WASHINGTON -- CEOs receiving bonuses as their companies teeter on the brink of bankruptcy have drawn the ire of members of Congress who say the payouts are unfair to shareholders who can wind up with nothing when a company becomes insolvent.
The Government Accountability Office is recommending that Congress consider amending the bankruptcy code to clearly define the extent to which companies can provide bonuses before declaring bankruptcy.
In a Sept. 30 report, the GAO found that of some 7,300 companies that declared bankruptcy in 2020, 42 granted executive bonuses shortly before filing. The bonuses, totaling some $165 million, ranged from five months to two days before a bankruptcy filing.
While the pre-bankruptcy bonuses were a minority among 2020 Chapter 11 bankruptcy cases, the GAO report raises questions about how many more corporate executives might seek to take advantage of the so-called Key Employee Incentive Plans, or KEIPs, if there is a more severe economic downturn.
“Congress should consider amending the U.S. Bankruptcy Code to clearly subject bonuses debtors pay executives shortly before a bankruptcy filing to bankruptcy court oversight and to specify factors courts should consider to approve such bonuses,” the GAO wrote.
Sen. Elizabeth Warren, D-Mass., earlier this year took aim at former Genesis Healthcare Inc. CEO George Hager Jr., who was reportedly paid a $5.2 million “retention” bonus before leaving the provider of nursing care services in January, even after more than 2,800 of its residents had died of COVID-19 and despite the fact that he left Genesis in dire financial straits, she said.
“A large portion of this pay was approved in late 2020, when it was clear that the company, under Mr. Hager’s watch, was already in deep financial trouble,” Warren said in a March letter to the company. “In short, it appears that Mr. Hager walked away with an extraordinarily rich compensation package, leaving behind thousands of dead and sick nursing home residents and staff and a company in financial ruin despite being bailed out by hundreds of millions of dollars in taxpayer funds.”
Following Hager’s departure, Genesis announced a restructuring plan allowing it to avoid bankruptcy. A spokesperson for the company didn’t immediately return a call seeking comment. Attempts to reach Hager were not successful.
COVID-19 brought a spotlight
Pre-bankruptcy bonuses first drew attention last year after the economic disruptions and stay-at-home orders to combat COVID-19 sent shock waves through several industries, including retail and oil and gas, said David Farrell, a partner in the bankruptcy and financial restructuring group at Thompson Coburn.
The coronavirus “was such an aberration … so that may have expedited the whole bankruptcy consideration” for some companies, Farrell said. “What would have been ordinarily a longer runway before people file may have forced bankruptcy considerations to be made on a much more expedited basis because folks’ cash flows disappeared.”
That led to filings from companies that highlighted KEIPs. One of the most high-profile cases was clothing retailer J.C. Penney Co., which awarded almost $10 million in bonuses to executives five days before its bankruptcy in May 2020.
A year and a half later, large business filings for Chapter 11 have dropped off, and so has the attention from lawmakers and investors, Farrell said.
“That is somewhat of a chronic problem with bankruptcy reform,” he said. “There is no question that bankruptcy filings tend to go in waves, so you have periods of intense bankruptcy filings and the business cycle turns, and then the filings drop off. Issues get raised and there is discussions about legislation, and then people lose their attention span as the business cycle changes and these issues are not getting much attention in the media because the filings drop off.”
No major changes since 2005
KEIPs emerged shortly after Congress made changes to tighten the country’s bankruptcy rules 16 years ago. For years, companies that wanted to keep certain senior executives on their payroll amid Chapter 11 reorganizations would ask bankruptcy courts to approve retention payouts. Those payments established a precedent for judges to allow distressed companies to give lucrative bonuses to executives under the argument that the senior management would be inclined to stay on board and lead the company through Chapter 11.
Unions complained that those bonuses allowed executives to get away with large payouts while rank-and-file employees faced the brunt of layoffs and restructurings. Those arguments culminated in 2005 bankruptcy legislation, after camera company Polaroid’s bankruptcy in 2001 that saw executives paid more than $7 million in bonuses.
The law restricted debtors’ ability to get court permission on such payments during bankruptcy. Companies came up with KEIPs to continue paying their executives to stay on through tough times, Farrell said.
Congress has not made major changes to the country’s bankruptcy code, including executive compensation and bonuses during Chapter 11, since that 2005 law.
Rep. Greg Steube, R-Fla., introduced a bill in January that would bar companies from paying bonuses to executives, insiders or other individuals who make more than $250,000 annually from one year before a company files for bankruptcy and for one year after filing. The bill in March was referred to the House Judiciary Subcommittee on Antitrust, Commercial and Administrative Law, where Steube is a member. No action has been taken.
Peter Karafotas, chief of staff for subcommittee Chairman David Cicilline, D-R.I., did not answer questions about whether he would work on Steube’s bill or similar legislation to address the loophole.
KEIPs were brought up in a July 28 subcommittee hearing on “current abuses” under the Chapter 11 system.
Adam Levitin, a professor of law at Georgetown University, echoed concerns raised in the GAO report. He told lawmakers that the bankruptcy code’s change to only compensate executives and directors to stay with a company through KEIPs based on certain goals has led to debtors exploiting a loophole.
“Rather than deal with KEIPs, however, debtors have increasingly turned to making payments to insiders on the eve of bankruptcy,” Levitin said in written testimony to the subcommittee in July. “While unseemly, this practice is currently perfectly legal; the Bankruptcy Code does not apply until the debtor files for bankruptcy.”
“Chapter 11 is now long overdue for a tune-up to ensure that it continues to fulfill its promise of providing a fair and efficient method for dealing with the inevitable reality of business failure,” he concluded.
Peter Feltman contributed to this report.
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