Prior to 2005, key-employee retention plans were often endemic to a company's recovery during a Chapter 11 bankruptcy. The general thought was management needed to have a vested stake in a distressed company, and without an incentive plan, managers would resign in droves.
In October of 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act, which placed significant restrictions on such incentive plans offered to key managers. In that legislation, Congress authored key changes to Section 503(c) of the Act.
At issue in the Pilgrim's Pride bankruptcy was which provision of Section 503(c) governed the debtor's motion to essentially buy non-compete agreements from departing executives. By way of background, Section 503(c)(1) governs retention bonuses to insiders. The Trustee argued the company's petition to pay nearly $500,000 to a departed CEO and COO fell within the ambit of (c)(1). However, the court disagreed, finding that the company wanted the CEO and COO gone - not retained. Indeed, the restructuring officer testified the voluntary resignations were given under threat of termination.
The court next determined that the sought-after non-compete payments did not fall within (c)(2), which expressly applied to severance pay. Here, the executives had already been paid severance, so no logical reading of (c)(2) could apply to the debtor's petition.
Finally, the court concluded that the non-compete payments were subject to (c)(3). That provision is a catch-all clause in the Bankruptcy Code governing plans outside the ordinary course of a debtor's business not formally designed to retain insiders.
The key issue for the court was what standard to apply to the petition. Noting that some courts implemented a simple "business judgment rule" test, the court went further and held that a debtor's petition was subject to stricter scrutiny. In particular, the court founds as follows:
"Section 503(c)(3) is intended to give the judge a greater role: even if a good business reason can be articulated for a transaction, the court must still determine that the proposed transfer or obligation is justified in the case before it. The court reads this requirement as meaning that the court must make its own determination that the transaction will serve the interests of creditors and the debtor's estate. Put another way, when a transaction is proposed between a debtor and its insiders, the court cannot simply rely on the debtor's business judgment to ensure creditors and the debtor's estate are being properly cared for."
Despite taking a de novo look at the petition for non-compete payments, the court approved them over the trustee's objection. The court noted the payments were not insubstantial, but that the threat of competition from two departed executives outweighed any cost borne by the estate. The court specifically found each executive had extensive knowledge about the debtor's customers and could divert large accounts, potentially costing the company millions of dollars. The court did not comment why the executives were not subject to pre-existing non-compete obligations, either as part of an executive employment agreement or severance package.
Court: United States Bankruptcy Court for the Northern District of Texas
Opinion Date: 2/26/09
Cite: In re Pilgrim's Pride, 401 B.R. 229 (N.D. Tex. 2009)