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[Legislative Updates] [ABI Logo]

Web posted and Copyright © November 1, 2002, American Bankruptcy Institute.

Scaled-back Employee Abuse Bill Would Elevate Employee Claims, Limit Retention and Severance Plans and Scrutinize Post-petition Employment

Written by:
Prof. G. Ray Warner
ABI Robert M. Zinman Resident Scholar

gwarner@abiworld.org

n Sept. 19, 2002, Sen. Dick Durbin (D-Ill.) introduced a substitute amendment to the Employee Abuse Prevention Act of 2002 (S. 2798). The substitute deletes the most controversial provisions of the prior bill, while retaining most of the provisions designed to protect employees and retirees when businesses file for bankruptcy.

The substitute amendment does not include a venue provision that would have limited Delaware and New York filings, provisions that would have enhanced the trustee's power to challenge security interests and asset securitization transactions, a provision that would have given claims for ERISA fiduciary breaches a super-priority, lien-priming status, and a provision that would have limited the §546(e) safe harbor for securities settlement payments to financial intermediaries. Like the original bill, the changes made by the substitute amendment would be effective immediately upon enactment and would apply to cases pending on that date.

Retiree Health Benefits

Several provisions of the bill address employee and retiree issues. First, current §1114 prevents a chapter 11 debtor from unilaterally modifying certain retiree benefits, such as retiree health insurance, during the case unless an authorized retiree representative is appointed and agrees to the modification, or the court authorizes the modification as necessary to the reorganization. The bill would amend §1114 to prevent debtors from evading its requirements by terminating retiree benefit plans on the eve of bankruptcy. The bill would require retroactive reinstatement of retiree benefits that were modified "in contemplation of bankruptcy" within 180 days before filing unless the pre-petition modification was essential to the continuation of the debtor's business. Modifications made within the 180-day period would be subject to a rebuttable presumption that they were made in contemplation of bankruptcy.

Employee Wage, Severance and Pension Priority

Several provisions are designed to enhance the employees' recovery on pension and wage claims. The bill would increase the current §507(a)(3) priority for unpaid wage claims from $4,650 to $13,500, and would extend the time period during which wages could qualify for priority from 90 days to 180 days.


[I]n certain instances, the bill would convert employee equity security interests held in pension plans from "interests" to "claims." The bill would amend the §101(5) definition of "claim" to include equity securities held in an ERISA pension plan if the employee was forced to invest the pension assets in equity securities of the debtor or an affiliate of the debtor.

More importantly, unlike the original bill, the substitute would deem severance payments to be earned in full on the day of layoff or termination. Thus, for employees terminated within 180 days before bankruptcy, the entire severance obligation would be subject to the §507(a)(3) priority, rather than merely that portion deemed to have been earned during the final 180 days. The bill makes a corresponding change to §503(b) that would give administrative expense priority treatment to the first $13,500 of severance obligations owed to employees who are terminated post-petition. Contra In re Hechinger Investment Co., 298 F.3d 219 (3d Cir. 2002) ("stay-on" benefits apportioned between pre-petition and post-petition periods). The full amount of severance owed would be given administrative expense status if the debtor had assumed the collective bargaining agreement or other contract that included the severance obligation.

Of greater significance, in certain instances the bill would convert employee equity security interests held in pension plans from "interests" to "claims." The bill would amend the §101(5) definition of "claim" to include equity securities held in an ERISA pension plan if the employee was forced to invest the pension assets in equity securities of the debtor or an affiliate of the debtor. The "claims" thus created would be entitled to priority under the §507(a)(4) "employee benefit plan contribution" provision. The amount of the §507(a)(4) priority claim would be set at the market value of the stock at the time it was contributed to, or purchased by, the pension plan. Note that the §507(a)(4) benefit plan priority is limited to the unused portion of the §507(a)(3) priority times the number of employees. This would remain the case for benefit plan contributions. No dollar limit would apply, however, to the new pension plan stock claim. The effect of these changes would be to elevate covered employee pension plan stock interests from the lowest priority common stock level to a fourth-level priority ahead of general unsecured claims. In a case like Enron, where the contributed stock had a high value at the time of the contribution, this provision could divert all of the residual value of the estate from the unsecured creditors to the employees.

Enhanced Avoidance of Fraudulent Transfers and Excessive Compensation

The bill would also enhance the recovery of voidable transfers and impose limits on executive compensation. Two changes would make it easier for the estate to avoid pre-petition transfers. First, the one-year look-back period for fraudulent transfers under §548 would be extended to four years. Thus, both actual fraudulent transfers and constructive fraudulent transfers (transfers for less than reasonably equivalent value when the debtor is insolvent) could be avoided by the estate if they occurred within four years before bankruptcy. This change would have relatively little impact in most cases since most such transfers already could be avoided under §544(b) using very similar state fraudulent transfer laws. The provision would enhance the estate's recovery in those cases where the state law statute of limitations was less than four years or where the state law was less expansive than §548.

The bill would also expand §548 to allow the recovery of excessive benefit transfers and obligations made to insiders (including officers and directors) during the four years prior to bankruptcy if the debtor was insolvent or was rendered insolvent by the transaction. This provision would apply even though the transaction was not otherwise fraudulent. A two-part test would be used to determine whether the benefit was excessive, and thus avoidable. If similar benefits were provided to non-management employees during the same calendar year, then the benefit would be excessive if it was equal to or greater than 10 times the average similar benefits provided to non-management employees during the same calendar year. If no such benefits were provided to non-management employees, then the benefit would be excessive if it was equal to or greater than 125 percent of the amount of any similar benefit provided in the calendar year prior to the year of the benefit transaction. The bill appears to avoid the entire transaction, and not merely the portion deemed excessive. This appears to be intended as a disincentive to engage in such transactions. The bill does not indicate whether the §548(c) "good-faith transferee for value" defense could be used to limit avoidance in appropriate cases.

Although the provision appears to be designed to apply to management compensation, nothing in the language of the provision expressly limits it to compensation. Arguably, it could be used to avoid non-fraudulent transfers between corporate affiliates if they met or exceeded the 125 percent threshold.

Limitations on Retention and Severance Programs

The bill also would impose new standards for the approval of retention and severance programs for officers and directors. Retention payments to insiders (including officers and directors) would not be allowed unless the court finds "based on evidence in the record" that the retention benefit is "essential" to the retention of such person and "essential to the survival of the business." The substitute does not include the original bill's requirement that the person have a competing job offer. Further, the amount of the retention benefit could not be greater than 10 times the average similar benefit provided to non-management employees during the same calendar year or, if no similar benefits were provided to non-management employees, the retention benefit could not exceed 125 percent of any similar benefit provided to the same insider during the prior calendar year. It is not clear which benefits would be considered in computing these caps since the bill refers to "similar" transactions "for any purpose." While use of the term "similar" suggests that the comparison is to other retention benefits, the "any purpose" language suggests that the cap is computed on the basis of total compensation. The bill would not limit retention programs for non-management employees.

The bill also would limit severance benefits for insiders (including officers and directors). The severance payment would have to be part of a program that is generally applicable to all full-time employees and could not be greater than 10 times the average severance given to non-management employees during the same calendar year.

Post-petition Employment of Officers or Consultants

Finally, the bill contains broad language barring post-petition transfers and obligations that are outside the ordinary course of business, unless they are justified by the facts and circumstances of the case. Transfers to, and obligations incurred for the benefit of, officers, managers or consultants hired post-petition would be deemed to be outside the ordinary course of business. The effect of this provision would be to subject the compensation arrangements for management personnel and consultants hired post-petition to greater scrutiny by the court. While such compensation arrangements are the obvious focus of the provision, the new "justified by the facts and circumstances" standard would apply to all non-ordinary course post-petition transfers and obligations. It is not clear whether this language would impose significant new limitations on the debtor's ability to use business judgment in entering into non-ordinary course transactions.

New House Bill Would Recover Excessive Insider Compensation and Raise Wage Claims for Employees

On Oct. 2, 2002, Rep. George Gekas (R-Pa.) introduced H.R. 5525, the "Corporate Abuse Prevention and Employee Protection Act of 2002." Like several pending bills introduced in both houses of Congress by both Republicans and Democrats, the Gekas bill would increase the wage priority, enhance the trustee's powers to recover excessive pre-petition compensation paid to insiders, and protect retiree benefits. Unlike some of the competing bills, this bill would not apply to pending cases. The bill was referred to the Committee on the Judiciary.

Increased Wage Priority

The bill would increase the §507(a)(3) wage priority and the §507(a)(4) employee benefits priority from $4,650 to $10,000 and would extend the time period during which wages could qualify for priority from 90 days to 180 days. This amendment would apply to cases filed on or after the date of enactment. Since few employees will continue working without pay for an extended period, the principal effect of extending the time period to 180 days is that a greater portion of unpaid vacation, severance and sick leave pay will be entitled to priority. In contrast, the recently introduced substitute for the Durbin-Delahunt bill, S. 2798, would increase the priority to $13,500 and would include all severance pay, not just the portion that accrued during the 180-day period.

Retiree Health Benefits

Current §1114 prevents a chapter 11 debtor from unilaterally modifying certain retiree benefits, such as retiree health insurance, during the case unless an authorized retiree representative is appointed and agrees to the modification, or the court authorizes the modification as necessary to the reorganization. The bill would amend §1114 to prevent debtors from evading its requirements by terminating retiree benefit plans on the eve of bankruptcy. The bill would require retroactive reinstatement of retiree benefits that were modified within 180 days before filing if the debtor was insolvent on the date of the modification, unless the court finds that the balance of the equities clearly favors the modification. This amendment would apply to cases filed on or after the date of enactment.

Enhanced Avoidance of Fraudulent Transfers and Excessive Compensation

The bill would also enhance the recovery of avoidable transfers and excessive pre-petition insider compensation. Two changes would make it easier for the estate to avoid pre-petition transfers. First, the one-year reach-back period for fraudulent transfers under §548 would be extended to two years. Thus, the estate could avoid both actual fraudulent transfers and constructive fraudulent transfers (transfers for less than reasonably equivalent value when the debtor is insolvent) if they occurred within two years before bankruptcy. This change would have relatively little impact in most cases since most such transfers already could be avoided under §544(b) using very similar state fraudulent transfer laws. The provision would enhance the estate's recovery in those cases where the state law was less expansive than §548.

The bill also would expand §548 to allow the recovery of excessive insider compensation during the two years prior to bankruptcy. In order to be avoidable, the transfer or obligation would have to satisfy four conditions: (1) the transfer or obligation must arise under an "employment contract;" (2) it must be to or for the benefit of an insider, including officers and directors of the debtor; (3) the debtor must have received less than a reasonably equivalent value in exchange for the transfer or obligation; and (4) the transfer or obligation must be outside of the ordinary course of business. Since the current provisions of §548 could reach many of the transfers and obligations addressed by the amendment, the change will have limited effect. The principal differences between the amendment and current law are that the amendment would extend the reach-back period from one year to two years and would allow recovery in cases where the debtor was not insolvent but the transfer or obligation was outside the ordinary course of business. However, since the §548(a)(1)(B)(ii) constructive fraud provision already includes prospective insolvency (unreasonably small capital and expectation of incurring debts beyond ability to repay) as an alternative to insolvency, there will likely be few cases where the estate will need to rely upon the new "non-ordinary course" alternative to insolvency.

The amendment expanding the §548 reach-back period to two years has a delayed effective date and will apply to cases filed one year or more after the date of enactment. The remaining changes to §548 apply to cases filed on or after the date of enactment.


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