The Protecting Employees and Retirees in Business Bankruptcies Act of 2020: A Sign of the Times

October 05, 2020

On September 29, 2020, the United States House of Representatives Committee on the Judiciary advanced a Democrat-backed bill to the full chamber that seeks to address perceived shortcomings in the Bankruptcy Code’s protections for employee and retiree benefits and to curtail the use of bonuses and special compensation arrangements for executives in bankruptcy cases. The bill, titled the Protecting Employees and Retirees in Business Bankruptcies Act of 2020 (the “PERBB”)largely warms over proposals first made in 2007 and which have been unsuccessfully introduced in the House and Senate every few years since. Given its history, in any other year it might be tempting to dismiss the PERBB as one more ambitious bankruptcy reform proposal with little chance of passage. 2020 is no ordinary year, however. The past ten months have been marked by economic turmoil with landmark unemployment and record numbers of chapter 11 filings some of which have featured the payment of headline-grabbing executive bonuses by debtor companies. 2020 is also an election year fraught with political consequence in which the Democratic Party hopes to capture the Presidency and both houses of Congress. Bankruptcy practitioners would thus do well to review the provisions of PERBB, many of which, if enacted, have the potential to substantially impact future business reorganizations. 

Summary of Proposals

At its core, the PERBB is centered around three fundamental objectives:  (1) improving the recoveries of rank-and-file employees and retirees on account of their claims for wages and benefits, (2) revamping the reorganization process to prioritize the preservation of jobs and employee and retiree benefits, and (3) curbing payments to debtors’ officers, directors, and other insiders, especially where seemingly made at the expense of employee and retiree recoveries.

To improve the recoveries on employee and retiree claims for wages and benefits, the PERBB proposes various changes to the Bankruptcy Code’s statutory priority for common types of employee and retiree claims.  Notably, the PERBB increases the amount of claims for prepetition wages and severance payments eligible for priority under section 507(a)(4) of the Bankruptcy Code to $20,000 per employee and eliminates the requirement that such claims arise within 180 days prior to a bankruptcy petition. The PERBB also classifies unpaid post-petition severance and benefit plan contributions as administrative expenses and (along with unpaid post-petition wages) treats these claims as necessary costs and expenses of preserving or disposing of secured creditors’ collateral under section 506(c) of the Bankruptcy Code—in effect, granting priming liens on secured creditors’ collateral for these post-petition employee claims.

The PERBB also toughens the procedural requirements necessary to reject or modify collective bargaining arrangements and retiree benefits in chapter 11 and mandates that courts consider alternative proposals made by organized labor and retiree representatives before implementing any modifications.  Such modifications must in any event be limited to the minimum necessary to achieve a successful reorganization. The PERBB reinforces these protections by including new elements for plan confirmation that will require that plans of reorganization have as their expressed goal the productive use of assets and preservation of jobs, and granting representatives of retirees and organized labor enhanced rights (including limited exemptions from the automatic stay) when negotiating on behalf of their constituencies. The PERBB also introduces new requirements to sections 363 and 1129 of the Bankruptcy Code which would apply to sales of a debtors’ assets which require courts to consider whether a potential sale of the assets preserves employee jobs, maintains the employees’ terms and conditions of employment, and provides for the assumption or match of pension and health care benefits before such sale could be approved. 

The PERBB seeks to toughen limits on post-petition bonus payments to executives and key employees by reducing the amount of such payments permitted under section 503(c) of the Bankruptcy Code and subjecting additional persons (adding the 20 highest paid employees, department and division managers, and consultants) and incentive payments (as opposed to the current restrictions which only bar retention payments) to such restrictions. The PERBB also imposes a strict ban on any such payments if the debtor has discontinued or reduced its customary severance payments for rank-and-file employees in the year prior to the bankruptcy filing or thereafter. Executive compensation upon emergence from bankruptcy is also limited under the PERBB through amendments to section 1129 of the Bankruptcy Code that generally limit special payments to executives and key employees under a plan of reorganization to those programs available to all employees and subject to the newly established limits under section 503(c). 

In addition, compensation for any “insiders” that will be employed or retained by the debtors upon emergence would be capped at an amount corresponding to the 50th percentile of similarly situated personnel at comparable companies and reasonable in light of the economic losses of the debtor’s non-management workforce. In situations where a debtor has modified employee or retiree benefit plans within 180 days prior to the bankruptcy filing or thereafter, the PERBB also provides a trustee or an official committee the ability to clawback a portion of the compensation paid to debtor directors in the year prior to the bankruptcy filing equivalent to the average percentage of diminution in value in benefits suffered by retirees and employees as a result of modifications or terminations of their benefits.

Potential Impacts

Certain of the PERBB’s impacts, namely the increase in allowed amounts of employee claims for wages and benefits and their elevated priority, have the potential to result in greater distributions to employees (likely at the expense of other unsecured creditors) and would increase the costs of administration of bankruptcy estates. These costs would be compounded by the PERBB’s designation of unpaid post-petition compensation as necessary expenses of preservation of secured creditors’ collateral—in effect, granting them priming liens. While this may have little direct effect in many chapter 11 reorganizations where employee wages are regularly paid pursuant to first day orders, this designation may increase the cost of debtor-in-possession financing, since secured creditors who often provide such financing will be taking greater risks in a downside liquidation scenario.

Other PERBB amendments intended to preserve employee and retiree benefits have broader implications on the restructuring process itself. By requiring reorganizing debtors to demonstrate that any proposed modifications to existing retiree and employee benefits are the minimum necessary to effect a reorganization, the PERBB weakens debtors’ ability to renegotiate or terminate burdensome contracts even where market practice in the debtors’ industry may no longer offer similar employment terms or benefits to employees or retirees. In addition, by providing additional procedural protections to representatives of retirees and organized labor, the PERBB elevates the role these creditor groups will play in restructuring negotiations. While this may produce the desired result from a public policy perspective, it introduces new complexity and potentially prolongs negotiations given these creditors’ divergent interests (i.e., retaining the greatest possible benefits going forward) from those of other key stakeholders (i.e., maximizing returns on account of prepetition indebtedness) or the debtors (i.e., successfully reorganizing the debtors’ business on profitable and sustainable terms). Finally, by extending considerations of job and retiree benefit retention in the context of section 363 sales, the PERBB has the potential to diminish the use of this increasingly popular restructuring alternative, since purchasers will no longer have the same latitude to leave unprofitable obligations with a debtor’s estate.

The PERBB also has the potential to alter certain trends regarding executive and key employee compensation though it is unclear whether these changes will curtail the most infamous practices. By expanding the restrictions under section 503(c) of the Bankruptcy Code to pick up a broader set of individuals and incentive payments, the PERBB arguably closes certain loopholes left open when section 503(c) was first created under the Bankruptcy Abuse and Consumer Protection Act of 2005. However, payments of bonuses on the eve of bankruptcy (not subject to section 503(c)’s restrictions) have become increasingly common and such payments are not addressed by the PERBB directly. Similarly, capping the compensation of debtors’ post-emergence insiders to a median market standard for similarly situated companies may have little practical effect in industries where the market for executive compensation is already generous. Alternatively, such restrictions may diminish debtors’ ability to recruit new management and it is unclear for how long the restrictions must remain in place. Likewise, clawing back compensation from directors in an amount proportionate to reductions in benefits suffered by employees and retirees may provide a limited mechanism to force directors to “share the pain.” But, the full effects of this clawback right are unclear and it may have the counterintuitive effect of raising market compensation for directors generally as they seek a greater “cushion” (or demand new forms of insurance) to mitigate the potential effects of any clawback.   

Conclusion   

While it is unclear whether the PERBB will ever become law in its current form, it is clear that the PERBB, if passed, could significantly affect future bankruptcy reorganizations. Employees and retirees would likely welcome the PERBB’s reforms as long overdue improvements on current market practice. Debtors and finance providers, however, may view the PERBB as imposing additional costs and complexity on an already expensive and complicated process and may be concerned that, without revisions, the PERBB may weaken the ability to recruit and retain senior management for companies emerging from bankruptcy. Thus, like so many other aspects of 2020, when it comes to the PERBB, the future is both uncertain and consequential.  Even if passed into law, however, only time will reveal the PERBB’s full impact on future restructurings.         

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Footnotes:
1. H.R. 7370, 116th Cong. (2020)