Velo Holdings KEIP Approved By SDNY Bankruptcy Court

On June 6, 2012, Bankruptcy Judge Martin Glenn of the U.S. Bankruptcy Court for the Southern District of New York approved a $2.875 million key employee incentive plan ("KEIP") in the Velo Holdings bankruptcy cases over the objection of the U.S. Trustee finding that it was primarily incentivizing and a sound exercise of the debtors' business judgment. In re Velo Holdings Inc., Case No. 12-11384 (MG), 2012 Bankr. LEXIS 2535 (Bankr. S.D.N.Y. 2012). The decision follows well-settled law in the Southern District and Delaware regarding approval of KEIPs.

Approving Retention and Incentive Plans

Section 503(c) was added to the Bankruptcy Code in 2005 to limit the practice of debtors providing bonuses to executives simply to retain their services during the bankruptcy process – so called "pay to stay" programs. Under section 503(c), if a program is found to be a retention plan and the employee is an insider, the plan must satisfy the strict standards of section 503(c)(1), which effectively require that (i) the payments thereunder are essential to retention of the employee because he has a bona fide job offer from another business, (ii) the services provided by the employee are essential to the survival of the business, and (iii) the amount of the payments is reasonable and customary. Alternatively, if a plan is primarily incentivizing or is not applicable to insiders, section 503(c)(1) does not apply.

Courts have found that KEIPs are primarily incentivizing if the compensation package (i) incentivizes management to produce and increase the value of the estate or (ii) motivates employees to achieve performance goals. Conversely, plans are retentive for purposes of section 503(c)(1) where no portion of the bonus is tied to anything other than staying with the company for a certain period of time. Notably, a KEIP may have retentive purposes and avoid scrutiny under section 503(c)(1) so long as it is primarily incentivizing. See In re Borders Group, Inc., 453 B.R. 459, 471 (Bankr. S.D.N.Y. 2011) (citing In re Dana Corp., 358 B.R. 567, 571 (Bankr. S.D.N.Y. 2006)); In re Global Home Prods., LLC, 369 B.R. 778, 785 (Bankr. D. Del. 2007).

When a KEIP falls outside of the scope of section 503(c)(1) and is not an ordinary course transaction, it can be approved under either section 363(b) of the Bankruptcy Code, which requires a showing of a valid good faith business purpose (i.e., the business judgment test), or section 503(c)(3), which requires that the plan...