Government scrutiny increases over pre-bankruptcy payouts

Government scrutiny increases over pre-bankruptcy payouts

In recent years, the practice of paying retention bonuses to top executives just before a company files for bankruptcy has become a topic of controversy. This trend, which has been prevalent in the retail sector, has raised concerns about the fairness of such payments, particularly when the company is unable to meet its financial obligations.

One notable example is J.C. Penney, which paid $10 million in retention bonuses to its top managers, including CEO Jill Soltau, receiving over $4 million, just days before filing for bankruptcy. This practice, however, is not unique to J.C. Penney, with retail giants such as Neiman Marcus, Ascena Retail Group, Tailored Brands, and Tuesday Morning also following suit.

The rules governing these pre-bankruptcy retention bonuses are primarily dictated by Section 503(c) of the Bankruptcy Code. This law imposes strict requirements on retention payments made to insiders, such as executives, unless the payment is justified as necessary for the retention of the individual and is not significantly greater than non-management employees receive for similar benefits. Payments to insiders are highly scrutinized, and only permitted if there is a clear, justifiable business need for the executive’s continued service.

Despite these restrictions, the bonuses paid to executives before bankruptcy are not subjected to the same level of court oversight as those paid during bankruptcy. This lack of oversight has led to concerns about the fairness of these payments, particularly when vendors are left shortchanged and employees are left without jobs or meaningful severance.

The optics of such bonuses are also a concern, with millions being paid to the managers of a company that can't meet its financial obligations. In the case of Toys R Us, executives received significant bonuses before its Chapter 11 bankruptcy, with CEO Dave Brandon receiving a $2.8 million payment. This has led to lawsuits being filed against former Toys R Us leaders by former vendors for the pre-bankruptcy bonuses.

While Congress put tight restrictions on executive bonuses in the Bankruptcy Code in 2005, these restrictions do not apply to bonuses paid before bankruptcy. This loophole has led to companies like Toys R Us and J.C. Penney taking advantage of the situation, with emails revealing that Toys R Us executives learned from their restructuring attorneys that bonuses and their amounts would be under greater restrictions during bankruptcy, prompting them to pay themselves bonuses before filing for Chapter 11.

Despite these concerns, the current status quo suggests that most bonuses paid before bankruptcy are likely to remain intact. The GAO report suggests that the Bankruptcy Code's fraudulent transfer provisions could be used to rein in pre-bankruptcy bonuses, but such litigation is expensive, difficult to prove, and outcomes are uncertain.

In conclusion, while current U.S. law provides robust limitations on pre-bankruptcy retention bonuses for executives, enforced through strict court oversight and detailed disclosure requirements, the lack of oversight before bankruptcy remains a contentious issue. The retail industry, in particular, has seen several bankruptcies that have left vendors and employees in unfavorable situations, raising questions about the fairness and necessity of these bonuses.

1. The controversy surrounding retention bonuses for top executives before a company files for bankruptcy has extended to various sectors, including retail giants like Neiman Marcus, Ascena Retail Group, Tailored Brands, and Tuesday Morning.
2. The fairness of these payments is questioned, especially when the company is unable to meet its financial obligations, as vendors may be left shortchanged and employees could lose their jobs or face reduced severance packages.
3. While the Bankruptcy Code imposes strict requirements on retention payments to insiders, the lack of court oversight on bonuses paid prior to bankruptcy raises concerns about their fairness and necessity.
4. Legislative efforts, such as those made in 2005, have tightened restrictions on executive bonuses during bankruptcy, but a loophole in the law allows for bonuses paid before bankruptcy to remain unchecked, potentially leading to situations like those at Toys R Us and J.C. Penney.

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