in the corporate chain of command, their distance from the board and senior management, and the limited extent of their corporate authority.” Global Aviation, 2012 WL 3018064, at *6.

Conclusion

The ultimate outcome of the Global Aviation decision was right; nothing in the record showed that the eligible employees had the ability to coerce or influence the debtors into instituting a KERP for their benefit. Nonetheless, creditors concerned about expensive bonuses being paid under KERPs proposed by chapter 11 debtors should be aware of the divergent standards for approving KERPs, and insist that courts apply the more precise recitation in the future. On this note, Judge Glenn is scheduled to consider approval of the KERP in the Residential Capital bankruptcy cases on August 8, 2012.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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