Supplemental Material - Turnaround Management Association

Transcription

In re Global Home Products, LLC, 369 B.R. 778 (2007)
Bankr. L. Rep. P 81,001
KeyCite Yellow Flag - Negative Treatment
Disagreed With by In re Nellson Nutraceutical, Inc., Bankr.D.Del., May 24, 2007
369 B.R. 778
United States Bankruptcy Court,
D. Delaware.
In re GLOBAL HOME PRODUCTS, LLC, et al., Debtors.
No. 06–10340(KG). | March 6, 2007.
Synopsis
Background: Chapter 11 debtors-in-possession moved for approval to implement management and sales bonus plans. Union
representing certain of debtors’ employees objected.
Holdings: The Bankruptcy Court, Kevin Gross, J., held that:
[1]
plans were incentive, not retention, plans, and thus not subject to review under bankruptcy statute restricting key employee
retention and severance plans, and
[2]
plans satisfied business judgment and reasonableness standards, warranting bankruptcy court’s approval.
Motion granted.
Attorneys and Law Firms
*779 Bruce Grohsgal, James E. O’Neill, Laura Davis Jones, Sandra G.M. Selzer, Pachulski Stang Ziehl Young Jones &
Wein, Wilmington, DE, for Debtors.
OPINION
KEVIN GROSS, Bankruptcy Judge.
INTRODUCTION
The following is the Court’s decision on the Motion of the Debtors1 for an Order Authorizing and Approving Management
Incentive Plan and Sales Bonus Plan (“the Motion”). Debtors seek approval for debtors Anchor Hocking Glass Operating
Company LLC, Anchor Hocking CG Operating Company and GHP Operating Company LLC (collectively, “Anchor
Hocking”) to implement what they refer to as a “performance and incentive based bonus plan” (“the Management Plan”) and
an “incentive based sales bonus plan” (“Sales Plan”, collectively, “the Plans”). The Court received two objections to the
Motion, one of which was subsequently withdrawn. The Court conducted an evidentiary hearing on the Motion on January
24, 2007 (the “Hearing”). At the conclusion of the Hearing, the Court announced that it would grant the Motion with the
© 2015 Thomson Reuters. No claim to original U.S. Government Works.
1
opinion to follow. Accordingly, this is the Court’s opinion with its factual findings and legal conclusions.2
JURISDICTION
The Court has jurisdiction over this Motion pursuant to 28 U.S.C. §§ 157 and 1334. This proceeding is a core proceeding
within the meaning of 28 U.S.C. §§ 157(b)(2)(A), (M), (N) and (O). Venue of these proceedings and this Motion is *780
proper in this District pursuant to 28 U.S.C. §§ 1408 and 1409. The statutory predicates for the relief sought herein are §§
105(a) and 363(b).3
BACKGROUND OF THE CASE
On April 10, 2006 (the “Petition Date”), the Debtors filed voluntary petitions for relief under the Bankruptcy Code and
continue to operate their businesses and manage their properties as debtors in possession pursuant to §§ 1107(a) and 1108 of
the Bankruptcy Code. On April 26, 2006, the United States Trustee appointed an official committee of unsecured creditors
(the “Committee”).
Global Home Products is a leading designer, manufacturer of well known, branded consumer and specialty products which it
markets to retail and hospitality customers and to original equipment manufacturers. On the petition date it operated three
primary businesses. Anchor Hocking produces beverageware, cookware, bakeware, home decor items, and glass components
for commercial customers. Wearever produced metal bakeware, cookware and accessories and was recognized as a leading
marketer and manufacturer of multi-branded metal cookware and bakeware products and accessories. The Burnes Group
designed and sold ready-made picture frames, photo albums, scrapbooks and related home accessories. Debtors have sold the
Burnes and Wearever operations pursuant to Court orders in the course of these cases.
THE PLANS 4
A full description of the Plans in this Opinion would be lengthy and unnecessary for the Court’s discussion and ruling. A
summary of the Plans is sufficient and the Court has attached the Plans as Exhibit A to the Opinion.
a. The Management Plan
The Court will describe the Management Plan and later the Sales Plan with liberal and often unattributed use of the
descriptions in the Motion. This is a summary without arithmetic detail which is undisputed and better left to the information
in Exhibit A to this Opinion and the illustrative detail Debtors have included in the Motion. In addition, Debtors presented
extensive testimony at the hearing.
The Debtors’ fiscal year began on April 1, 2006 (ten days before Debtors commenced their cases) and will end on March 31,
2007. The Management Plan would award each Eligible Employee, on a quarterly basis and as a percentage of their base
salary, up to four (4) potential incentive payments (each a “Quarterly Payment”) payable if the Management Plan’s minimum
EBITDAR and/or Cash Flow objectives are met at the end of each of the following periods: (i) the first six months of the
2007 fiscal year, which began on April 1, 2006 and ended on September 30, 2006, (ii) the 2007 third fiscal quarter, which
period began on October 1, 2006 and ended on December 31, 2006; (iii) the 2007 fourth fiscal quarter, which period began
on January 1, 2007 and will end on March 31, 2007, and (iv) the entire 2007 fiscal year, which ends on March 31, 2007 (each
*781 of these aforementioned four periods is referred to as a “Quarter”). The Plan is comprised of two components:
EBITDAR (“Earnings Before Interest, Taxes, Depreciation and Rent”) goal objectives and Cash Flow goal objectives. The
components are both weighted to count for 50% of the potential Quarterly Payment. In order to remain eligible to receive
Quarterly Payments under the Management Incentive Plan for a particular Quarter, Eligible Employees must be employed
2
with the Debtors as of the last day of the particular Quarter on which the requisite EBITDAR and/or Cash Flow objectives
are actually achieved.
Mark Eichhorn is Debtors’ Interim Chief Executive Officer and President of Anchor Hocking. In lieu of Quarterly Incentive
Payments, the Management Incentive Program provides for an amortization based upon a formula of Mr. Eichhorn’s existing
obligations owed to Debtors in the amount of $310,000 in respect of a prepetition loan and relocation allowance advanced to
him prepetition in connection with expenses incurred pursuant to Mr. Eichhorn’s relocation from Illinois to Ohio (the
“Relocation Obligation”). Rather than pay Mr. Eichhorn Quarterly Incentive Payments, the Debtors and Mr. Eichhorn have
agreed to quarterly amortizations of the Relocation Obligation based upon a formula.
Under no circumstances may the total amortization ever exceed the amount of the Relocation Obligation. In other words, Mr.
Eichhorn bears the risk that the Relocation Obligation may not be fully amortized if the Debtors do not achieve 100% of the
projected EBITDAR and Cash Flow objectives for the 2007 fiscal year. However, unlike other Eligible Employees, Mr.
Eichhorn is not entitled to any additional benefit if the Debtors exceed 100% of the EBITDAR and Cash Flow objectives
because, as noted above, the full amortization of the Relocation Obligation can never exceed $310,000.
Debtors estimate that the total cost of the Management program will range between $890,000 (if the 75% minimum
EBITDAR and Cash Flow objectives are each achieved during each Quarter), up to a maximum of $2,700,000 (if Anchor
Hocking achieves 125% or more of its EBITDAR and Cash Flow objectives during each Quarter of the 2007 fiscal year).
b. The Sales Bonus Plan
Debtors’ Sales Plan covers certain sales managers (the “Eligible Sales Managers”). The Sales Plan is fully set forth in Exhibit
A and is an updated version of the sales plan in effect at the Petition Date. Eligible Sales Managers are entitled to receive up
to (i) 30% of their annual salaries based on the annual percentage increase of annual sales for their division calculated at the
end of the 2007 fiscal year over the prior year, plus (ii) a 15% Target Bonus Percentage payment pursuant to the same terms
and conditions applicable to the Management Plan.
The Sales Plan also is divided into three categories: (1) the Debtors’ sales to Wal–Mart, (2) the Debtors’ international sales,
and (3) the Debtors’ sales to other customers who are not included in (1) and (2) above. Each Eligible Sales Manager
participating in the Sales Bonus Program falls into one (and only one) of the above three categories based on their job
descriptions and the bonus calculations vary by category.
THE OBJECTION
The Court has before it the objection (the “Objection”) to the Motion of the United Steel, Paper and Forestry, Rubber,
Manufacturing, Energy, Allied Industrial and Service Workers International Union *782 (“USW”).5 The stated grounds for
the Objection are that “the Debtors have proposed a management compensation scheme that runs afoul of the obligations set
forth in Sections 503(c)(1) and (3) of the Code, 11 U.S.C. § 503(c)(1), (3), and have elected to do so at a time when
management is seeking to extract deep concessions from the employees and retirees represented by the United Steel
Workers.” (USW Objection at 1) USW is the bargaining agent for approximately 1,300 employees who work at Debtors’
facilities in Lancaster, Ohio and Monaca, Pennsylvania. USW also represents retirees and surviving spouses receiving
retirees benefits from Debtors. USW complains that the collective bargaining agreement which covers the Pennsylvania
Plant, with “significant pressure from the Debtors, froze the existing defined benefit pension plan, eliminated an incentive
pay program, increased employee health insurance premiums, and reduced other economic benefits paid to the bargaining
unit employees.” (Id. at 2) USW further states that Debtors are pursuing a similar agreement covering the Ohio plant,
including a limitation on future participation in Debtors’ retiree benefits program. As discussed further below, USW argues
that the Plans are disguised retention programs which fail to meet the requirements of § 503. In addition, USW contends that
the Plans are “inimical to the principle of shared sacrifice that is common in chapter 11 cases.” (Id. at 7)
3
THE HEARING
At the hearing, Debtors presented the live testimony of Mark Eichhorn, Debtors’ Interim CEO and President of Anchor
Hocking (“the Eichhorn Testimony”), Ronald Stengel, Debtors’ Chief Restructuring Officer (“Stengel Testimony”), and Jeff
Visithpanich, Debtors’ expert witness (“the Expert Testimony”).6
The testimony of Debtors’ witnesses was largely unrefuted.7 The testimony of Debtors’ witnesses established the following
pertinent facts.
a. Eichhorn Testimony
1. Mr. Eichhorn has worked at Anchor Hocking since 1987, and was its President for five years beginning in 1994. (Hearing
Transcript, 8–9, January 24, 2007)
2. The Plans are nearly identical to management and sales incentive plans previously in effect at Anchor Hocking since his
time with Anchor Hocking. (Hr’g Tr. 9)
3. Mr. Eichhorn structured the Plans “emulating the prior plans” in existence in prior years. (Hr’g Tr. 10–11)
4. Anchor Hocking’s Board of Directors and its Compensation Committee approved the Plans unanimously. (Hr’g Tr. 12)
5. The 2006 management incentive plan resulted in no payments to management because the targets were not met. The 2006
sales plan generated bonus payments. (Hr’g Tr. 13)
6. The Plans were announced in June–July 2007 to motivate management to work hard to produce. (Hr’g Tr. 16)
*783 7. Debtors set aggressive incentive targets for earning bonuses. (Hr’g Tr. 10, 14–15)
8. The participants in the Plans occupy the same positions as historically participated in previous plans. (Hr’g Tr. 21)
9. The Plans are intended to be self-funded. “So the financial targets that we establish for the business are net of the cost of
any incentive plans associated with the business.” (Hr’g Tr. 23)
10. Funding for the Plans is incorporated in the Debtors’ budget and the actual cost based upon business results will be only
approximately half of the amount budgeted. (Hr’g Tr. 26)
b. Stengel Testimony
11. The Chief Restructuring Officer reviewed all aspects of the Plans and found them to be reasonable and in Debtors’ best
interests. (Hr’g Tr. 53–54)
12. The Management Plan terms applicable to Mr. Eichhorn are debt forgiveness (costs of moving which Debtors advanced)
in lieu of cash payments relating to relocation costs. The debt forgiveness rather than cash payments benefits Debtors because
Debtors “live on limited liquidity, and to the degree that we wouldn’t have to pay that cash, the company’s liquidity would be
enhanced by it”. (Hr’g Tr. 55)
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c. Expert Testimony
13. Jeff Visithpanich was retained to render an expert opinion “regarding whether the debtors [Plans] are reasonable because
the payments thereunder are within market norms.” (Hr’g Tr. 58)
14. Mr. Visithpanich is a principal at Johnson Associates Incorporated, a compensation consulting firm. Such work involves
evaluating, structuring and implementing compensation plans. (Hr’g Tr. 59)
15. USW did not object after voir dire to the Debtors’ use of expert testimony or Mr. Visithpanich’s competency to render an
expert opinion. (Hr’g Tr. 64)
16. Mr. Visithpanich concluded that the Plans are reasonable, typical and common. They are within market norms based upon
comparison with numerous companies of similar size and which, like Anchor Hocking, manufacture durable goods. (Hr’g Tr.
64–75)
17. Without the additional compensation the Plans could make possible, Anchor Hocking’s key employees’ compensation
would fall approximately 35 percent short of the median compensation for similar companies. A shortfall of such an amount
would be “a pretty significant business risk for key professionals, in this case.” (Hr’g Tr. 68)
18. Visithpanich concluded that:
If we were to have a plan that was intended to motivate, to drive performance, to incentivize professionals, this is a very
common plan we see very, very often.
(Hr’g Tr. 74–75)
DISCUSSION
The Court’s decision turns on whether the Plans constitute a Key Employee Retention Plan (“KERP”), also known as a “pay
to stay” compensation plan, or are intended to create incentive for management and key employees, or a “pay for value”
compensation plan. If the Court finds the Plans are a KERP, they are subject to the bright light and restrictions of § 503(c). If
they are plans intended to incentivize management, the analysis utilizes the more liberal business judgment review under §
363.
[1] [2]
Compensation issues are normally governed by the business judgment standards, i.e., proof that there is a broad *784
business purpose for an action. Dai–Ichi Kangyo Bank, Ltd. v. Montgomery Ward Holding Corp. (In re Montgomery Ward
Holding Corp.), 242 B.R. 147, 153 (D.Del.1999) (affirming bankruptcy court approval of KERP on basis that debtors showed
a “sound business purpose” justifying such approval); Cf. Myers v. Martin (In re Martin ), 91 F.3d 389, 395 (3d Cir.1996)
(courts defer to a trustee’s judgment concerning use of property under § 363(b) when there is a legitimate business
justification). The reasonable use of incentives and performance bonuses are considered the proper exercise of a debtor’s
business judgment. In re U.S. Airways, Inc., 329 B.R. 793, 795 (Bankr.E.D.Va.2005) (debtor carried its burden of showing
use of sound business judgment in adopting business plan).
[3]
In 2005, Congress made significant changes to the Bankruptcy Code. BAPCA, as the Act amending the Code is now
called, took specific aim at Congressional concern over what it viewed as KERP abuses. The import of the BAPCA
provisions dealing with KERPs was Congress’s effort “to eradicate the notion that executives were entitled to bonuses simply
for staying with the Company through the bankruptcy process. BAPCA imposed a set of challenging standards debtors must
meet to have ‘stay’ bonuses approved.” Karen Lee Turner & Ronald S. Gellert, Dana Hits a Roadblock: Why Post–BAPCPA
Laws May Impose Stricter KERP Standards, 3 No. 14 Andrews Bankr.Litig. Rep. 2, 2 (2006). The question remains,
however, whether or not the Plans are a KERP thereby triggering the Court’s post-BAPCA obligation to apply greater
5
scrutiny under § 503(c). BAPCA requires the Court to apply specific standards if a bankruptcy court is asked to authorize
payments to insiders8 for the purpose of inducing insiders to remain in a debtor’s employ, or payments made on account of
severance.
Section 503(c)(1) (3) provides, in part,
(c) Notwithstanding subsection (b), there shall neither be allowed, nor paid—
(1) a transfer made to, or an obligation incurred for the benefit of, an insider of the debtor for the purpose of inducing
such person to remain with the debtor’s business, absent a finding by the court based on evidence in the record that—
(A) the transfer or obligation is essential to retention of the person because the individual has a bona fide job offer
from another business at the same or greater rate of compensation;
(B) the services provided by the person are essential to the survival of the business; and
******
(2) a severance payment to an insider of the debtor, unless—
(A) the payment is part of a program that is generally applicable to all full-time employees; and
(B) the amount of the payment is not greater than 10 times the amount of the mean severance pay given to
nonmanagement employees during the calendar year in which the payment is made; or
(3) other transfers of obligations that are outside the ordinary course of business and not justified by the facts and
circumstances of the case, including *785 transfers made to, or obligations incurred for the benefit of, officers, managers,
or consultants hired after the date of the filing of the petition.
11 U.S.C. § 503(c)(1)-(3).
The statute makes it abundantly clear that in a post-BAPCA bankruptcy case, KERPs and severance arrangements subject to
review under § 503(c)—those whose purpose is to retain employees—are severely restricted. See, e.g., In re U.S. Airways,
329 B.R. at 797–98 (“Congressional concern over KERP excesses is clearly reflected in changes to the Bankruptcy Code....
Those changes will severely limit both the circumstances under which severance and retention payments may be made to
insiders as well as the amount of such payments ...”). Section 503(c)(1) prohibits payments to “insiders” to induce them to
remain with the debtor unless a court finds that the evidence establishes that the payment is “essential” because the individual
has a “bona fide” offer from another entity at the same or greater rate of compensation, and the individual’s services are
“essential” to the debtor’s survival. The retention bonuses are also limited in amount. Section 503(c)(2) permits severance
payments to “insiders” only if they are part of a program which is applicable to all employees and are less than ten times the
mean of severance payments given to nonmanagement employees. Sections 503(c)(1) and (2) are plainly high hurdles to clear
if payments are primarily designed for retention.
The entire analysis changes if a bonus plan is not primarily motivated to retain personnel or is not in the nature of severance.
In the Objection, USW relies largely upon In re Dana Corp., 351 B.R. 96 (Bankr.S.D.N.Y.2006) (“Dana I”),9 in which the
learned Judge Lifland held that debtors’ compensation packages at issue did not satisfy either the business judgment rule or §
503(c) limitations. The Court observed that the bonus plan “walks like a duck (KERP), quacks like a duck (KERP), it’s a
duck (KERP).” In re Dana Corp., 351 B.R. 96, 102 n. 3 (Bankr.S.D.N.Y.2006). Finding that debtors failed to meet their
burden of establishing that the bonus plan was not severance for purposes of § 503(c), the court also noted, even while
rejecting the bonus program under § 503(c), that “it may be possible to formulate a compensation package that passes muster
under the section 363 business management rule or section 503(c) limitations, or both....” Id. at 103.
Dana I is not the end of the story in this Court’s analysis. In In re Dana Corporation, 2006 WL 3479406
(Bankr.S.D.N.Y.2006) (“Dana II”), the court encountered as a motion for reconsideration “Debtors’ second effort to obtain
approval of an execution compensation package ...”. In re Dana Corporation, 2006 WL 3479406, *1 (Bankr.S.D.N.Y.2006).
6
Debtors proposed that the revised plan was a true incentivizing package and a wholly different plan from the proposal the
Court rejected in Dana I.
Judge Lifland posited that:
[S]ection 503(c) was not intended to foreclose a chapter 11 debtor from reasonably compensating
employees, including “insiders,” for their contribution to the debtors’ reorganization. In re Nobex
Corp., 2006 WL 4063024, 2006 Bankr.LEXIS 417 (Bankr.D.Del. Jan. 19, 2006); see also In re Werner
Holding Co., Inc., Case No. 06–10578 (Bankr.D.Del.2006).
*786 In re Dana Corporation, 2006 WL 3479406, *5 (emphasis in original).
In arriving at its conclusion that Dana’s compensation plan was meant to incentivize, the court focused on the fact, as is
present here, that:
[A] short term incentive plan has been a common component of compensation plans at Dana for the
past fifty years and does not differ significantly from Dana’s prepetition practice. Accordingly, it is
within the ordinary course of Debtors’ business.
In re Dana Corporation, 2006 WL 3479406, *10. The Dana II court then focused on whether the compensation proposal was
a proper exercise of Debtors’ business judgment.
The court, citing numerous cases, listed the factors courts use to determine, ... if the structure of a compensation proposal
and the process for developing the proposal meet the ‘sound business judgment’ test:
—Is there a reasonable relationship between the plan proposed and the results to be obtained, i.e., will the key employee
stay for as long as it takes for the debtor to reorganize or market its assets, or, in the case of a performance incentive, is the
plan calculated to achieve the desired performance? (emphasis added)
—Is the cost of the plan reasonable in the context of the debtor’s assets, liabilities and earning potential?
—Is the scope of the plan fair and reasonable; does it apply to all employees; does it discriminate unfairly?
—Is the plan or proposal consistent with industry standards?
—What were the due diligence efforts of the debtor in investigating the need for a plan; analyzing which key employees
need to be incentivized; what is available; what is generally applicable in a particular industry?
—Did the debtor receive independent counsel in performing due diligence and in creating and authorizing the incentive
compensation?
In re Dana Corporation, 2006 WL 3479406, * 6 (citations omitted).
All of the evidence before the Court satisfies the foregoing factors sufficient to mandate the Court’s conclusion that the terms
and adoption of the Plans satisfy the business judgment test. The only factor which Debtors do not squarely satisfy is whether
Debtor used independent counsel in performing due diligence and authorizing the Plans. While the evidence indicates that
Debtors did not use independent counsel, these are not “new” compensation programs but, instead, are nearly identical to
plans previously used, and approved by a compensation committee and board of directors. In other words, the Plans have
satisfied the independent “test of time.”
The Plans are clearly in the ordinary course of Debtors’ businesses. The Court is wholly satisfied, and so finds, that the Plans
are primarily incentivizing and only coincidentally retentive because Debtors employed virtually identical plans prepetition
when retention was not the motive. The fact, as Debtors pointed out, that all compensation has a retention element does not
reduce the Court’s conviction that Debtors’ primary goal to create value by motivating performance. All companies seek to
retain employees they value by fairly compensating them.
7
USW argues pointedly that because the Plans include two plus Quarters of Debtors’ fiscal year 2007 which have already
occurred (April through June and July through September) and a portion of the *787 third quarter,10 there can be no incentive.
The testimony revealed, however, that the Plan’s beneficiaries relied upon Debtors’ historical practice of providing
performance bonuses and that Debtors told the beneficiaries that they would ask the Court to approve the Plans. Thus, the
beneficiaries were performing in response to a financial incentive and not merely to remain with Debtors. Moreover, the
Plan’s beneficiaries are not required to remain with Debtors through the emergence from bankruptcy to benefit from the
Plans.
[4] [5]
The Court is fully satisfied on the basis of the facts presented that Debtors are asking it to approve incentive, not
retention plans and, therefore, § 503(c) does not come into play. Instead, the Court must determine if the Plans satisfy the
business judgment and reasonableness standards. The Court finds, based upon the evidence which USW did not successfully
challenge, that the Plans meet the standards for approval under § 363.
1. The Plans are calculated to achieve performance for Debtor’s benefit.
2. The cost is reasonable.
3. The Plans are consistent with industry standards.
4. The Plans are virtually identical to plans Debtors used consistently in the past.
5. The Plans are part of Debtors’ budget which the DIP lenders, whose money is at risk and whose financial acumen is
apparent, approved. Wachovia Bank, the pre-petition and DIP Lenders supports the Motion. (Hr’g Tr. 86–88) In supporting
the Motion, the Lender argued:
This is not a situation where management has come and by virtue of bankruptcy filing maybe perhaps
holding the creditor constituencies hostage to the fact that they have the history and familiarity with the
company, have asked for large bonuses to simply stay around and be retained.
(Hr’g Tr. 87)
The Court agrees with Wachovia Bank’s point that “[Section] 503 is really inapplicable to the plan, in that it is a incentive
plan consistent with ordinary course of business.” (Hr’g Tr. 87–88)
Finally, USW importunes the Court to reject the Plans because its constituency has been asked to sacrifice benefits while the
Plan beneficiaries receive bonuses. However, USW did not provide the Court with any evidence of “sacrifice.” In contrast, to
the extent the Plans motivate management and sales people to create additional value, all creditors will benefit.
Accordingly, Debtors have established that the Plans are not KERP’s but, instead, were reasonably intended to incentivize
management and senior level sales managers to produce and increase the value of Debtors’ estate and are therefore consistent
with Debtors’ proper exercise of their business judgment. The Court will issue an Order consistent with this opinion
approving the Plans.
All Citations
369 B.R. 778, Bankr. L. Rep. P 81,001
Footnotes
1
The “Debtors” consist of the following entities: Global Home Products LLC; GHP Holding Company LLC; GHP Operating
Company LLC; Anchor Hocking Acquisition Inc.; Anchor Hocking Inc.; AH Acquisition Puerto Rico, Inc.; Anchor Hocking
Consumer Glass Corporation; Anchor Hocking CG Operating Company LLC; Anchor Hocking Operating Company LLC; Burnes
8
Acquisition Inc.; Intercraft Company; Burnes Puerto Rico, Inc.; Picture LLC; Burnes Operating Company LLC; Mirro Acquisition
Inc; Mirro Puerto Rico, Inc.; Mirro Operating Company LLC.
2
This Opinion constitutes the findings of fact and the conclusions of law of the Court pursuant to Rule 7052 of the Federal Rules of
Bankruptcy Procedure.
3
Hereafter, references to section numbers are to the Bankruptcy Code, 11 U.S.C. §§ 101, et seq.
4
Prior to the Petition Date, Debtors had for fiscal year 2006 ended March 31, 2006, both a management incentive program and a
sales bonus program for certain employees. Required financial objectives were not met and no payments to management were
made. Certain employees satisfied the sales requirements for bonuses and those employees received their sales bonuses pursuant to
Court order.
5
The Committee filed an objection to the Motion and withdrew it prior to the Hearing. USW is a member of the Committee.
6
Mr. Visithpanich is a principal of Johnson Associates, Inc., which specializes in the management and design of executive
compensation plans.
7
USW cross-examined Debtors’ witnesses but did not present its own witnesses or any direct evidence in support of the Objection.
8
The Court is not deciding which of the Plans’ participants are “insiders” under the Bankruptcy Code, since the Plans are not
governed by § 503 and the determination is not relevant to the holding.
9
Dana I was a bench ruling.
10
The Debtors filed the Motion on December 8, 2006. [D.I. 1043].
End of Document
9
In re Blitz U.S.A. Inc., 475 B.R. 209 (2012)
56 Bankr.Ct.Dec. 202
475 B.R. 209
D. Delaware.
In re BLITZ U.S.A. INC., et al., Debtors.
No. 11–13603 (PJW). | July 9, 2012.
Synopsis
Background: Chapter 11 debtors-in-possession moved for approval to make payments associated with earnings-based
employee bonus plan for current fiscal year. Unsecured creditors committee and United States Trustee (UST) objected.
Holdings: The Bankruptcy Court, Peter J. Walsh, J., held that:
[1]
plan satisfied vertical dimension of inquiry to determine whether transaction was in the ordinary course of business;
[2]
plan satisfied horizontal dimension of inquiry to determine whether transaction was in the ordinary course of business; and
plan was taken in good faith and with sound business judgment, warranting court’s authorization of payments associated
with first two targets under plan.
[3]
Motion granted.
*211 Daniel J. DeFranceschi, Michael J. Merchant, Julie A. Finocchiaro, Amanda R. Steele, Richards, Layton & Finger,
P.A., Wilmington, DE, for Debtors and Debtors in Possession.
Francis A. Monaco, Jr., Kevin Mangan, Womble Carlyle Sandridge & Rice LLP, Wilmington, DE, Jeffrey Prol, Mary E.
Seymour, Lowenstein Sandler PC, Roseland, NJ, for Official Committee of Unsecured Creditors.
MEMORANDUM OPINION
PETER J. WALSH, Bankruptcy Judge.
This opinion is with respect to the amended motion seeking authorization to make payments associated with an employee
bonus plan (the “Motion”) by Blitz USA, Inc. (“Blitz”). (Doc. # 418.) For the reasons detailed below, I will grant the Motion.
Jurisdiction
This Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 1334 and 157. This is a core proceeding pursuant to 28
1
U.S.C. § 157(A), (M), and (O).
Background1
Blitz manufactures portable consumer gas containers, which are distributed through various retailers. Prior to entering
bankruptcy, Blitz spent millions of dollars to defend numerous product liability lawsuits alleging injuries sustained in the use
of Blitz’s gas cans. In part, the influx of litigation and rapidly escalating defense costs led Blitz to seek bankruptcy
protection. In addition to the gas can business, the Blitz enterprise included F3 Brands LLC (“F3”), which constituted
non-gas-can products. F3 was spun off from Blitz in October 2011.
On November 9, 2011, Blitz and several of its affiliates (collectively “Debtors”) filed for bankruptcy protection under chapter
11 of the Bankruptcy Code, 11 U.S.C. § 101 et seq. Debtors continue to operate as debtors in possession, pursuant to sections
1107(a) and 1108 of the Bankruptcy Code.
Debtors filed the Motion on May 5, 2012, seeking the Court’s approval of an EBITDA 2-based employee bonus plan for Fiscal
Year 2012 (the “Bonus Plan”). Debtors argue that the Bonus Plan is an ordinary course transaction that Debtors are
authorized to make without notice and a hearing. In the alternative, Debtors assert that, even if it is not in the ordinary course
of business, the Bonus Plan satisfies the stringent requirements of *212 § 503(c)(3)3 of the Bankruptcy Code. The Official
Committee of Unsecured Creditors (the “Committee”) filed an objection to the Motion, arguing that the Bonus Plan is not an
ordinary course transaction and is not justified by the facts and circumstances of this case. (Doc. # 435.) The U.S. Trustee
also filed an objection, taking issue with the amount of payments designated for certain insiders. (Doc. # 436.)
On May 31, 2012, after briefing from the Debtors, Committee, and the U.S. Trustee, the Court held an evidentiary hearing.
Debtors presented testimony from Rocky Flick, President and CEO of Blitz, and Fernando Maddock, director at Zolfo
Cooper, the Debtors’ restructuring firm. Committee and U.S. Trustee called no witnesses. The Court asked the parties to
submit post-hearing statements. Committee and Debtors submitted statements and supporting exhibits, and the issue is now
ripe for decision.
Discussion
Creation of the Bonus Plan
The Court makes the following findings of relevant fact regarding the creation of the Bonus Plan:
• Since 1992, Blitz has offered an employee bonus plan as part of its compensation package. (Hr’g Tr. 16:4–5.)
• At its inception, the program paid a bonus based on Blitz’s net income, but was changed to an EBITDA-based model in
2007. (Tr. 16:8–9.)
• Compensation, including bonuses, is set by a four-member Compensation Committee. (Tr. 6–8.) All members are Blitz
employees who are eligible beneficiaries under the bonus plan. (Tr. 46:25–47:2.)
• The Compensation Committee meets biannually to review compensation, using yearly evaluations with employees and
market-based data from Kenexa CompAnalyst (“Kenexa”). Kenexa, a subscription service, compiles data on salary broken
down by job description and geographic region. The Compensation Committee reviews Kenexa data in comparing current
Blitz salaries with benchmarks in the relevant market. (Tr. 8–11; Debtors’ Ex. 1.)
• The FY4 2008 bonus plan—the first plan based on EBITDA—was designed by the Compensation Committee, who
“worked with [Flick] and the Board [of Directors]” to implement it. (Tr. 17.) The Board is comprised of Flick and three
outside directors who are not included in the bonus plans. (Tr. 48:7–9.)
2
• The FY 2008 plan was modeled on one of a number of plans designed by Springfield Remanufacturing, a group of
companies offering books and seminars on compensation. (Tr. 33.)
• Springfield Remanufacturing’s philosophy of “employees having a stake in the outcome and how important that is to
get employees motivated” influenced the decision to implement the FY 2008 bonus plan. (Tr. 33:10–13.)
• The Compensation Committee sets the annual bonus targets. (Tr. 8, 35.)
• The Compensation Committee’s recommendations regarding salary and bonus are approved by Flick and the Board of
Directors in connection with the Board’s *213 approval of the yearly budget and business plan. (Tr. 15:10–13.)
• The plan designed for FY 2008 is essentially the same in structure as the current Bonus Plan. (Tr. 17:23–18:1, 35.)
Parameters of the Bonus Plan
The Court makes the following findings of fact regarding the details of the Bonus Plan:
• The Bonus Plan’s parameters and targets were set prior to the commencement of FY 2012 and prior to the filing of the
bankruptcy petition. (Tr. 60.)
• The Compensation Committee sets the EBITDA targets so that employee total compensation levels, on average, will be
competitive with the market once three targets are hit. (Tr. 27:6–11.)
• In previous years (2008 through 2011), the first EBITDA target was $6 million. The second target was $9 million, and
subsequent targets increased in $3 million increments. (Tr. 19:1–2.)
• In 2008, one EBITDA target was hit, and approximately $533,620 was paid to employees. Three targets were hit in each
2009 and 2010, for total payments of $1.6 million and $1.75 million, respectively. In 2011, none of the targets were met
and so no bonuses were paid. (Debtors’ Ex. 4.)
• In the Bonus Plan, the first EBITDA target is $5 million with $2.5 million incremental targets. (Tr. 19:2–4.)
• The 2012 targets were lowered due to the spinoff of F3 Brands. The bonus plans in 2008 through 2011 included F3
Brands, which made up roughly one-third of the combined company’s sales. After F3 Brands was spun off, the
Compensation Committee reduced the first EBITDA target for Blitz to $5 million, from the pre-spinoff level of $6 million.
Although no written analysis was done to arrive at the reduced target, $5 million was chosen to reflect the loss in sales but
account for Blitz’s greater efficiency and better margins. (Tr. 20, 49–50.)
• All Blitz employees are eligible for the Bonus Plan. (Tr. 33:25–34:1.)
• As in previous years, the Bonus Plan divides employees into five levels, depending on their job functions. The
Compensation Committee determines the levels, subject to the approval of Flick and the Board. (Tr. 30:12–31:1.) The
levels determine each employee’s bonus, as a percentage of his or her base salary. Level 1 employees would receive 4
percent of their base salary each time a bonus target is hit, while the sole Level 5 employee, Flick, would receive 67
percent of his base salary. (Tr. 31.)
• With the Motion, Debtors are seeking approval for the payments associated with meeting only the first two EBITDA
targets. (Tr. 18:10–12.) Only the first target has been reached. (Tr. 27:18–28:5.)
• The achievement of each target would result in a total payout of approximately $427,000. (Debtors’ Ex. 4.)
• Debtors’ DIP lenders have not objected to the Motion, and indicated to Flick that “they would be in support of paying the
first incentive.” (Tr. 42:18–22.) Maddock also testified that the lenders have expressed their approval. (Tr. 174:11–13.)
3
The Bonus Plan is an Ordinary Course Transaction
Debtors argue that the Bonus Plan is an ordinary course transaction and thus need only be evaluated under the business
judgment standard applied in § 363.5 Committee, *214 on the other hand, argues that the elevated standard prescribed in §
503(c)(3) should apply. Section 503(c)(3) requires that a payment out of the ordinary course of business be “justified by the
facts and circumstances of the case.” Committee asserts that the Bonus Plan is not so justified here.
[1] [2]
A number of cases addressing an employee incentive bonus plan first examine whether the plan is a transaction made in
the ordinary course of business. See, e.g., In re Nellson Nutraceutical, Inc., 369 B.R. 787 (Bankr.D.Del.2007); In re Global
Home Products, LLC, 369 B.R. 778 (Bankr.D.Del.2007); In re Dana Corp., 358 B.R. 567 (Bankr.S.D.N.Y.2006). In order to
determine whether a transaction is in the ordinary course of business, the Third Circuit and other courts use a two-part
inquiry. Nellson, 369 B.R. at 797; Dana, 358 B.R. at 580. First, the transaction must be examined on the “vertical”
dimension, which “analyzes the transactions from the vantage point of a hypothetical creditor[,] and the inquiry is whether
the transaction subjects a creditor to economic risk of a nature different from those he accepted when he decided to extend
credit.’ ” Nellson, 369 B.R. at 797 (quoting In re Roth Am., Inc., 975 F.2d 949, 953 (3d Cir.1992)). In other words, the
vertical analysis looks at the “debtor’s pre-petition business practices and conduct.” Id. Next, the court must look at the
transaction from the “horizontal” dimension, that is, “ ‘whether from an industry-wide perspective, the transaction is of the
sort commonly undertaken by companies in that industry.’ ” Id. (quoting Roth, 975 F.2d at 953).
[3]
Flick testified that Blitz has had some form of bonus plan since 1992 and an EBITDA-based plan since FY 2008. Although
the EBITDA-based plan has only been in existence for three years prior to FY 2012, this is sufficient to establish a course of
pre-petition conduct. With regard to the downward adjustment of the first $6 million target and the subsequent increments, it
is foreseeable that Blitz would lower its EBITDA target as a result of the F3 spinoff. Given that F3 accounted for nearly
one-third of the combined company’s sales, it makes sense for the target to be lowered where F3 is no longer part of the Blitz
company. Thus, I conclude that the vertical test has been satisfied.
[4]
Turning to the horizontal dimension, I find that the evidence has demonstrated that an incentive-based bonus plan is
common to the industry. Flick testified that there are only a few gas can manufacturers, and that the Compensation
Committee relied on a compensation scheme designed by Springfield Remanufacturing, another Midwest manufacturer. (Tr.
33.) Springfield Remanufacturing publishes books and holds seminars on compensation in the manufacturing industry, and
its advice is sought by many companies in the industry. (Id.) Flick further testified that it was likely that other companies had
bonus and other incentive programs. (Tr. 13:24–25.) Committee has produced no evidence to refute Flick’s testimony on this
point. I am satisfied that the Bonus Plan is in line with the bonus structures of other similar companies.
[5]
In light of the horizontal and vertical analysis, I hold that the Bonus Plan is an ordinary course transaction. The Bonus Plan
is essentially the same as the *215 EBITDA-based plans the company has had since 2008. Even before the switch to the
current model of the plan, Blitz has had an incentive bonus plan for its employees since 1992. Flick’s uncontested testimony
demonstrates that the Blitz plan was based on a model from another company recognized for its guidance in compensation
structure, and that other manufacturing companies have similar bonus plans. Consequently, the Bonus Plan is an ordinary
course transaction that is not subject to the requirements of § 503(c)(3). See Nellson, 369 B.R. at 803–04 (concluding that the
text of § 503(c)(3) clearly restricts its application to transactions outside of the ordinary course of business).
The Bonus Plan Passes the Test under the Business Judgment Standard of Section 363
[6]
Because the Bonus Plan is an ordinary course transaction, we need only see if it was taken in good faith and with sound
business judgment. See Nellson, 369 B.R. at 799. I find that it was.
The Bonus Plan was designed before the filing of the petition and with the same parameters and under the same process as
the previous bonus plans dating back to FY 2008. The only changes to the Plan were made as a result of the F3 spinoff. It
was reasonable for the Compensation Committee to reduce the first target and increments because F3’s sales would no longer
be counted toward Blitz’s EBITDA; as Flick testified, the total of F3’s new bonus target ($1.75 million) and Blitz’s new
bonus target ($5 million) exceeds the combined company’s previous target of $6 million. (Tr. 21, 123:5–12.)
Committee argues that the Board approval process was incomplete because the exact targets were not disclosed and no
written analysis was presented, but it has produced no evidence showing that either of these facts demonstrates a lack of good
4
faith or improper process. Flick’s testimony establishes that the Bonus Plan was approved under the same process as the
bonus plans in prior years. (Tr. 123:13–125:2.)
Likewise, the fact that the average payment per employee is higher than in prior years can be explained by the loss of F3
employees. After the spinoff, the number of employees in Level 1, who would receive only 4 percent of their salary, dropped
considerably. Flick, who as the sole Level 5 employee would receive the largest single share of the bonus payments, remains
a Blitz employee. Comparing the total amount of bonus payments year over year illustrates this fact: the payments
contemplated under the Bonus Plan are slightly less than the payments associated with hitting each target in FYs 2008
through 2011. (Debtors’ Exs. 4 & 5.) This difference is due to the loss of personnel, particularly in Level 1. (See Tr.
149:21–151:3, 191–92.) Thus, Committee’s argument that the contemplated payments under the Bonus Plan are too high is
unfounded and unsupported by the evidence.
Committee also argues that the targets set in the Bonus Plan are not a stretch and are thus designed only to reward certain
insiders before the company is liquidated. To support its argument, Committee points to a document containing several
scenarios prepared in April 2012 by Zolfo Cooper, projecting year-end EBITDA ranging from $8.8 million to $23 million
based on two variables, price and market share. (Comm. Ex. 8.) Despite these projections, both Flick and Maddock testified
that Blitz only passed the $5 million EBITDA mark in April of 2012. (Tr. 27:18, 185:24–35.) As of the date of the hearing,
Blitz had not yet hit the second target and it was not guaranteed to do so. (Tr. 28:4–7.) Regardless of what scenarios were
*216 projected by Zolfo Cooper—well after the Bonus Plan targets were set by the Compensation Committee—Blitz’s actual
results show that it has just recently passed the first EBITDA target. When the Bonus Plan targets were set, Blitz’s budget for
FY 2012 predicted year-end EBITDA of approximately $4.9 million. (Tr. 24:6–8, Debtors’ Ex. 2.) Therefore $5 million was
a stretch at the time the Bonus Plan was designed, in September 2011.
Committee makes much of the fact that, once the automatic stay went into effect upon filing of the bankruptcy petition, Blitz
no longer had to incur the $10 million in product liability defense costs that it had listed in its budget. This reduction in costs,
argues Committee, should have been factored into the Bonus Plan in the form of higher EBITDA targets. While the
Compensation Committee certainly could have raised the EBITDA targets, I do not agree that the failure to do so invalidates
the Bonus Plan as it currently stands. The actual numbers demonstrate that EBITDA has not skyrocketed due to the lack of
defense costs. Further, the bankruptcy itself may have had a negative impact on EBITDA, as Blitz’s sales figures are down
from FY 2011—some of this decrease may be due to the bankruptcy filing. (See Comm. Ex. 9, at 6.) Blitz also recently raised
the price of its gas cans by 85 percent, which has had a negative impact on market share and thus sales. (Tr. 112, 126, 159.)
Committee argues that the failure to reduce the target to account for the drop in defense costs rewards employees for a result
that was not due to their increased sales efforts. This argument has no legs when one notes that Blitz did not move the target
downward once the defense costs spiraled from “below $5 million” in 2008 to more than $10 million in 2011. (Tr. 177.)
The Bonus Plan is intended to provide an incentive for employees, who are informed of the Plan’s targets and parameters
during their yearly review, and have no control over the rise and fall of defense costs or the effects of the bankruptcy. Further,
where, as here, the employees have known about the Plan since October 2011 (Tr. 39), rewarding them for hard work already
done and encouraging them to continue working hard to fill existing orders until operations cease at the end of July does not
smack of bad faith or unsound business judgment. Therefore, I conclude that the Bonus Plan satisfies the standard of § 363.
Conclusion
For the reasons described above, I hold that the Bonus Plan is an ordinary course transaction made with sound business
judgment and in good faith. I will grant the Motion and authorize the payments associated with the first two EBITDA targets
under the Plan.
ORDER
5
For the reasons set forth in the Court’s memorandum opinion of this date, the Bonus Plan is hereby approved, subject to the
modification announced at the beginning of the May 31, 2012 hearing that the Debtors are seeking the requested relief with
respect to just the first two EBITDA targets under the Bonus Plan.
All Citations
475 B.R. 209, 56 Bankr.Ct.Dec. 202
Footnotes
1
The facts detailed in this section are undisputed by the parties.
2
Earnings before interest, taxes, depreciation, and amortization.
3
“[T]here shall neither be allowed, nor paid—other transfers or obligations that are outside the ordinary course of business and not
justified by the facts and circumstances of the case, including transfers made to, or obligations incurred for the benefit of, officers,
managers, or consultants hired after the date of the filing of the petition.” 11 U.S.C. § 503(c)(3) (2005).
4
Fiscal Year.
5
“If the business of the debtor is authorized to be operated under section 721, 1108, 1203, 1204, or 1304 of this title and unless the
court orders otherwise, the trustee may enter into transactions, including the sale or lease of property of the estate, in the ordinary
course of business, without notice or a hearing, and may use property of the estate in the ordinary course of business without notice
or a hearing.” 11 U.S.C. § 363(c)(1) (2010).
End of Document
6
In re Nellson Nutraceutical, Inc., 369 B.R. 787 (2007)
48 Bankr.Ct.Dec. 96
Distinguished by In re Fieldstone Mortg. Co., Bankr.D.Md., February 25, 2010
369 B.R. 787
Editor’s Note: Additions are indicated by Text and deletions by Text.
D. Delaware.
In re NELLSON NUTRACEUTICAL, INC., et al., Debtors.
No. 06–10072 (CSS). | May 24, 2007.
Synopsis
Background: Chapter 11 debtors moved for approval of modification to their employee incentive plan for prior year. United
States Trustee (UST) opposed motion.
Holdings: The Bankruptcy Court, Christopher S. Sontchi, J., held that:
[1]
modification of employee incentive plan was within ordinary course of debtors’ business;
[2]
modification of employee incentive plan involved business judgment made in good faith upon a reasonable basis;
bonus payments were not restricted or precluded by statutory restrictions on retention payments made to debtor’s insiders;
and
[3]
statute limiting debtor payments to officers, managers, or consultants did not apply to debtors’ modification of employee
incentive plan.
[4]
Motion granted.
*790 Laura Davis Jones, Curtis A. Hehn, Michael Seidl, Pachulski Stang Ziehl, Young Jones & Weintraub, Wilmington, DE,
Brad R. Godshall, Alan J. Kornfeld, Pachulski Stang Ziehl, Young Jones & Weintraub, Los Angeles, CA, for Debtors and
Debtors in Possession.
Robert S. Brady, M. Blake Cleary, Margaret B. Whiteman, Young Conaway Stargatt & Taylor, LLP, Wilmington, DE, Fred
S. Hodara, Abid Qureshi, Akin, Gump, Strauss, Hauer & Feld, New York, NY, Scott L. Alberino, Akin, Gump, Strauss,
Hauer & Feld, Washington, D.C., for Informal Committee of First Lien Lenders.
Kurt F. Gwynne, Thomas J. Francella, Jr., Reed Smith, LLP, Wilmington, DE, Claudia Springer, Reed Smith, LLP,
Philadelphia, PA, for Official Committee of Unsecured Creditors.
Richard W. Riley, Duane Morris, LLP, Wilmington, DE, James J. Holman, Duane Morris, LLP, Philadelphia, PA, Linda
Dakin–Grim, Gregory A. Bray, Thomas R. Kreller, Jason B. Baim, Milbank, Tweed, Hadley & McCoy, Los Angeles, CA,
for UBS AG, Stamford Branch.
William K. Harrington, Trial Attorney, Office of United States Trustee, Wilmington, DE, for Kelly Beaudin Stapleton,
1
48 Bankr.Ct.Dec. 96
United States Trustee for Region 3.
OPINION1
CHRISTOPHER S. SONTCHI, District Judge.
Introduction
Before the Court is the Debtors’ Precautionary Motion For Order Approving Modification To Ordinary Course Bonus
Compensation Program For Employees [Docket No. 1222]. Through the motion, the Debtors seek the Court’s approval to
modify the Debtors’ “ordinary course employee bonus compensation program” for the calendar year 2006 (the “2006
OCP”).2 The Debtors’ motion raises a number of issues relating to the interplay between section 363(c)(1) of the Bankruptcy
Code, which provides that “the [Debtors] may enter into transactions ... and may use property of the estate in the ordinary
course of business without notice and a hearing,” and section 503(c) of the Bankruptcy Code, which severely limits the
Debtors’ ability to pay retention bonuses, severance, and other amounts. More specifically, the motion concerns the scope of
the Court’s inquiry in determining whether to approve the Debtors’ use of property in the ordinary course of business to make
payments governed by section 503(c) of the Bankruptcy Code. Is the Court’s inquiry limited to whether the Debtors are
making payments in the ordinary course of business and application of the standard governing such transactions or does
section 503(c) of the Bankruptcy Code impose additional criteria (and, if so, what criteria) that must be satisfied before such
payments can be approved by the Court?
In evaluating the motion, the Court must address the following questions: (i) is the Debtors’ proposed modification to the
2006 OCP a transaction or use of property that is “in the ordinary course of business” under 363(c)(1) of the Bankruptcy
Code and, if so, have the Debtors satisfied the *791 standard governing such transactions; (ii) is section 503(c)(1) of the
Bankruptcy Code, which limits retention payments to insiders, applicable to an otherwise valid transfer made in the ordinary
course of business to “an insider of the debtor for the purpose of inducing such person to remain with the debtor’s business;”
(iii) assuming section 503(c)(1) is applicable, is the modification of the 2006 OCP a transfer to “an insider of the debtor for
the purpose of inducing such person to remain with the debtor’s business;” and (iv) is section 503(c)(3) of the Bankruptcy
Code, which limits “other transfers ... that are outside the ordinary course of business,” including payments to officers,
managers or consultants, applicable to an otherwise valid transfer made in the ordinary course of business, notwithstanding
the limitation on the face of the statute to the contrary.
Applying the horizontal and vertical dimensions test articulated by the Third Circuit, the Court finds that the modification of
2006 OCP is within the ordinary course of the Debtors’ business under 363(c)(1) of the Bankruptcy Code. The Court further
finds that the Debtors have satisfied the standard governing transactions in the ordinary course of business.
The Court also finds that section 503(c)(1) is applicable to an otherwise valid “transfer made in the ordinary course of
business to an insider of the debtor for the purpose of inducing such person to remain with the debtor’s business.”
Nonetheless, the Court finds that the modification of the 2006 OCP is not such a transfer.
Finally, the Court finds that section 503(c)(3) is specifically limited to transactions outside of the ordinary course of business
and, thus, is not applicable to the modification of the 2006 OCP.
Jurisdiction
This Court has jurisdiction over this matter pursuant to 28 U.S.C. § 1334. Venue of this proceeding is proper in this district
pursuant to 28 U.S.C. §§ 1408 and 1409. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(A)(B), (M) and (O).
2
48 Bankr.Ct.Dec. 96
Statement of Facts
General Background
On January 28, 2006, Nellson Nutraceutical, Inc. and certain of its affiliates (collectively, the Debtors) filed voluntary
petitions for relief under chapter 11 of the Bankruptcy Code. The Debtors continue to operate their business as debtors in
possession under sections 1107(a) and 1108 of the Bankruptcy Code.
The Debtors are contract manufacturers of nutritional bars and powders. As such, the Debtors do not manufacture or sell
products under their own label. Rather, the Debtors develop and produce products for sale by their customers.
2006 Employee Incentive Programs
In January, 2006, prior to the filing of these Chapter 11 cases, the Debtors implemented a key employee retention plan (the
“KERP”) that provided for payment to nine management employees (all of which are “insiders” under section 101(31) of the
Bankruptcy Code) in the aggregate amount of $710,000 upon the occurrence of the earlier of a termination of employment
without cause or a “capital event” involving a sale of the Debtors’ business or a restructuring of its capital structure.
Almost immediately after the filing of these Chapter 11 cases, in April, 2006, the Debtors implemented two separate
incentive plans for certain of its employees. The first such plan was a management incentive plan (“MIP”), which replaced
the KERP. Under the MIP, the Debtors established a bonus pool of approximately $1.4 million to provide incentive to the
*792 same nine management employees (and insiders) covered under the KERP to assist the Debtors in the effort to
restructure the Debtors’ business. Unlike the original KERP, payment of the bonuses under the MIP was to be earned by the
achievement of certain EBITDA targets for 2006, which were described as “performance milestones.”3 After conducting a
two-day trial on the matter, the Court entered an order in July, 2006, approving the MIP. Ultimately, the Debtors paid
bonuses totaling approximately $550,000 under the MIP as the Debtors did not achieve all of the performance milestones. No
further payments under the KERP or the MIP are due to any of the Debtors’ employees.
In April 2006, the Debtors also implemented the 2006 OCP. The 2006 OCP is an employee incentive plan covering
approximately 130–140 employees divided into six categories. Under the 2006 OCP, the Debtors established a bonus pool of
approximately $2.1 million to motivate employees to “keep[ ] momentum going forward ... in both sales and EBITDA.”
Hr’g. Tr. 40, Apr. 23, 2007. But see Debtors Ex. 2 (“For 2006, the purpose is to build EBITDA.”). The categories under the
2006 OCP and their respective share of the bonus pool are set forth below:
Approximate
Number of
Category
Description of Covered Employees
Level I
Management level officers, including the Chief Executive
Officer, Chief Financial Officer and various vice
presidents of the Debtors
Covered
Bonus Pool
Employees
(’000)
8
$1,037
3
48 Bankr.Ct.Dec. 96
Level II
Operational directors4 of the Debtors, including Director of
Purchasing, Director of Manufacturing and Director of
Finance
14
$490
Level III
Managers, including R & D Managers, Materials Managers
and Maintenance Managers
32
$469
Sales Directors
Director level employees in charge of sales to customers
3
$27
Sales Managers
Manager level employees in charge of sales to customers
5
$16
Line Managers/
Office Staff
Employees responsible for managing the day-to-day tasks
of the Debtors
71
$87.6
131
$2,126.6
Total
For Level I, Level II and Level III employees, payment of the bonuses under the 2006 OCP was “totally based on
achievement of the Consolidated Budgeted EBITDA level” for 2006, which was $43.2 million. Debtors Ex. 2. For the
remaining employees, payment of the bonuses was based on other criteria, such as sales, *793 earnings or hours worked. Id.5
Under the 2006 OCP, the Level I, II and III employees would receive a bonus calculated as a percentage of base salary in the
event the Debtors achieved their target EBITDA of $43.2 million for 2006. This “target bonus” was 50% of base salary for
Level I employees; 30% of base salary for Level II employees; and 20% of base salary for Level III employees.6 In the event
the Debtors did not achieve their target EBITDA of $43.2 million but achieved at least 93% of their target, i.e., EBITDA of
$40.2 million, the Level I, II and III employees would still receive a bonus at 50% of the target level. Thus, under the 2006
OCP, if the Debtors achieved EDITDA in the range of $40.2—$43.2 million, the Debtors would pay bonuses of 25% of base
salary for Level I employees;7 15% of base salary for Level II employees; and 10% of base salary for Level III employees. 8
The Debtors’ Chief Executive Officer, Mr. Jeffrey Dias, testified that the target EBITDA of $43.2 million established in
March 2006 was a “stretch” and did not take into account the possible negative effects to the Debtors’ business that might
result from the Debtors’ bankruptcy. Nonetheless, Mr. Dias testified that the Debtors set a target of $43.2 million of EBITDA
because: (i) it exceeded the Debtors’ results for the last 12 months as of March 2006, which had been trending positively in
late 2005 and early 2006; (ii) the initial reaction of the Debtors’ customers, employees and suppliers to the bankruptcy had
been favorable; (iii) there was no reason to believe the Debtors’ performance would decline; and (iv) it would not
successfully motivate the employees to establish a bonus program contingent upon the Debtors performing more poorly than
the most recent operating results.
Ultimately, the Debtors did not achieve their target EBITDA for 2006. In fact, the Debtors’ EBITDA for 2006 was $37.1
million or 86% of the target EBITDA of $43.2 million. Thus, under the terms of the 2006 OCP as implemented in April,
2006, no bonuses are due to the Level I, II or III employees.9
2007 Modification of the 2006 OCP Program
Notwithstanding that the Debtors did not achieve their target EBITDA for 2006, in January 2007, the Debtors modified the
2006 OCP to authorize paying bonuses to all of the employees covered under the program. Under the modified 2006 OCP (as
4
48 Bankr.Ct.Dec. 96
adopted in January 2007), the Level I, II and III employees would receive bonuses in excess of those payable under the
original 2006 OCP had the Debtors achieved EDITDA in the range of $40.2— *794 $43.2 million. In order to mollify the
Debtors’ primary creditor constituencies, the Debtors subsequently reduced the bonuses payable to the Level I employees
(including the Chief Executive Officer) to an amount slightly below that which would have been payable had the Debtors
achieved 93% of the target EBITDA. The specific bonuses payable under the modified 2006 OCP to Level I, II and III
employees (after the reduction described above) are as follows:
Original
Original
Modified Bonus
Bonus at 100%
Bonus at
Bonus at
Modified Bonus
Target EBITDA
93% EBITDA
87% EBITDA
Pool at 87%
(% Base Salary)
(% Base Salary)
(% Base Salary)
EBITDA (’000)
Level I
50%10
25%11
23.5%
$ 487.7
Level II
30%
15%
22.5%
$ 355.7
Level III
20%
10%
15%
$ 350.6
Category
$1,194.0
Total
In addition, under the modified 2006 OCP, the Sales Directors would receive bonuses at 98% of the level that would have
been due had the Debtors achieved their target. The Sales Managers, Line Managers and Office Staff would receive bonuses
under the modified 2006 OCP at 100% of the level that would have been due had the Debtors achieved their target. The total
bonus pool under the modified 2006 OCP for the employees below Level III is $130,000 compared to approximately $1.2
million in the aggregate for Level I, II and III employees.
Mr. Dias testified that, notwithstanding the failure to achieve the lowest threshold for payment of bonuses under the original
plan, the payment of bonuses under the modified 2006 OCP is justified because the Debtors’ failure to achieve those targets
was not a result of any failure by the employees.
The Board looked back across the year, said now we can understand at least some of the impact of
bankruptcy and other effects on the business which were not the responsibility of either the
management or the employees, and they decided that ... should not be a basis for denying people
compensation when the things they could influence, they had done, frankly a great job on.
Hr’g Tr. 62.
Rather, Mr. Dias testified that the failure to achieve the EBITDA target was primarily the result of (i) a reduction in new
business from existing customers related directly to the ongoing bankruptcy; and (ii) currency fluctuations that adversely
affected the earnings of the Debtors’ Canadian operations. Thus, Mr. Dias testified that it made “good business sense” to
modify the 2006 OCP to allow for payment of bonuses.
The EBITDA target was set in an environment where we had no idea of the impact of [bankruptcy],
and we said so. We told our employees—I told them that I didn’t want them to have in their mind
thinking about any impact of [bankruptcy]. I wanted them to perform as though this was better than a
normal year for the company. The numerical analysis when you do a look back shows that if you add
5
48 Bankr.Ct.Dec. 96
back the amount of money that was due to the hit on sales from bankruptcy, and you make an
adjustment for the currency effect, *795 even by the very original rules of the plan that I presented to
the Board, a 70 percent payment of target would have been justified.
Hr’g Tr. 66—67.
Pre–2006 Employee Incentive Programs
The Debtors had previously adopted employee incentive programs for 2003, 2004 and 2005 that were substantially similar to
the 2006 OCP. In each of those years, the Debtors established an EBITDA target, divided the employees into different
categories, and established a bonus as a percentage of base salary based upon achieving the EBITDA target (with an
increased bonus if the employees outperformed the objective and a reduced bonus if the employees underperformed the
objective).
In addition, in each of those years the Debtors made ex-post adjustments to the employee incentive program. Mr. Dias
testified that:
two things typically happen every year. One is, you design a program for that year that addresses the
unique circumstances of the year, and then you also look back across the year, and the Board always
reserves the right to make changes in a plan based on what it sees as operationally significant for the
year.
Hr’g Tr. 42.
Thus, in early 2004, the Debtors decided to make bonus payments under the 2003 employee incentive program even though
the Debtors failed to achieve the target for 2003. Those payments were at 30% to 50% of what would have been payable had
the Debtors achieved the target for 2003.
Similarly, in early 2005, the Debtors decided to make bonus payments to certain employees under the 2004 employee
incentive program even though the Debtors failed by a wide margin to achieve the target for 2004. In this instance, the
Debtors did not grant bonuses to senior management but did make payments to junior managers and other employees.
Finally, in early 2006, the Debtors decided to make bonus payments under the 2005 employee incentive program even though
the Debtors failed to achieve the target for 2005. The Debtors made bonus payments at 66% of what would have been
payable had the Debtors achieved the 2005 target.
The Motion and the Hearing
The Debtors did not seek Court approval when the 2006 OCP was established in April 2006. In July 2006, during the trial on
approval of the MIP, the Debtors’ counsel represented to the Court that the Debtors would seek Court approval prior to
making any payments to employees under the 2006 OCP in the event the performance milestones under the 2006 OCP were
not met.
In March 2007, after negotiations with the UST, the Official Committee of Unsecured Creditors (the “Committee”), UBS
AG, Stamford Branch, the agent for the First Lien Lenders and the Second Lien Lenders (“UBS”), and the Informal
Committee of First Lien Lenders (the “Informal Committee”), the Debtors filed the motion. On April 23, 2007, the Court
conducted a hearing on the motion.
At the hearing, the Debtors’ Chief Executive Officer, Mr. Dias, testified in favor of the motion. In addition, the Debtors
offered the testimony of a compensation expert.12 The Debtors’ expert, Jeff Visithpanich, offered the following opinions 13 at
the hearing:
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48 Bankr.Ct.Dec. 96
i) it is common for companies comparable to the Debtors to have bonus programs similar to the 2006 OCP;
*796 ii) it is common for companies comparable to the Debtors to modify bonus programs in a manner similar to
the Debtors’ modification of the 2006 OCP;
iii) the 2006 OCP as modified is reasonable because the total compensation (including base salary and all bonuses)
to be paid to the Debtors’ Level I and II employees is within market norms for companies comparable to the
Debtors; and
iv) the payment of bonuses to the Level I, II and III employees under the 2006 OCP as modified is consistent with
the Debtors’ payment of bonuses in 2003, 2004 and 2005.
The UST opposed the motion, cross-examined each of the witnesses and submitted a number of exhibits into evidence in
opposition to the motion.
Counsel for the Committee stated at the hearing that, based upon the agreed reduction of the bonus payable to the Level I
employees and the clarification that no further payments were due to any employees under the MIP or the KERP, the
Committee did not object to the motion. In addition, counsel for UBS and the Informal Committee both expressed support for
the motion. Thus, the motion has the tacit or active support of the parties with an economic stake in the outcome of these
Chapter 11 cases.
Legal Analysis
The Debtors’ modification of the 2006 OCP is “in the ordinary course of business” under 363(c)(1) of the Bankruptcy
Code and the Debtors have satisfied the standard governing such transactions.
[1]
Under sections 1107(a) and 1108 of the Bankruptcy Code, the Debtors (as debtors in possession) are authorized to operate
their business. 11 U.S.C. §§ 1107(a) and 1108. Section 363(c)(1) of the Bankruptcy Code provides that, unless the Court
orders otherwise, a debtor in possession may enter into transactions, including the use, sale or lease of estate property in the
ordinary course of business, without notice and a hearing. 11 U.S.C. § 363(c)(1). In contrast, section 363(b)(1) of the
Bankruptcy Code provides that a debtor in possession, “after notice and a hearing, may use, sell, or lease, other than in the
ordinary course of business, property of the estate.” 11 U.S.C. § 363(b)(1) (emphasis added).14 Thus, whether notice and a
hearing are required depends on whether a transaction is “in the ordinary course of business.”
The distinction between transactions in the ordinary course of business and those outside the ordinary course of business,
however, goes beyond the procedural requirements of notice and a hearing. “The framework of section 363 is designed to
allow a trustee (or debtor in possession) the flexibility to engage in ordinary transactions without unnecessary creditor and
bankruptcy court oversight, while protecting creditors by giving them an opportunity to be heard when transactions are not
ordinary.” In re Roth American, Inc., 975 F.2d 949, 952 (3d Cir.1992).
Indeed, “the discretion [for a debtor in possession] to act with regard to ordinary business matters without prior court
approval has been said to be ‘at the heart’ of the powers of a ... debtor in possession, and courts have shown a reluctance to
interfere, in the making of routine, day-to-day business decisions.” 7 *797 COLLIER ON BANKRUPTCY ¶ 1108.07 (Alan
N. Resnick and Henry J. Sommer eds. 15th ed.2006) (emphasis in original). As such, if the Court determines that a
transaction is in the ordinary course of a debtor’s business, the Court will not entertain an objection to the transaction,
provided that the conduct involves a business judgment made in good faith upon a reasonable basis and within the scope of
authority under the Bankruptcy Code. In re Curlew Valley Associates, 14 B.R. 506, 513 (Bankr.D.Utah 1981). Put another
way, the Court will not disturb a transaction within the ordinary course of business if “the trustee can articulate reasons for
his conduct (as distinct from a decision made arbitrarily or capriciously)” Id. at 513 n. 11a.
[2] [3]
[4]
Although the determination of whether a transaction is in the ordinary course of business can have broad implications,
“[n]either the Bankruptcy Code nor its legislative history provides a framework for analyzing whether particular transactions
are in the ordinary course of a debtor’s business.” Roth American, 975 F.2d at 952. In order to determine whether or not a
7
48 Bankr.Ct.Dec. 96
transaction falls in the ordinary course of business most courts, including the Third Circuit, have adopted a two-step inquiry.
Id. This inquiry consists of looking at the transaction from horizontal and vertical dimensions. Id. The test for the horizontal
dimension “is whether, from an industry-wide perspective, the transaction is of the sort commonly undertaken by companies
in that industry.” Id. at 953.
The vertical dimension, which is also known as the creditor’s expectation test, “analyzes the transactions from the vantage
point of a hypothetical creditor and the inquiry is whether the transaction subjects a creditor to economic risk of a nature
different from those he accepted when he decided to extend credit.” Id. (quotations omitted). Under the vertical test, “the
touchstone of ordinariness is the interested parties’ reasonable expectations of what transactions the debtor in possession is
likely to enter in the course of business.” Id. Thus, a debtor’s pre-petition business practices and conduct is the primary focus
of the vertical analysis. Id. The Court must “also consider the changing circumstances inherent in the hypothetical creditor’s
expectations.” Id. (citations omitted.)
[5]
In this case, the Debtors’ modification of the 2006 OCP satisfies both the horizontal and vertical dimensions tests and,
thus, is within the ordinary course of the Debtors’ business. First, with regard to the horizontal dimension test, Mr.
Visithpanich’s testified that not only is it common for companies comparable to the Debtors to have bonus programs similar
to the 2006 OCP, it is also common for those comparable companies to modify bonus programs in a manner similar to the
Debtors’ modification of the 2006 OCP.
[6]
Specifically, Mr. Visithpanich identified 20 companies that he opined were comparable, based upon revenue, EBITDA and
products, to the Debtors. Mr. Visithpanich “then analyzed, based upon publicly available documents, what [the comparable
companies’] bonus plans look like and from analyzing those bonus plans, [determined] that the measures there are very
similar to what we have at [the Debtors].” H’rg Tr. 137. Mr. Visithpanich testified that 12 of the 20 comparable companies
have bonus programs containing measures very similar to those applicable to the Level I, II, and III employees as well as the
sale professionals.
Mr. Visithpanich further testified that 10 of those 20 companies had language in their bonus plans allowing for ex post
adjustments and 6 of those 20 companies actually made ex post adjustments to their *798 bonus plans similar to the
modification of the 2006 OCP by the Debtors. Moreover, Mr. Visithpanich testified that, because he relied upon publicly
available data, the frequency of ex post adjustments may be even higher than he observed in that many of those cases where
the comparable companies were not identified as having similar programs or making similar ex post adjustments there was
insufficient information available to determine whether the company’s bonus program was similar to the Debtors’ program.
Thus, Mr. Visithpanich’s testimony established that the horizontal dimension test is satisfied because “from an industry-wide
perspective, the transaction is of the sort commonly undertaken by companies in that industry.” Roth American, 975 F.2d at
953.
Second, with regard to the vertical dimension test, Mr. Dias testified that the Debtors’ modification of the 2006 OCP is
consistent with the Debtors’ pre-petition business practices. Specifically, Mr. Dias testified that the Debtors had previously
adopted employee incentive programs for 2003, 2004 and 2005 that were substantially similar to the 2006 OCP. Each of
those bonus programs established an EBITDA target, divided the employees into different categories, and established a bonus
as a percentage of base salary based upon achieving the EBITDA target. Moreover, in each of those years, the Debtors
awarded bonuses to some or all of the covered employees at reduced levels, notwithstanding that in each year the Debtors
failed to achieve the target for that year. Finally, Mr. Visithpanich opined that the payment of bonuses to the Level I, II and
III employees under the 2006 OCP as modified is consistent with the Debtors’ payment of bonuses in 2003, 2004 and 2005.
Thus, the testimony of Mr. Dias and Mr. Visithpanich established that the Debtors’ modification of the 2006 OCP was
consistent with the Debtors’ pre-petition business practices—at least for the somewhat limited period of 2003–2005. As a
result, the modification of the 2006 OCP is consistent with “the interested parties’ reasonable expectations of what
transactions the debtor in possession is likely to enter in the course of business” and, thus, the vertical dimension test is
satisfied. Id.
The finding that the Debtors’ modification of the 2006 OCP is in the ordinary course of the debtors’ business is consistent
with the holdings of two recent cases where bankruptcy courts have determined that an incentive plan established
post-petition by a debtor-in-possession for the benefit of senior management is in the ordinary course of the debtor’s
8
48 Bankr.Ct.Dec. 96
business. See In re Dana Corp., 358 B.R. 567 (Bankr.S.D.N.Y.2006); and In re Global Home Products, LLC, 369 B.R. 778,
2007 WL 689747 (Bankr.D.Del.2007).
In Dana Corp., the debtors sought court approval of an executive compensation package, including a long term incentive
plan, but took the position that Court approval was not necessary with respect to a separate, short-term annual bonus
program. Dana Corp., 358 B.R. at 579–80. The short-term program was a “refinement of the [pre-petition] short-term
incentive program, reflecting the current business conditions and a reduction in the number of participants, and [was] similar
to [the debtor’s] previous short-term incentive programs.” Id. at 579. Applying the horizontal and vertical tests, the court in
Dana Corp. found that the short-term incentive plan was within the ordinary course of the debtor’s business. Id. at 581. In so
ruling, the court specifically stated that a short-term incentive plan similar to that before the Dana Corp. court had “been a
common component of compensation plans at [the debtor] for the past fifty years and does not differ significantly from *799
[the debtor’s] pre-petition practice.” Id. Notwithstanding the ruling that the short-term incentive plan was within the ordinary
course of the debtor’s business, the court reviewed the short-term incentive plan “in the context of determining whether the
overall compensation proposal is a proper exercise of [the debtor’s] business judgment.” Id.
In other words, while the court did not rule on the merits of the short-term incentive plan, it considered the payments to be
made under the short-term plan as evidence in determining the reasonableness of the long-term incentive plan, the adoption
of which was not in the ordinary course of the debtor’s business. Indeed, in approving the long-term incentive plan, the Court
required the imposition of limits on the total compensation payable to the covered employees based, in part, on the payments
to be made under the short-term plan. Id. at 583–84. In considering whether to approve the long-term incentive plan, the
court, citing numerous cases, applied a number of factors generally used by courts to determine whether a compensation
program established outside the ordinary course of business meets the “sound business judgment” test. Id. at 576–77.
A similar result was reached in Global Home Products. Global Home Products, 369 B.R. 778, 2007 WL 689747. In Global
Home Products, the debtors sought approval of a “performance and incentive based bonus plan” for senior management and
an “incentive based sales bonus plan.” Id. at 779, 2007 WL 689747 *1. The focus of the court’s opinion in Global Home
Products is whether the proposed plans were retention or severance arrangements subject to review under section 503(c) of
the Bankruptcy Code. Id. at 779–82, 2007 WL 689747 *1–3. In addition, while not specifically applying the horizontal and
vertical dimension tests, the court found that the adoption of the incentive plans was “clearly in the ordinary course of the
[d]ebtors’ businesses.” Id. at 786, 2007 WL 689747 *8. The court then found that the adoption of the incentive plans was a
reasonable exercise of the debtors’ business judgment, applying the factors identified by the Dana Corp. court. Id.
The modification of the 2006 OCP before the Court is very similar to the short-term incentive plan that the court in Dana
Corp. found to be in the ordinary course of business. Because the entire incentive program before the Court in this case is
within the ordinary course of the Debtors’ business judgment, however, the criteria developed in Dana Corp. for analyzing
whether an incentive plan adopted outside the ordinary course of business is a reasonable exercise of a debtor’s business
judgment are not applicable here. To the extent that the court in Global Home Products held that the Dana Corp. factors are
applicable to an incentive program adopted in the ordinary course of a debtor’s business, this Court respectfully disagrees
with that holding.
Rather, since the modification of the 2006 OCP is within the ordinary course of the Debtors’ business, the Court will not
entertain an objection to the transaction, provided that the conduct involves a business judgment made in good faith upon a
reasonable basis and within the scope of authority under the Bankruptcy Code. See In re Curlew Valley Associates, 14 B.R. at
513. The evidence established that the Debtors’ modification of the 2006 OCP involves a business judgment made in good
faith upon a reasonable basis. Mr. Dias testified at length as to why the payment of bonuses under the modified 2006 OCP
“made good business sense,” notwithstanding the failure to achieve the lowest *800 threshold for payment of bonuses under
the original plan.
[7]
In addition, Mr. Visithpanich testified that the 2006 OCP as modified is reasonable because the total compensation (including
base salary and all bonuses) to be paid to the Debtors’ Level I and II employees is within market norms for companies
comparable to the Debtors. Mr. Visithpanich’s testimony on this point, however, is of limited utility because Mr.
Visithpanich’s analysis did not consider financial performance. For example, Mr. Visithpanich did not analyze whether the
compensation to be paid to the Level I and II employees was within market norms for companies with poor financial
performance.
9
48 Bankr.Ct.Dec. 96
Nonetheless, the evidence presented by the Debtors was more than sufficient to satisfy the relatively light evidentiary burden
of establishing that the Debtors made a business judgment in good faith upon a reasonable basis. Id. Whether that business
judgment is “within the scope of authority under the Bankruptcy Code” is discussed below.
Section 503(c)(1) of the Bankruptcy Code, which limits retention payments to insiders, is applicable to the Debtors’
modification of the 2006 OCP.
Section 503(c) of the Bankruptcy Code is the result of an amendment to the Bankruptcy Abuse Prevention and Consumer
Protection Act of 2005, Pub.L. No. 109–8, § 331, 119 Stat. 23, 102–03 (2005), that was proposed by Senator Edward
Kennedy during the Judiciary Committee’s mark-up of the bill. See Dana Corp., 358 B.R. at 575 (discussing the origins of
Section 503(c) of the Bankruptcy Code). Although there is little in the way of legislative history, it is widely acknowledged
that the amendment was a response to perceived abuses of the bankruptcy system by “the executives of giant companies ...
who lined their own pockets, but left thousands of employees and retirees out in the cold.” Id. (quoting Statement of Senator
Edward Kennedy (March 1, 2005)). In this vein, Section 503(c) imposes a variety of restrictions on the compensation that can
be paid both to executives and other employees of companies that are in bankruptcy.
Section 503(c)(1) of the Bankruptcy Code limits retention payments that can be made to insiders of the debtor. Specifically,
Section 503(c)(1) provides, subject to certain exceptions not applicable in this case, that “[t]here shall neither be allowed, nor
paid ... a transfer made to, or an obligation incurred for the benefit of, an insider of the debtor for the purpose of inducing
such person to remain with the debtor’s business.” 11 U.S.C. § 503(c)(1).
Relying on Dana Corp., the Debtors argue that section 503(c)(1) is not applicable to the modification of the 2006 OCP
because the modification was adopted in the ordinary course of the Debtors’ business. Dana Corp., 358 B.R. at 575 (“Section
503(c) ... restricts transfers or payments by debtors to the extent that such payments are outside the ordinary course.”). The
Debtors argue that the holding in Dana Corp. is that section 503(c) only restricts payments made outside the ordinary course
of business. As the word “only” does not appear in the sentence, the Court disagrees with the Debtors’ interpretation.
Nonetheless, to the extent that the court in Dana Corp. so held, this Court respectfully disagrees.
[8] [9]
Nothing in section 503(c)(1) of the Bankruptcy Code limits its applicability to transactions or payments made outside
the ordinary course of business. The only limitation in section 503(c)(1) is that the transfer be “for the benefit of, an insider of
the debtor for the purpose of inducing such person to remain with the *801 debtor’s business.” 11 U.S.C. § 503(c)(1). Under
well-established canons of statutory construction, the Court need go no further than the plain meaning of the statute to
determine its meaning. Perrin v. United States, 444 U.S. 37, 42, 100 S.Ct. 311, 62 L.Ed.2d 199 (1979) (The plain meaning
rule stands for the fact that “unless otherwise defined, words will be interpreted as taking their ordinary, contemporary,
common meaning.”).
[10]
This reading of the plain meaning of the statute is reinforced by the language of section 503(c)(3), which is part of the
same amendment proposed by Senator Kennedy. Section 503(c)(3) provides that it is applicable to “transfers or obligations
that are outside the ordinary course of business.” 11 U.S.C. § 503(c)(3) (emphasis added). Under the principle of noscitur a
sociis, the meaning of an unclear word or phrase should be determined by the words immediately surrounding it. James v.
United States, 550U.S. 192, ––––, 127 S.Ct. 1586, 1605, 167 L.Ed.2d 532 (2007) (Scalia, J., dissenting). “Of course noscitur
a sociis is just an erudite (or some would say antiquated) way of saying what common sense tells us to be true: ‘[A] word is
known by the company it keeps,’—that is to say, which of various possible meanings a word should be given must be
determined in a manner that makes it ‘fit’ with the words with which it is closely associated.” Id. (citing Jarecki v. G.D.
Searle & Co., 367 U.S. 303, 307, 81 S.Ct. 1579, 6 L.Ed.2d 859 (1961)). The inclusion of the limiting language “outside the
ordinary course of business” in section 503(c)(3) counsels against reading such a limitation into section 503(c)(1).
[11]
Thus, under the established canons of statutory construction, section 503(c)(1) of the Bankruptcy Code is applicable to the
Debtors’ modification of the 2006 OCP, provided that the payments under the bonus program are to “an insider of the debtor
for the purpose of inducing such person to remain with the debtor’s business.”
10
48 Bankr.Ct.Dec. 96
Modification of the 2006 OCP is not a transfer to “an insider of the debtor for the purpose of inducing such person to
remain with the debtor’s business.”
Having held that section 503(c)(1) is applicable, the Court must determine whether the modification of the 2006 OCP is, in
fact, a transfer to an insider of the debtor for the purpose of inducing such person to remain with the debtor’s business.
As a preliminary matter, section 503(c)(1) only applies to transfers to “insiders,” which includes the directors and officers of
the Debtors. 11 U.S.C. § 101(31). Only the Level I employees under the 2006 OCP are “insiders” as defined in the
Bankruptcy Code. Thus, section 503(c)(1) does not preclude or restrict any payments under the 2006 OCP to the Level II or
Level III employees.15
[12]
The more difficult question is whether the bonus payments to the Level I employees under the modified 2006 OCP are
“for the purpose of inducing such person to remain with the debtor’s business.” “It is well established that ‘when the statute’s
language is plain, the sole function of the courts—at least where the disposition required by the text is not absurd—is to
enforce it according to its terms.’ ” Lamie v. United States Tr., 540 U.S. 526, 534, 124 S.Ct. 1023, 157 L.Ed.2d 1024
(U.S.2004) *802 (quoting Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1, 6, 120 S.Ct. 1942, 147
L.Ed.2d 1 (2000) (in turn quoting United States v. Ron Pair Enterprises, Inc., 489 U.S. 235, 241, 109 S.Ct. 1026, 103
L.Ed.2d 290 (1989) (in turn quoting Caminetti v. United States, 242 U.S. 470, 485, 37 S.Ct. 192, 61 L.Ed. 442 (1917)))).
[13]
Any payment to an employee, including regular wages, has at least a partial purpose of retaining the employee. Therefore
if the Court did not apply a materiality standard, all payments to insiders would be subject to 503(c)(1), which would be an
absurd result. At the same time, applying a “sole purpose” standard goes too far. Thus, the Court reads section 503(c)(1) to
mean “a transfer made to ... an insider of the debtor for the [primary] purpose of inducing such person to remain with the
debtor’s business.” 11 U.S.C § 503(c)(1) (emphasis added).
This reading of section 503(c)(1) is consistent with the holdings in Dana Corp. and Global Home Products. The court in
Dana Corp. held that “merely because a plan has some retentive effect does not mean that the plan, overall, is retentive rather
than incentivizing in nature.” Dana Corp., 358 B.R. at 571. The court then held that “[b]y presenting an executive
compensation package that properly [motivates senior management] to produce and increase the value of the estate, the
[debtor has] established that section 503(c)(1) does not apply to [the debtor’s motion].” Id. at 584.
Similarly, in discussing whether a bonus plan satisfies the criteria of section 503(c), the court in Global Home Products noted
that “[t]he entire analysis changes if a bonus plan is not primarily motivated to retain personnel.” Global Home Products, 369
B.R. at 785, 2007 WL 689747 at *6 (emphasis added). The court went on to find that:
[the bonus plans] are primarily incentivizing and only coincidently retentive because [the debtors]
employed virtually identical plans prepetition when retention was not the motive. The fact, as [the
debtors] pointed out, that all compensation has a retention element does not reduce the Court’s
conviction that [the debtor’s] primary goal [is] to create value by motivating performance. All
companies seek to retain employees by fairly compensating them.
Id. at 786, 2007 WL 689747 *8.
Under the facts of this case, although the modification of the 2006 bonus program has some retentive effect, it is for the
primary purpose of motivating employees and, thus, the limitations of section 503(c)(1) are not applicable. Mr. Dias testified
that the 2006 OCP was designed to motivate employees to “keep[ ] momentum going forward ... in both sales and EBITDA.”
He further testified that the target EBITDA of $43.2 million established in March 2006 was a “stretch” and did not take into
account the possible negative effects to the Debtors’ business that might result from the Debtors’ bankruptcy. 16
Mr. Dias also testified that the payment of bonuses under the modified 2006 OCP is justified, notwithstanding the failure to
*803 achieve the lowest threshold for payment of bonuses under the original plan, because the Debtors’ failure to achieve
those targets was not a result of any failure by the employees, who, in fact, had done a “great job.” Thus, Mr. Dias testified
that it made “good business sense” to modify the 2006 OCP to allow for payment of bonuses even though the Debtors missed
their EBITDA target.
11
48 Bankr.Ct.Dec. 96
Finally, both Mr. Dias and Mr. Visithpanich testified that the payment of bonuses under the modified 2006 OCP was
consistent with the Debtors’ pre-petition practices. Mr. Dias went on to testify that departing from the pre-petition practice
would have an adverse affect on employee morale.
The UST argues with some force that if an incentive plan is based on achievement of EBITDA targets and those targets are
not achieved, yet the bonus is still received, that the plan cannot be an incentive plan but must, in fact, be solely a retention
plan.
[I]f you have an incentive plan that’s analyzed after the fact and the incentive plan is based on
achievement of EBITDA targets and you don’t achieve those EBITDA targets but yet you still get a
bonus ... I don’t understand what other purpose it could serve other than to be a retention plan when the
threat is that it will cause destruction, and these people will leave.
Hr’g Tr. 196.
While the Court agrees that the payment of bonuses under the modified 2006 OCP has some retentive effect, the Court
disagrees with the UST’s argument that its sole or primary purpose is retention. Consistent with the Debtors’ pre-petition
practice, the 2006 OCP must be considered as a whole. It consists of two parts: the establishment of “aspirational goals” in
the early part of the year; and a review at the end of the year to consider whether those goals have been met and, if not, why.
In this case, the Debtors’ did just that and determined that the 2006 OCP served its purpose by motivating the employees to
do a “great job” in connection with the matters that those employees could reasonably be expected to influence. As such, the
Debtors seek to award bonuses at a reduced level to compensate the employees for their success (albeit somewhat limited) in
2006 and to motivate the employees in 2007.
Thus, the Court finds that the bonus payments to the Level I employees under the modified 2006 OCP are not for the primary
purpose of inducing the Level I employees to remain with the Debtors’ business and, thus, they are not precluded or restricted
by section 503(c)(1) of the Bankruptcy Code.
Section 503(c)(3) of the Bankruptcy Code, which limits payments to officers, managers or consultants, is not
applicable to the Debtors’ modification of the 2006 OCP.
[14]
Section 503(c)(3) of the Bankruptcy Code limits payment of obligations outside of the ordinary course of business that are
not covered by subsection (1) or (2), providing:
[there shall neither be allowed, nor paid-] (3) other transfers or obligations that are outside the ordinary
course of business and not justified by the facts and circumstances of the case, including transfers
made to, or obligations incurred for the benefit of, officers, managers, or consultants hired after the
date of the filing of the petition.
11 U.S.C. § 503(c)(3).
Section 503(c)(3) applies to “officers, managers, or consultants”—a broad category of employees that includes all Level I, II
and III employees under the 2006 *804 OCP.17 Nonetheless, section 503(c)(3) only limits “transfers or obligations that are
outside the ordinary course of business.” 11 U.S.C. § 503(c)(3) (emphasis added). As discussed at length above, the Court
finds that the Debtors’ modification of the 2006 OCP was in the ordinary course of the Debtors’ business. Thus, under the
plain meaning of the statute, section 503(c)(3) is simply inapplicable here. Perrin, 444 U.S. at 42, 100 S.Ct. 311.
The UST argues that section 503(c)(3) should not be read so restrictively. Rather, the UST argues that section 503(c)(3)
requires that all transfers to officers, managers, or consultants, including transfers outside the ordinary course of business,
must be justified by the facts and circumstances of the case. The Court disagrees with the UST’s reading of the statute.
In effect, the UST wants to rewrite section 503(c)(3) to read as follows:
12
48 Bankr.Ct.Dec. 96
[there shall neither be allowed, nor paid-] (3) other transfers or obligations that are outside the ordinary
course of business and not justified by the facts and circumstances of the case, including transfers
outside the ordinary course of business and made to, or obligations incurred for the benefit of,
officers, managers, or consultants hired after the date of the filing of the petition.
In other words, the UST wants to read the phrase “outside the ordinary course of business” as illustrative as opposed to
exclusive. While Senator Kennedy could certainly have written his amendment that way, he did not. Moreover, reading the
statute as written does not lead to an absurd result. See Lamie, 540 U.S. at 534, 124 S.Ct. 1023 (Where the disposition
required by the text is not absurd the function of the Court is to apply the text as written). Indeed, such a reading is wholly
consistent with section 363 of the Bankruptcy Code, which is the source of the distinction between transfers within and
outside the ordinary course of business and is “designed to allow a trustee (or debtor in possession) the flexibility to engage
in ordinary transactions without unnecessary creditor and bankruptcy court oversight, while protecting creditors by giving
them an opportunity to be heard when transactions are not ordinary.” Roth American, 975 F.2d at 952.
Thus, under the plain meaning of section 503(c)(1) of the Bankruptcy Code, the statute is inapplicable to the Debtors’
modification of the 2006 OCP.18
Conclusion
In this case and under the facts established at the hearing, the Court finds that the Debtors’ modification of the 2006 OCP was
within the ordinary course of the Debtors’ business. The Court further finds that section 503(c)(1) of the Bankruptcy Code is
not applicable because the Debtors’ modification of the 2006 OCP was not for the primary purpose of inducing employees to
remain with the Debtors’ business. Because section 503(c)(3) is also not applicable, the Court’s inquiry is limited to the
standard under section 363(c)(1), i.e., whether the Debtors’ modification of the 2006 OCP was a business judgment made in
good faith upon a reasonable basis and within the scope of authority under *805 the Bankruptcy Code, which the Court finds
satisfied.
Debtors’ counsel is instructed to submit a proposed order consistent with this opinion under certification of counsel.
All Citations
369 B.R. 787, 48 Bankr.Ct.Dec. 96
Footnotes
1
This Opinion constitutes the findings of fact and conclusions of law of the court pursuant to Federal Rule of Bankruptcy Procedure
7052, which is made applicable to contested matters by Federal Rule of Bankruptcy Procedure 9014.
2
The Debtors did not seek Court approval when they established the 2006 OCP in April, 2006.
3
“EBITDA” means earnings before interest, taxes, depreciation and amortization.
4
The Debtors’ use of “director” in describing certain of its employees does not mean that these employees are members of the board
of directors. In fact, the only employee that is also a member of the board of directors is the Debtors’ Chief Executive Officer, Mr.
Dias. Hr’g Tr. 45–50.
5
At the conclusion of the hearing on the motion, the UST withdrew her objection to the 2006 OCP as it pertains to Sales Directors,
Sales Managers and Line Managers/Office Staff and the Court entered an order approving bonuses for those employees. Thus, the
Court will focus its recitation of the facts to those applicable to the Level I, II and III employees.
6
The “target bonus” for the Debtors’ Chief Executive Officer was 60% of base salary.
13
48 Bankr.Ct.Dec. 96
7
30% for the Debtors’ Chief Executive Officer.
8
The Debtors’ Chief Executive Officer testified that he was authorized to pay bonuses under the 2006 OCP if the Debtors achieved
90% of target EBITDA. Nonetheless, the documentation implementing the 2006 OCP established 93% of target EBITDA as the
minimum threshold for payment of bonuses.
9
In addition, under the terms of the 2006 OCP as implemented in April, 2006, no bonuses are due to the Sales Directors, Sales
Managers or Office Staff. It is unclear from the record whether any bonuses are due to the Line Managers.
10
11
12
The Debtors also submitted numerous exhibits into evidence in support of the motion.
13
Mr. Visithpanich was qualified under Rule 702 of the Federal Rules of Evidence (without objection) as an expert in compensation.
14
Absent notice and a hearing, a transaction outside the ordinary course of business is avoidable. 11 U.S.C. § 549(a)(2)(B).
15
Neither does section 503(c)(1) restrict any payments to the Sales Directors, Sales Managers, Office Staff or Line Managers.
16
The testimony that the target EBITDA of $43.2 million established in March 2006 was a “stretch” is consistent with previous
evidence before this Court in connection with a different matter. See In re Nellson Nutraceutical, Inc., No. 06–10072(CSS), 2007
WL 201134 at *13–14, 2007 Bankr.LEXIS 99 at *38–9 (Bankr.D.Del. Jan. 18, 2007) (In April, 2006, “Mr. Dias proposed a base
revenue goal of $305 million and EBITDA of $41.05, with the previous goals suggested at the March 16 Board Meeting of
revenue $314 and EBITDA $43.02 being relegated to ‘stretch’ goals.”) (emphasis added).
17
In addition, it would appear that the employees in the Sales Directors, Sales Managers and Line Managers categories under the
2006 OCP are covered by this section. It is unclear whether any employees in the Office Staff category are covered.
18
Having determined that section 503(c)(3) is inapplicable, the Court need not determine whether the modification of the 2006 OCP
is “justified by the facts and circumstances of the case.”
End of Document
14
In re Foothills Texas, Inc., 408 B.R. 573 (2009)
62 Collier Bankr.Cas.2d 212, Bankr. L. Rep. P 81,589
Distinguished by Aleynikov v. Goldman Sachs Group, Inc., D.N.J., October 22, 2013
408 B.R. 573
D. Delaware.
In re FOOTHILLS TEXAS, INC., et al., Debtors.
No. 09–10452. | July 28, 2009.
Synopsis
Background: Motion was filed for leave to pay retention bonuses to employees who, while holding title of “vice president,”
were allegedly not “officers” of debtor and thus not insiders.
Holdings: The Bankruptcy Court, Christopher S. Sontchi, J., held that:
mere fact that employees to whom Chapter 11 debtor sought to make retention payments both held title of “vice president”
was not determinative of whether they were, in fact, “officers” of debtor, and thus “insiders,” for purpose of bankruptcy
statute limiting debtor’s ability to make retention payments to insiders;
[1]
in order to rebut presumption that employees were “officers,” debtor had to submit evidence sufficient that they did not
actually participate in management of debtor; and
[2]
employees were “officers” of debtor in fact as well as in name and qualified as statutory “insiders,” to whom debtor’s
ability to pay retention bonuses was limited by statute.
[3]
Motion denied.
*574 Norman L. Pernick, Patrick J. Reilley, Cole, Schotz, Meisel, Forman & Leonard, P.A., Wilmington, DE, Charles R.
Gibbs (Argued), David F. Staber, Sarah Link Schultz, Akin Gump Strauss Hauer & Feld, LLP, Dallas, TX, for Debtors and
Debtors in Possession.
Joseph J. McMahon, Jr. (Argued), Trial Attorney, United States Department of Justice, Office of the United States Trustee,
Wilmington, DE, for Roberta A. DeAngelis, Acting United States Trustee.
OPINION 1
CHRISTOPHER S. SONTCHI, Bankruptcy Judge.
INTRODUCTION
Before the Court is the Debtors’ motion seeking authorization to pay retention bonuses to two persons who are vice
1
presidents of the Debtors. Section 503(c)(1) of the Bankruptcy Code governs payments for the purpose of inducing an insider
to remain with the debtor’s business. In order for a debtor to make such payments the criteria of section 503(c)(1) must be
satisfied.
The issue in this case is whether the recipients are insiders? If not, section 503(c)(1) is inapplicable and the payments can, in
all likelihood, be made. “Insider” is defined under the Bankruptcy Code by providing a non-exclusive list of persons, which
includes an “officer of the debtor.” The employees in this case are “vice presidents.” Under the plain meaning of the words, a
vice president is an officer.
A person holding an officer’s title is presumptively an officer and, thus, an insider. A party seeking to rebut that presumption
must present evidence sufficient to establish that the person holds the title *575 of an officer in name only and, in fact, does
not meet the substantive definition of the same, i.e., he or she is not taking part in the management of the debtor.
In this case, the two persons at issue are presumptively officers and insiders by virtue of their job titles. Moreover, based
upon the evidence submitted at the hearing, both participate in the management of the Debtors and are, in fact, officers and
insiders. The Debtors did not submit any evidence that would support a finding that the criteria of section 503(c)(1) are
satisfied. Thus, the motion seeking authorization to pay the retention bonuses will be denied.
JURISDICTION
This Court has jurisdiction over this matter pursuant to 28 U.S.C. § 1334. Venue is proper in this district pursuant to 28
U.S.C. §§ 1408 and 1409. This is a core proceeding pursuant to 28 U.S.C. §§ 157(b)(2)(B), (M), and (O).
STATEMENT OF FACTS 2
The facts of this case are straight forward. Foothills Resources, Inc. (“Foothills”) and its subsidiaries (collectively, the
“Debtors”) filed Chapter 11 in February, 2009. The Debtors are independent energy companies engaged in the acquisition,
exploration, exploitation and development of oil and natural gas properties. The Debtors have 10 employees.
I. The Employment Agreements
In 2006, Foothills hired James H. Drennan as its Vice President, Land and Legal and the parties entered into an employment
agreement. In October, 2008, Foothills and Mr. Drennan entered into a modification of his employment agreement, which
provides, among other things, that if Mr. Drennan is employed on June 30, 2009 he is entitled to a one-time payment of 75%
of his annual salary, i.e., $112,500.3 Mr. Drennan remained employed by Foothills through June 30, 2009, and, if the
modified employment agreement is assumed he will be entitled to receive a retention payment of $112,500.
In 2006, Foothills also hired Michael Moustakis as its Vice President, Engineering and the parties entered into an
employment agreement. As with Mr. Drennan, in October, 2008, Foothills and Mr. Moustakis entered into a modification of
his employment agreement, which provides, among other things, that if Mr. Moustakis is employed on June 30, 2009, he is
entitled to a one-time payment of 75% of his annual salary, i.e., $135,000. 4 Mr. Moustakis remained employed by Foothills
through June 30, 2009, and, if the modified employment agreement is assumed he will be entitled to receive a retention
payment of $135,000.5
*576 II. Debtors’ Organizational Structure
The Debtors’ Chief Financial Officer was the sole witness at the hearing in this matter. He stated that the Debtors’ senior
management team consists of the Chief Executive Officer, the President and himself. These persons supervise the day to day
management of the Debtors as a whole.
2
Mr. Drennan is the Vice President, Land and Legal. His responsibilities include overseeing the Debtors’ oil and gas leases
and communicating with landlords regarding those leases. In addition, Mr. Drennan is responsible for ensuring the Debtors
are in compliance with state and federal laws and regulations and communicating with governmental authorities regarding the
same. Finally, Mr. Drennan provides “land and legal support” to the Debtors and their lenders.
Mr. Drennan reports to the President and is not a member of senior management. He does not play any role in making
operational, tactical or strategic decisions for the Debtors. He is the sole employee in the Land and Legal Division and he
does not supervise any employees. The Debtors’ CFO testified that, as a result of the Debtors’ small size and their inability to
pay competitive compensation, their sole motivation in offering Mr. Drennan a title was to assist in enticing him to work for
the Debtors. He further testified that Mr. Drennan’s job is the “functional ... equivalent of a manager” and that he would have
been denominated as such if he had not been offered the title of vice president in an attempt to entice him to work for the
Debtors.
Mr. Moustakis is the Vice President, Engineering. His responsibilities include overseeing the Debtors’ oil and gas production,
evaluation of reserves, technical reporting and development of capital spending projects. In addition, Mr. Moustakis provides
“engineering and reserve support” for the Debtors’ and their lenders.
Mr. Moustakis reports to the President and is not a member of senior management. He does not play any role in making
operational, tactical or strategic decisions for the Debtors. Mr. Moustakis supervises four employees who work in the
Debtors’ Texas oil fields. As with Mr. Drennan, the Debtors’ sole motivation in offering Mr. Moustakis a title was to assist in
enticing him to work for the Debtors; and Mr. Moustakis’s job is the functional equivalent of a manager.
III. The Retention Agreements
At the time the Debtors entered into the retention agreements, the Debtors were undergoing significant financial difficulties.
More specifically, in October, 2008, the Debtors were in default under their pre-petition credit agreement and had engaged
Parkman Whaling LLC to assist the Debtors in evaluating strategic alternatives, including a possible sale of the company.
The Debtors entered into the retention agreements in an attempt to ensure that certain key employees of the Debtors’
remained with the Debtors despite the uncertainty.6 These employees were critical to maintaining the Debtors’ business and
assisting Parkman Whaling in its efforts. The employment agreements of the senior management were substantially different
*577 from the terms of the employment agreements of Messrs. Drennan and Moustakis and were not modified in October
2008 to provide for a retention bonus.7
LEGAL DISCUSSION
I. Who Is An Officer Under Section 101(31) Of The Bankruptcy Code?
Section 503(c) of the Bankruptcy Code, which was adopted in 2005, imposes a variety of restrictions on the compensation
that can be paid both to executives and other employees of company that is in bankruptcy. These payments are not prohibited.
Rather, section 503(c) states that there shall not be any claim allowed or paid unless it meets the applicable standard.
Section 503(c)(1) governs payments for the purpose of inducing an insider to remain with the debtor’s business. The
requirement in section 503(c)(1)(A) that payments may only be made to insiders that have “a bona fide job offer from another
business at the same or greater rate of compensation,” has proven virtually impossible for debtors to meet. 8 In addition,
section 503(c)(1)(C), which limits the amount of compensation for retention payable to insiders, has made such programs
unattractive and unpersuasive to management-even if section 503(c)(1)(A) can be satisfied.9
*578 Debtors have responded to the difficulties in satisfying section 503(c)(1) by arguing that the post-petition payments to
insiders for which they are seeking authorization do not fall under the auspices of section 503(c)(1) because they are: (i) in
the form of “incentive” payments rather than retention payments;10 and/or (ii) not for the benefit of an insider. In this case, the
Debtors argue that Messrs. Drennan and Moustakis are not officers of Foothills and, thus, not insiders. If so, section 503(c)(1)
3
would be inapplicable.11
“Insider” is a defined term under section 101(31) of the Bankruptcy Code. The relevant provision states that:
(31) The term “insider” includes—
***
(B) if the debtor is a corporation—
(i) director of the debtor;
(ii) officer of the debtor;
(iii) person in control of the debtor;
(iv) partnership in which the debtor is a general partner;
(v) general partner of the debtor; or
(vi) relative of a general partner, director, officer, or person in control of the debtor;
11 U.S.C. § 101(31)(B) (emphasis added).
In Winstar Communications, Inc., the Third Circuit recently addressed the meaning of the term insider under the Bankruptcy
Code.12 The issue in Winstar Communications was whether the defendant in a preference action was a “non-statutory
insider.” Noting that Congress uses the word “includes” in section 101(31), the Third Circuit held that there is “a category of
creditors, sometimes called ‘non-statutory insiders,’ who fall within the definition but outside of any of the enumerated
categories.”13 The Court rejected the argument that only a “person in control” could be an insider.14 Rather, the *579 Court
held that “the question ‘is whether there is a close relationship [between debtor and creditor] and ... anything other than
closeness to suggest that any transactions were not conducted at arm’s length.’ ”15 The Third Circuit’s focus of inquiry is in
accord with the plain meaning of insider—“a person who is within some society, organization, etc.; a person who is a party to
a secret, esp. so as to gain an unfair advantage.”16
Included in the enumerated categories of insiders of a corporation are its officers. 17 “Officer” is not defined under the
Bankruptcy Code. It goes without saying (or at least citation) that in considering a statute the Court starts with its plain
meaning. An officer is a “person holding office and taking part in the management or direction of a society or institution, esp.
one holding the office of president, treasurer or secretary.”18 “Management,” in this context, is defined as “the administration
of (a group within) an organization or commercial enterprise.”19
The “officers” at issue in this case are vice presidents. A vice president is “[a] person representing or deputizing for a
president; an official who ranks immediately below a president.”20 An official is obviously an officer.21 Thus, under the plain
meaning of the words, a vice president is presumptively an officer, who, in turn, is an insider. Nonetheless, the mere title of a
person does not end the inquiry.22
[1]
[2] [3] [4]
Just as there may be non-statutory insiders that fall within the definition of an insider but are outside of the
enumerated categories,23 there may be persons that fall within the enumerated categories but do not meet the definition of the
category. Under the plain meaning of the words, the question is whether a person is taking part in the management of the
debtor.24 In order to overcome the presumption that a person holding an officer’s title is not what he or she appears to be
requires submission of evidence sufficient to establish that the officer is, in fact, not participating in the management of the
debtor.25
*580 The Debtors cite to a number of cases that stand for a different proposition, i.e., an officer is a person who is in control
4
of a debtor.26 That standard necessarily limits officers to the very highest level of senior management. The Court will address
these cases in chronological order.
The opinion in NMI Systems is the seminal case defining officer under section 101(31). NMI Systems involved a preference
action brought against a vice president of the debtor. The bankruptcy court declined to consider the defendant as an officer
based solely on his title.
Pillard’s title of vice president and mid-management responsibilities of running the company’s
consulting division ought not suffice to make him an officer if he did not enjoy the elements of being
an officer that would per se put him in a position of advantage as against other creditors. The difficult
task is to articulate what, as a matter of law, suffices to make one a corporate officer as that term is
used in the Bankruptcy Code’s definition of insider.27
The NMI Systems court determined that an officer under the Bankruptcy Code “obviously includes anyone holding a position
in which that person controls the decision whether to pay an antecedent claim.”28 But the court went on to hold that the
category is broader than “control” and includes “those in the collective group exercising overall authority regarding the
debtor’s corporate decisions who, as members of that insider group, are in a position to exert undue influence over corporate
decisions regarding payment of their claims in tight financial times including those who are privy to critical information
regarding the debtor’s financial stability and able to act to their advantage on the basis of such information.”29
In so ruling, the bankruptcy court was heavily influenced by the fact that the case before the court was a preference action.
That is reflected in the court’s emphasis in the quotations above on the payment of claims. Indeed, the court specifically
states that the test of whether one is an officer “ought to be one that takes account of the bankruptcy policies behind the use of
the term ‘insider’ in the preference statute and that is best designed to further those policies.”30
The NMI Systems court was mistaken in focusing so heavily on the preference *581 statute in determining the appropriate
definition of officer. The term “insider” appears several times in the Bankruptcy Code, including sections 303 (involuntary
petitions), 1129(b) (confirmation of a plan), and, since 2005, section 503(c) (payments to insiders). The definition of officer
and, thus, insider, should not be tailored to fit just one section of the Bankruptcy Code. Rather, the definition should be based
upon the plain meaning of the word officer. The effect of the holding in NMI Systems is to add an adjective such as “senior”
or “controlling” to the term “officer of the debtor” in section 101(31)(B)(ii). Congress has already made a similar limitation.
Managers are not insiders. Rather, managers that are sufficiently senior to hold the title of an officer are insiders. There is no
rational basis under the plain meaning of the relevant words to further limit the definition of officers to those “in the
collective group exercising overall authority regarding the debtor’s corporate decisions.”31
The issue in DeLuca was whether the votes of a creditor that was exercising financial control over certain aspects of the
debtor’s business should be included in determining whether an impaired class had accepted a proposed plan of
reorganization (excluding the vote of insiders) so that the debtor could cram down the plan on its creditors under section
1129(b).32 Importantly, there was no allegation that the creditor was an officer. Indeed, as the debtor in DeLuca was a
partnership, officers are not even included in the relevant definition of insider. 33 Rather, the analysis was whether the creditor
was a person in control. While an officer may be a person in control, the words are not interchangeable. 34 Thus, the DeLuca
case is entirely inapplicable to the issue before the Court.
Public Access Technology.com was an appeal of the entry of summary judgment in a preference action. 35 The issue was
whether the defendant, an executive vice president of the debtor, was an officer. The bankruptcy court below held that
because the defendant held the title of executive vice president he was, per se, an officer and, thus, an insider.36 On appeal,
the district court disagreed, holding that the defendant’s stipulation that he was an executive vice president, without more,
was insufficient to establish that he was an officer of the debtor under section 101(31). The district court did not articulate
what evidence was required to prove that the defendant was an officer, noting only that there was no evidence whatsoever in
the record on the issue.37 Moreover the court went on to state in a footnote that “[t]he Bankruptcy Code itself does not define
the term ‘officer.’ As such, this court finds no basis for proclaiming a rigid rule to determine who qualifies as a corporate
officer— *582 beyond observing that proof of officer status requires more than just a title, and less than actual control of the
corporate debtor, this court does not seek to constrain whatever inquiry the practical experience of the bankruptcy court may
lead it to conduct.”38 Thus, the district court reversed the entry of summary judgment and remanded to the bankruptcy court.
5
While the district court did not state in Public Access Technology.com that a person with the title of an officer is
presumptively the same, its opinion is otherwise consistent with the Court’s holding in this case. In dicta, the court noted that
title alone is insufficient to establish that a person is an officer. In addition, the court implicitly rejected the NMI Systems
holding that control of the debtor is the relevant inquiry. But, as the decision does not specifically state the standard for
determining whether a person is an officer other than to set broad parameters and it does not state what evidence is required
to make that determination, it has limited applicability to the issue before the Court. 39
Finally, in an unpublished “interim” opinion, the bankruptcy court in CEP Holdings addressed the question of whether
certain of the debtor’s vice presidents as well as its chief financial officer were officers for purposes of applying section
503(c)(3) of the Bankruptcy Code.40 Section 503(c)(3) provides that transfers or obligations not addressed by sections
503(c)(1) and (2) that are outside the ordinary course of business for the benefit of, among others, officers must be “justified
by the facts and circumstances of the case.”41
The bankruptcy court adopted the NMI Systems standard for determining whether a person is an officer. 42 Interestingly,
however, the court stated in a footnote that “the record in this case [does not] suggest ... that the Potential Plan Participants
possess characteristics that should render them insiders even if the Court finds that they are not ‘in control’ of the Debtor.”43
In any event, the court went on to hold that what constitutes “control” and, presumably whether a person is an officer will
“vary according to context.”44 In the context of section 503(c)(3), the court adopted the following standard:
insider status under the ‘control’ provision of Section 101(31)(B)(iii) should be determined, at least in part, by reference to
the payment recipient’s control of the specific transaction under consideration and the impact of that transaction upon the
debtor’s creditors. Phrased in terms of Section 503(c)(3), the proposed payment recipient’s control over the specific
transaction and its impact upon other creditors constitute ‘facts and circumstances’ that must be considered before
determining that the transaction is justified. With respect to payment programs such as the Plan, the Court believes it is
important to know whether the potential plan recipient had significant input into the negotiation of *583 the plan
(including the amount of additional compensation that the employee would receive under the plan). There are other factors
relevant to the determination, namely the base salary compensation of the employee and the additional responsibilities that
the employee is required to undertake in order to receive the additional compensation. 45
This Court disagrees that the meaning of “officer” should vary according to the context in which the word is used. That
would be inconsistent with the Third Circuit’s statement in Winstar Communications that the relevant inquiry includes
whether there is “anything other than closeness to suggest that any transactions were not conducted at arm’s length.”46 To
adopt the holding in CEP Holdings would also ignore the plain meaning of the word officer and, instead, alter its meaning
depending upon its application and effect. This is exactly the type of analysis that the plain meaning doctrine is designed to
thwart.
[5]
A more appropriate holding in CEP Holdings would have been that the type of evidence that might support finding a
person to be an officer may vary from case to case based on the facts and circumstances surrounding the debtor’s business.
This Court agrees with the suggestion in Public Access Technology.com that a flexible approach should be taken in
considering what evidence might rebut the presumption that a person who holds the title of an officer is, in fact, an officer.47
Determining whether a person is an officer is the first step. The next question is whether that renders him or her an insider.
Here, no further inquiry is needed. Congress has explicitly stated that an officer is an insider.48 Having been found to be the
former, one must be the latter.49 Thus, under the plain meaning of the statute an officer is, per se, an insider.50
In summation, a person holding the title of an officer, including a vice president, is presumptively what he or she appears to
be—an officer and, thus, an insider. To overcome that presumption requires the submission of evidence sufficient to establish
that the officer does not, in fact, participate in the management of the debtor.
II. The Debtors’ Vice Presidents Are, In Fact, Officers And, Thus, Insiders Under Section 101(31) Of The Bankruptcy
Code
[6]
Now we turn to whether Messrs. Drennan and Moustakis are, in fact, officers and insiders of the Debtors, i.e., whether they
are participating in the management of the Debtors. The Court finds *584 that the evidence is insufficient to rebut the
presumption that Messrs. Drennan and Moustakis are officers and insiders of the Debtors.
6
Neither Mr. Drennan nor Mr. Moustakis are members of senior management and they do not play a role in the management
of the company as a whole. Nonetheless they are in charge of important aspects of the Debtors’ business, which is the
acquisition, exploration, exploitation and development of oil and natural gas properties. Mr. Drennan oversees the Debtors’
oil and gas leases and communications with landlords regarding those leases. Without those leases, the Debtors would have
no business. In addition, he is responsible for ensuring the Debtors are in compliance with state and federal laws and
regulation—obviously a requirement of staying in business. Mr. Moustakis, in turn, oversees the Debtors’ oil and gas
production, evaluation of reserves, technical reporting and development of capital spending projects. Again, without these
activities the Debtors would have no business.
Management is “the administration of (a group within) an organization or commercial enterprise.”51 Certainly, one would
normally consider the supervision of employees as a necessary component of management. But, that is not necessarily the
case. The Debtors have 10 employees, including three members of senior management; an administrative assistant; and
Messrs. Drennan and Moustakis. Mr. Drennan does not supervise any employees while Mr. Moustakis supervises four
persons. In a company of this size, it is not surprising that a person could hold a position of critical importance in managing
the business enterprise but still only supervise few or no employees. Thus, the number of employees under the officer’s
supervision is of little importance in this case.
Given their broad responsibilities over significant aspects of the Debtors’ business as well as the fact that they report directly
to the Debtors’ President, both men are clearly participating in the management of the Debtors. Indeed, the Debtors’ CFO
testified that he considered both of them to be performing the job of a manager. This, in and of itself, is sufficient evidence to
find that Messrs. Drennan and Moustakis are participating in the management of the Debtors’ business. Thus, the Court finds
that the Debtors have not presented sufficient evidence to rebut the presumption that Messrs. Drennan and Moustakis are
officers and, thus, insiders.52
III. As The Debtors’ Vice Presidents Are Insiders, The Court Will Deny The Motion To Authorize Assumption Of
Their Employment Agreements Under Section 365 And Payment Of The Retention Payments Under Section 363
[7]
The motion before the Court seeks authorization for the Debtors to assume the modified employment agreements under
section 365. In addition, provided that the agreements are assumed, the Debtors seek authority to make the retention
payments as a use of property of the estate (outside the ordinary course of business) under *585 section 363(b) of the
Bankruptcy Code. The governing standard for both requests for relief is whether the proposed action would be a reasonable
exercise of the Debtors’ business judgment.53 As the Debtors’ sole motivation for filing and prosecuting the motion is to
obtain authority to make retention payments that are prohibited by section 503(c)(1) of the Bankruptcy Code, it is not a
reasonable exercise of the Debtors’ business judgment to assume the agreements and/or make the payments.54 Thus, the
motion will be denied.
CONCLUSION
A person holding the title of an officer, including vice president, is presumptively what he or she appears to be—an officer
and, thus, an insider. Nonetheless, this presumption can be rebutted by evidence sufficient to establish that the person does
not participate in the management of the debtor. Messrs. Drennan and Moustakis are presumptively officers and the Debtors
have failed to submit evidence sufficient to rebut that presumption.
A retention payment may only be made to an insider if the standard under section 503(c)(1) has been satisfied. As there is no
evidence that section 503(c)(1) has been met, the retention payment cannot be made. Since the Debtors’ sole reason for filing
and prosecuting the motion is to obtain authorization to make the retention payments, the motion to assume those agreements
will be denied.
An order will be issued.
7
All Citations
408 B.R. 573, 62 Collier Bankr.Cas.2d 212, Bankr. L. Rep. P 81,589
Footnotes
1
This Opinion constitutes the Court’s findings of fact and conclusions of law pursuant to Federal Rule of Bankruptcy Procedure
7052.
2
The Court conducted an evidentiary hearing in this matter. The facts set forth herein are based upon the evidence submitted at that
hearing and the statements in the Debtors’ motion.
3
The employment agreement, as modified in 2008, also provides for payments in the event that Mr. Drennan is fired or there is a
change of control before June 30, 2009. As those events did not occur and there have been no such payments these provisions are
not before the Court.
4
The employment agreement, as modified in 2008, also provides for payments in the event that Mr. Moustakis is fired or there is a
change of control before June 30, 2009. For the same reasons set forth in n. 3 above, these provisions are not before the Court.
5
The Debtors also entered into an employment agreement and subsequent change in control, severance and retention agreement with
Lynn M. Marks, who serves as an Administrative Assistant. No party has argued that Ms. Marks is an officer and there was no
objection to the Debtors’ assumption of her modified employment agreement.
6
At this time, the Debtors entered into virtually identical retention agreements with two other employees, excluding Ms. Marks. The
Debtors have not sought to assume those agreements.
7
In December, 2008, those agreements were modified for tax purposes. Although they contain a severance component, they do not
entitle the employees to any retention payment. The Debtors have not sought to assume the employment agreements of its senior
management.
8
One can argue that section 503(c)(1)(A) is counter-productive to debtors because the entire point of a retention payment plan is to
discourage insiders from seeking alternative employment.
9
Consider two scenarios:
• Debtor wants to make payments to retain its CEO who made $300,000 in 2008. Debtor has made bonus payments averaging
$2,000 to non-management employees during 2009.
—Payment to CEO can only be made if:
(i) CEO has an offer for employment at another company for $300,000 or more annually;
(ii) CEO’s services are essential to debtor’s survival; and
(iii) CEO’s services are essential to debtor’s survival; and Payment does not exceed $20,000, i.e., 6.67% of CEO’s current
salary, which is 10 times the average payments to non-management employees during 2009.
• Debtor wants to make payments to retain its CEO who made $300,000 in 2008. Debtor has not made bonus payments to
non-management employees during 2009.
—Payment to CEO can only be made if:
(i) CEO has an offer for employment at another company for $300,000 or more annually;
(ii) CEO’s services are essential to debtor’s survival; and
(iii) Payment does not exceed $75,000, i.e., 25% of the CEO’s 2008 salary
Interestingly, to the extent that section 503(c)(1) is intended to encourage retention payments be made to all employees rather
than just senior management it is counter-productive. For example, under the above scenarios, senior management is better off
not providing bonus payments to non-management employees because in that instance the cap on payment is $75,000 rather than
$20,000. The $20,000 payment to the CEO under the first scenario could be increased to $75,000 or more by sufficiently
increasing the bonus payments already being paid to non-management employees, however, the cost would be prohibitive. For
example, in the second scenario, to increase the payment for non-management employees from $20,000 to $75,000 would
require increasing the average bonus payment from $2,000 to $7,500. In a company with 1,000 non-management employees this
would cost the debtor $5.5 million, i.e., ($7,500—$2,000) * 1,000.
In any event, the amount of the retention payments under these scenarios are well below the amount generally sought by the
debtors under a retention plan. For example, in this case, the Debtors seek authority to make payments constituting 75% of the
recipients’ base salary.
10
See, e.g., In re Nellson Nutraceutical, 369 B.R. 787, 801–03 (Bankr.D.Del.2007) (allowing payments to insiders because primarily
8
motivational and not retentive); In re Global Home Products, LLC, 369 B.R. 778, 786 (Bankr.D.Del.2007) (allowing payments to
insiders that are primarily motivational and only coincidentally retentive); and In re Dana Corp., 358 B.R. 567, 577
(Bankr.S.D.N.Y.2006) (allowing payments to insiders even though they might have some retentive impact because any such
impact was merely incidental).
11
Section 503(c)(2) governs severance payments to insiders. Section 503(c)(3) applies to payments made outside the ordinary course
of business for the benefit of officers, managers and consultants, provided, however, that sections (c)(1) or (2) are not applicable.
As the payments here are clearly retentive, section 503(c)(2) is not implicated. Section 503(b)(3) would only be applicable were
the Court to find that Messrs. Drennan and/or Moustakis are not officers. See n. 54, infra. Thus, as a preliminary matter, the
Debtors’ motion rises or falls under section 503(c)(1).
12
Schubert v. Lucent Technologies Inc. (In re Winstar Communications, Inc.), 554 F.3d 382 (3rd Cir.2009).
13
Id. at 395 (citing Anstine v. Carl Zeiss Meditec AG (In re U.S. Med., Inc.), 531 F.3d 1272, 1276 (10th Cir.2008)).
14
Id. at 396 (“[N]ot all of the enumerated insiders possess actual control over the debtor. For example, a ‘relative of a general
partner, director, officer, or person in control of the debtor’ is an insider. 11 U.S.C. § 101(31)(B)(vi). Similarly, a ‘partnership in
which the debtor is a general partner’ is an insider-even though the direction of control is reversed, i.e. the debtor as general partner
controls the partnership. 11 U.S.C. § 101(31)(B)(iv). Cf. 11 U.S.C. § 101(31)(E) (providing that an ‘affiliate’ of the debtor is an
insider, even though an affiliate under § 101(2)(B) includes a corporation ‘20 percent or more of whose outstanding voting
securities are directly or indirectly owned ... by the debtor’).”).
15
Id. (quoting U.S. Med., Inc., 531 F.3d at 1277).
16
I SHORTER OXFORD ENGLISH DICTIONARY 1394 (emphasis added).
17
11 U.S.C. § 101(31)(B)(ii).
18
II SHORTER OXFORD ENGLISH DICTIONARY 1988. Note that the term is further modified to state “esp[ecially] a president,
treasurer or secretary.” The use of the word especially makes the list of examples illustrative rather than exclusive.
19
I SHORTER OXFORD ENGLISH DICTIONARY 1692.
20
II SHORTER OXFORD ENGLISH DICTIONARY at 3527 (emphasis added).
21
Id. at 1988 (an official is a person “[h]olding office ...”).
22
See, e.g., Duke Energy Royal, LLC v. Pillowtex Corporation (In re Pillowtex, Inc.), 349 F.3d 711, 716 n. 6 (3d Cir.2003) (where
the parties to a contract intended to create a “true lease” it is presumed to be a true lease and the party seeking to establish that it is
“something other than what it purports to be” bears the burden of proof to rebut the presumption).
23
Winstar Communications, 554 F.3d at 395.
24
The definition neither states nor implies that the management of the debtor must be at the most senior level.
25
The Court is aware that its holding may be thought to render the use of the word “officer” in section 503(c)(3) to be superfluous as
the Court has, in effect, held that an officer is a manager who is sufficiently senior to hold the title of an officer. 11 U.S.C. §
503(c)(“(c) Notwithstanding subsection (b), there shall neither be allowed, nor paid ... (3) other transfers or obligations that are
outside the ordinary course of business and not justified by the facts and circumstances of the case, including transfers made to, or
obligations incurred for the benefit of, officers, managers, or consultants hired after the date of the filing of the petition.”)
(emphasis added). However, as all managers are not officers, the use of both terms is not redundant. Rather, the statute provides
that the standard under section 503(c)(3) governing a payment that it is made to managers and consultants, who are not necessarily
insiders, is different on its face from that which applies to payments made to directors and control persons, who are insiders. The
former must be “justified by the facts and circumstances of the case” while the latter must satisfy the business judgment test under
section 363 (provided sections 503(c)(1) and (2) are not applicable). Whether there is any substantive difference between the two
standards and, if so, what constitutes “justified by the facts and circumstances of the case” is an issue for another day.
26
Smith v. Ruby (In re Public Access Technology.com, Inc.), 307 B.R. 500 (E.D.Va.2004); In re CEP Holdings, LLC, 2006 WL
9
3422665 (Bankr.N.D.Ohio Nov.28, 2006); Principal Mutual Life Insurance Co. v. Lakeside Associates, L.P. (In re DeLuca), 194
B.R. 797 (Bankr.E.D.Va.1996); and NMI Systems, Inc. v. Pillard (In re NMI Systems, Inc.), 179 B.R. 357 (Bankr.D.C.1995).
27
NMI Systems, 179 B.R. at 368.
28
Id. at 370 (emphasis added).
29
Id. (emphasis added).
30
Id. at 369.
31
Id. at 370. The Debtors argue that as a result of “title inflation,” the use of an officer title, in fact, does not reflect that such persons
are sufficiently senior to hold the title of an officer and, thus, should not be considered as such. While that may be true, it is an
argument for Congress and not this Court. This Court must limit its inquiry to the plain meaning of the statute and not a debtor’s
misapplication of that term’s plain meaning.
32
DeLuca, 194 B.R. at 801.
33
11 U.S.C. § 101(31)(C).
34
See, e.g., Winstar Communications, 554 F.3d at 395–97.
35
Public Access Technology.com, 307 B.R. at 502.
36
Id. at 505 (“the bankruptcy court held that ‘Smith admits that he was the debtor’s Executive Vice President, and we do not have to
carry the inquiry any further.’ ”).
37
Id. at 506.
38
Id. (emphasis added).
39
The district court does provide some examples of evidence that may be used, in whole or in part, to establish whether a person is an
officer. Id. (“There are no affidavits, articles of incorporation, corporate minutes, resolutions, or any documents or evidence that
show this title makes [the executive vice president] an officer of the corporation.”).
40
CEP Holdings, 2006 WL 3422665.
41
11 U.S.C. § 503(c)(3).
42
CEP Holdings, 2006 WL 3422665 at *2.
43
Id. at *2 n. 2.
44
Id. at *2.
45
Id. at *3.
46
Winstar Communications, 554 F.3d at 396 (emphasis added). Note that the court used “any transaction” not “transaction before the
court” or similar language.
47
Public Access Technologies.com, 307 B.R. at 506.
48
11 U.S.C. § 101(31)(B).
49
It does not, however, follow that having been found not to be an officer one is, per se, not an insider. While, in that instance,
section 101(31)(B) would not be a proper basis to a person to be an insider, there may be facts that would support finding a person
to be an insider under the other categories of the definition of insider, i.e., director, person in control, etc., or as a non-statutory
10
insider.
50
Plain meaning is the starting point of statutory analysis but it is not the mandatory exit. Hon. Thomas F. Waldron and Neil M.
Berman, Principled Principles of Statutory Interpretation: A Judicial Perspective After Two Years of BAPCPA, 81 AM. BANKR.
L.J. 195, 232 (2007) In this instance, none of the exceptions to applying plain meaning of the text are applicable (such as doing so
would render an absurd result).
51
I SHORTER OXFORD ENGLISH DICTIONARY 1692.
52
In opposition to the motion, the United States Trustee argues that the identification of Messrs. Drennan and Moustakis as officers
in the Debtors’ most recent 10K and the Statements of Financial Affairs filed in this case establishes that they are officers. The
Court has held, however, that the inquiry is whether they are, in fact, participating in the management of the Debtors. As the
identification of Messrs. Drennan and Moustakis as officers on these public documents is additional evidence of the already
established conclusion that they are presumptively officers, it does not relate to the inquiry into whether they are, in fact,
participating in management. Thus, it is irrelevant.
53
In re Taylor, 913 F.2d 102 (3rd Cir.1990) (assumption of executory contracts); and In re Abbotts Dairies of Pa., Inc., 788 F.2d 143
(3d Cir.1986) (use of property of the estate outside the ordinary course of business).
54
Had section 503(b)(1) not been applicable, the Court would have been required to determine whether the requested relief is
“justified by the facts and circumstances of the case.” Whether that standard would have been met in that instance is not before the
Court.
End of Document
11
In re Airway Industries, Inc., 354 B.R. 82 (2006)
56 Collier Bankr.Cas.2d 1059, 47 Bankr.Ct.Dec. 52
Distinguished by In re Fieldstone Mortg. Co., Bankr.D.Md., February 25, 2010
354 B.R. 82
W.D. Pennsylvania.
In re AIRWAY INDUSTRIES, INC., Debtor.
Official Committee Of Unsecured Creditors, Movant,
v.
Airway Industries, Inc., Cerberus Capital Management, L.P., Madeleine, L.L.C., Respondents.
No. 06–20224 JKF. | Oct. 3, 2006.
Synopsis
Background: Unsecured creditors committee filed turnover motion, seeking order directing that incentive bonuses that were
to be provided by secured creditor to four of Chapter 11 debtor’s executives be turned over to bankruptcy estate or,
alternatively, disallowing or prohibiting payment of bonuses. The United States Trustee (UST) also objected to payment of
bonuses. Creditor and debtor opposed committee’s motion.
Holdings: The Bankruptcy Court, Judith K. Fitzgerald, J., held that:
[1]
creditor did not have to turn over bonuses;
[2]
statute governing administrative expenses did not provide basis for bankruptcy court to disallow or prohibit bonuses; and
[3]
potential for breach of fiduciary duty arising from bonus agreements did not provide equitable basis for granting motion
seeking turnover of bonuses to estate.
Turnover motion denied; objection to bonuses overruled.
*83 Joel M. Walker, Pittsburgh, PA, for Debtor.
MEMORANDUM OPINION1
JUDITH K. FITZGERALD, Bankruptcy Judge.
Before the court is a motion by the Official Committee of Unsecured Creditors (“Turnover Motion”)2 seeking entry of an
order pursuant to §§ 503, 541, 542, and 105 of the Bankruptcy Code directing that Transaction Bonuses3 provided by a
secured creditor be turned over to Debtor’s estate or, in the alternative, disallowing or prohibiting payment of the bonuses
pursuant to § 503. The beneficiaries of the bonuses are four executives of the Debtor. The bonuses are to be provided by
Cerberus Capital Management, L.P. (“Cerberus Capital”), an affiliate4 of Cerberus *84 Partners, L.P. (“Cerberus Partners”),
and Madeleine, L.L.C. (“Madeleine”, and collectively with Cerberus Partners and Cerberus Capital, “Cerberus”).5 The
bonuses were conditioned on the executives remaining with the company until the proposed sale was completed and the
bonuses were to be paid by Cerberus, following the sale. 6 The purported intention of the bonuses, as asserted by Cerberus,
1
was to stabilize the company and maximize the value of the sale. Both Cerberus and the Debtor filed responses, requesting
that the court deny the Turnover Motion.7
BACKGROUND
It is undisputed that the Debtor is a Pennsylvania corporation founded in 1919 as Reliable Trunk Company. Debtor did
business as “Atlantic Luggage Company” and sold specialty luggage products and travel accessories to department stores,
specialty luggage stores, and other distribution channels in the United States, Canada, and China. As of the Petition Date,
Debtor had approximately 90 employees. Approximately 67 of these employees were located at Debtor’s corporate
headquarters in Ellwood City, Pennsylvania, and the remaining employees worked in Debtor’s facilities in Orland,
California, Mississauga, Canada, and Hangzhou, China.
The Cerberus Entities hold secured claims and interests in a partnership that holds shares of Debtor’s preferred stock.
Cerberus Capital, signatory to the Bonus Agreements, is an affiliate of Cerberus Partners. Madeleine, an affiliate of Cerberus
Partners, is also a prepetition secured creditor of the Debtor and was the lender to Debtor under a debtor-in-possession
financing facility.
On January 20, 2006, Debtor filed its voluntary petition under Chapter 11 of the Bankruptcy Code in the United States
Bankruptcy Court for the Western District of Pennsylvania. The United States Trustee for the Western District of
Pennsylvania (the “U.S. Trustee”) appointed the Official Committee of Unsecured Creditors of Airway Industries, Inc. (the
“Committee”) on February 6, 2006. No trustee or examiner has been appointed in this case. Pursuant to § 1107 and § 1108 of
the Bankruptcy Code, Debtor continues to operate its business and manage its respective properties as debtor-in-possession.
11 U.S.C. § 1107; 11 U.S.C. § 1108.
Prior to the Chapter 11 filing, Debtor’s business was in substantial decline. According to the testimony of Grace Kurowska,
Debtor’s Executive Vice President and Chief Financial Officer:
We realized that our sales [were] dropping significantly. It got to the point that in September of 2004
we ran out of cash to run the operation.... We, at that time, lost the business with J.C. Penney. We lost
the business with Kohl’s. Eventually, in early 2005 we lost business with Marshall Fields.
2/27/06 Sale Hearing Transcript at 33:20–22; 37:22–24, DN 180. Many of the sales people left the company for more
lucrative *85 opportunities elsewhere, which accelerated Debtor’s financial decline. Id. at 39:9–13. The former Chief
Executive Officer, John Dudash, was one of those who left Debtor’s employ during that time. Without access to capital,
management decided that a sale was Debtor’s only viable option. As the company was considering its options, its senior
management employees were being offered more lucrative opportunities elsewhere. In an effort to stabilize the business and
preserve the value of Debtor’s assets in any subsequent sale, and well before the bankruptcy was filed or the BAPCPA
amendments took effect, Cerberus Capital, on behalf of Cerberus, proposed to pay Transaction Bonuses and entered into
written incentive Bonus Agreements with William Berry (Chief Executive Officer) (“Berry”) and Grace Kurowska
(Executive Vice President and Chief Financial Officer) (“Kurowska”) and oral agreements with Brian Miller (Vice President,
Sales and Marketing) (“Miller”) and Gerald Carr (Comptroller) ( “Carr” and, collectively with Berry, Kurowska and Miller,
the “Management Employees”). See 2/27/06 Sale Hearing Transcript, DN 180, Kurowska’ testimony beginning at 31. The
written Agreements were signed in August, 2005. DN 90, Exhibits A, B; DN 214, Exhibit A.
The Bonus Agreements provide that if Debtor sells all or substantially all of its assets—regardless of whether such sale
occurs outside or in the context of a bankruptcy case—and Cerberus receives cash distributions from the sale proceeds, each
Management Employee will receive his or her applicable Transaction Bonus. See DN 90, Exhibits A, B; DN 214, Exhibit A.
The amounts of the bonuses were as follows: $500,000 for Berry; $75,000 for Carr; and the greater of (i) $300,000 and [sic]
(ii) 4 percent of the amount by which the net proceeds of distributions to Cerberus from the sale exceed $14.6 million, up to a
maximum of $320,000 for Kurowska and Miller. The Berry, Kurowska, and Miller Bonus Agreements also provide that if
those individuals are not offered positions as of the closing of a sale comparable to those they held with Debtor at the time of
execution of the Bonus Agreement, each would have the opportunity to become a consultant on the “operations team” of
Cerberus Capital and its affiliated companies. The Bonus Agreements were signed on August 15, 2005. See DN 90, Exhibits
2
A, B; DN 214, Exhibit A.
On January 27, 2006, Debtor filed a motion for an order approving an asset purchase agreement among itself, TravelPro
International, Inc. (“TPI”), Austin House, Inc. and Cerberus Partners. DN 70. On February 8, 2006, Debtor filed a
supplement (the “Supplement”) to the Sale Motion, disclosing to the court and interested parties that four of Debtor’s
executive officers—Berry, Kurowska, Miller, and Carr—had either entered into or would enter into incentive bonus
agreements with Cerberus Capital. DN 90.
On February 10, 2006, the U.S. Trustee filed an objection to the Sale Motion requesting that the court prohibit the payment of
the bonuses. DN 92. On February 23, 2006, the Committee filed its Turnover Motion, demanding that the bonuses be turned
over to Debtor’s estate or, alternatively, that the court disallow or prohibit payment. DN 147.
The hearing on the Sale Motion was held on February 27, 2006. 8 This court entered an order on February 28, 2006, approving
the sale to TPI and found that “Debtor’s marketing efforts and solicitations conducted in connection with the sale process
were appropriate and reasonable *86 and designed to obtain the highest and/or best price for the Acquired Assets.”9 On
March 2, 2006, the closing on the sale to TPI occurred.
ANALYSIS
Under the facts of this case, Debtor pursued the sale of the company and negotiated the Bonus Agreements prepetition and
prior to the effective date of BAPCPA. The court recognizes that the timing of the sale, the bankruptcy filing, and the
changes in the Bankruptcy Code created a unique situation likely never to occur again.
The Committee first requests that the Transaction Bonuses be turned over to Debtor’s estate under Bankruptcy Code § 541
and § 542. Under § 541, the filing of a petition creates an estate compromised of all property, “wherever located and by
whomever held, of all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. §
541(a)(1). See also U.S. v. Whiting Pools, Inc., 462 U.S. 198, 205, 103 S.Ct. 2309, 76 L.Ed.2d 515 (1983). If property is
established to be property of the estate and is not in possession of the debtor, trustee, or debtor-in-possession, § 542 governs
the turnover of such property to the bankruptcy estate. See 11 U.S.C. § 542. Additionally, the court has authority, under §
105(a) to “issue any order ... necessary or appropriate to carry out the provisions of” title 11.
[1]
A turnover under § 542 is predicated on a determination under § 541 that the property at issue is property of the estate. The
Committee alleges that the Transaction Bonuses will be paid from property of the estate; however, that is not so. Rather,
Cerberus has agreed to pay the bonuses from its own funds. See DN 90, Exhibits A, B; DN 214, Exhibit A. The Bonus
Agreements explicitly provide that Cerberus, not the Debtor, will pay them “in the event that the [Debtor] sells all or
substantially all of its assets ... and, as a result, [Cerberus] receives cash distributions ...” DN 214, Exhibit A.
The Committee cites no relevant law to show that a court may order turnover of non-estate property under § 542. The
Committee relies on In re Dalow Industries, Inc., 333 B.R. 640 (Bankr.E.D.N.Y.2005), arguing that it is analogous to the
current situation. However, Dalow is easily distinguishable. In Dalow, the debtor sold its assets to the highest bidder at an
auction, with the provision that as part of the purchase price, the purchaser would pay the secured claim of the debtor’s bank.
Id. at 641. After the sale and payment, an accounting error was discovered, through which the bank had received
overpayment of interest. The debtor successfully moved for turnover of the overpayment, pursuant to § 542. The issue was
not whether the funds properly paid to the bank remained property of the estate, but whether the overpayment—to which the
bank had never been entitled or made a claim—remained an asset of the estate. The current situation would be analogous to
the funds properly paid to the bank, not the overpayment. Here the proceeds of sale will be paid to Cerberus in satisfaction of
its security interest. In fact, the proceeds of sale will not pay the secured claim in full. Cerberus then will use its own funds to
pay the bonuses. Because Cerberus will pay the bonuses from its own funds, the request for turnover under § 542 must be
denied.
[2]
The Committee alternatively argues that if the court determines that the bonuses are not property of the estate, they should
be disallowed or prohibited *87 because § 503(c) of the Bankruptcy Code “expressly prohibits such payments.” DN 147 at
11. Section 503(c) covers three categories of administrative expense:
3
(1) a transfer made to, or an obligation incurred for the benefit of, an insider of the debtor for the purpose of inducing such
person to remain with the debtor’s business ...
(2) a severance payment to an insider of the debtor ...
(3) other transfers or obligations that are outside the ordinary course of business and not justified by the facts and
circumstances of the case, including transfers made to, or obligations incurred for the benefit of, officers, managers, or
consultants hired after the date of the filing of the petition.
These three categories of administrative expense are prohibited unless a finding by the court based on evidence in the record
indicates that the statutorily prescribed limitations are not exceeded. The Committee made an argument for the application of
§ 503(c)(1) and the U.S. Trustee argued that both § 503(c)(1) and § 503(c)(2) apply.10 However, the application of § 503(c) is
inappropriate considering the unique facts of this case.
Section 503 applies to “Administrative Expenses of the Estate.” The court did not receive an administrative expense request
from the parties who would receive the bonuses or from Cerberus. Rather, notice of the agreement was introduced in a
Supplement to the Sale Motion.11 An administrative expense request is filed in order to obtain court approval for the
expenditure of estate assets. Here, the estate is not paying the bonuses; Cerberus voluntarily agreed to make the payment
from its own funds in an effort to maximize its distribution. The payments will not be allowed administrative expenses to be
paid from the Debtor’s estate, nor will Cerberus seek reimbursement from the estate for payment of the Transaction Bonuses.
Section 503(c) of BAPCPA was adopted in an effort to deal with the effect that large administrative claims arising pursuant
to KERPs have on the estate.12 The court in In re U.S. Airways, Inc., 329 B.R. 793 (Bankr.E.D.Va.2005), noted that the
primary concern with KERPs is an unwarranted depletion of the debtor’s estate at the expense of the creditors:
All too often [KERPs] have been widely used to lavishly reward—at the expense of the creditor body—the very executives
whose bad decisions or lack of foresight were responsible for the debtor’s financial plight.
Id., 329 B.R. at 797. These concerns do not arise under the facts of this case because the bonuses create no expense to the
*88 estate or diminution to the creditor body. The financial burden rests solely on Cerberus. Because Cerberus is
undersecured, there is no way unsecured creditors will be paid from the sale. The objections of the Committee and the U.S.
Trustee asserting application of § 503(c) are inappropriate because the Transaction Bonuses are not administrative
expenses and do not otherwise deplete the Debtor’s estate at the expense of the creditors. The Transaction Bonuses will not
be disallowed or prohibited under § 503(c).
The Committee also alleges that Cerberus constructed the Bonus Agreements with the intention of circumventing § 503(c).
However, the evidence establishes otherwise. Under the Bonus Agreements, Cerberus’s obligation is not predicated on the
Debtor’s bankruptcy filing but only on the sale of assets. The only conditions to payment of the Transaction Bonuses are: (i)
the sale of substantially all of the Debtor’s assets (whether in or outside of a bankruptcy case); (ii) Cerberus receiving a cash
distribution as a result thereof; and (iii) the applicable Management Employee being in good standing immediately prior to
the closing of any sale. The credible evidence indicates that the Bonus Agreements were not written in anticipation or even
contemplation of the new bankruptcy law.
Q: The agreements that you reviewed you signed in August?
A: Okay.
Q: Did you discuss these agreements with [the Management Employees] before they were signed?
A: Yes.
Q: It was about the same time that you learned about the changes in the Bankruptcy Code?
A: No, there was no connection between the two. I think our assumption was when we entered into these agreements, the
company was going to file for bankruptcy before the Code changed. So I don’t think there was any relevance.
Q: Why were you considering filing for bankruptcy before the Code changed?
4
A: I think the assumption was that the Asset Purchase Agreement with TravelPro would have been done.
Davenport Deposition, DN 214, Exh. C at 179–80. The evidence establishes that the agreements were precipitated by the
former CEO (Dudash) aggressively recruiting the Management Employees away from Debtor. 13 Further, the sale of the
company was initially intended to be conducted outside of bankruptcy. 14
[3]
The U.S. Trustee argues that if the court finds that the structure of the Bonus Agreements prevents the bonuses from being
considered administrative expenses of the estate, therefore avoiding the limitations of § 503(c), the directors and controlling
shareholders of the Debtor may have created a conflict of interest by allowing the officers to be compensated by a secured
lender.15 In doing so, the U.S. Trustee contends, the directors, officers, and controlling shareholders may have breached their
fiduciary duty to act in the best interests of the corporate Debtor and creditor body. “[T]he willingness ... to leave debtors in
possession ‘is premised upon an assurance that the officers and managing employees of the debtor can be depended *89 upon
to carry out the fiduciary responsibilities of a trustee.’ ” Commodity Futures Trading Commission v. Weintraub, 471 U.S.
343, 355, 105 S.Ct. 1986, 85 L.Ed.2d 372 (1985) (citation omitted). See also Wolf v. Weinstein, 372 U.S. 633, 651, 83 S.Ct.
969, 10 L.Ed.2d 33, rehearing denied 373 U.S. 928, 83 S.Ct. 1522, 10 L.Ed.2d 427 (1963).
[4] [5]
A debtor-in-possession, as a fiduciary of the bankruptcy estate, is required to protect and conserve property for the
benefit of creditors. “Directors of an insolvent corporation hold their powers ‘in trust’ for all creditors of the corporation.
They may not use their powers for their own benefit and to the detriment of creditors.” In re Insulfoams, Inc., 184 B.R. 694,
703–04 (Bankr.W.D.Pa.1995), aff’d sub nom. Donaldson v. Bernstein, 104 F.3d 547 (3d Cir.1997). In essence, the argument
asserts that if Mr. Davenport, who was signatory to the agreement as the Managing Director of Cerberus Capital and also a
member of the Board of Directors of the Debtor, was acting on behalf of Cerberus, and the agreement to pay the bonuses to
the officers was for the benefit of Cerberus and to the detriment of the remaining creditors of Debtor, then Mr. Davenport
may have breached his fiduciary duty as a Director of the Debtor. Similarly, if Berry, Kurowska, Miller, and Carr signed the
agreement for their benefit and to the detriment of Debtor and the creditor body, then they also may have breached their
fiduciary duty. Thus, we examine this issue to determine if there is an equitable basis on which to grant the Turnover Motion.
The Bonus Agreements themselves explicitly provide that the Management Employees must continue to comply with their
fiduciary duties to the Debtor, even if such duties would conflict with the interests of Cerberus:
Duties. Notwithstanding anything to the contrary set forth herein, you will carry out your duties to the [Debtor] in a
manner consistent with your fiduciary duties to the [Debtor] regardless of whether those duties would conflict with any
duties owed to, or the interests of, Cerberus. If the transaction contemplated in this letter agreement would, in the
reasonable opinion of the [Debtor] or Cerberus, create any actual or perceived conflict of interest, the parties will use their
reasonable efforts to enter into mutually satisfactory arrangements to compensate you in a manner that is reasonably
designed to eliminate any such conflicts.
DN 214, Exhibit A. Additionally, once in bankruptcy, the Management Employees were advised of their fiduciary duties to
all of the Debtor’s creditors.16
Despite the potential for breaches of fiduciary duty, none have been established in this case. All evidence indicates that both
Cerberus and the Management Employees of the Debtor acted in good faith to maximize the value of the Debtor’s business
and estate. After the CEO left Debtor’s employ and started to recruit Debtor’s employees, and after Debtor lost many
customers and faced winding down its business, Cerberus and Debtor were concerned that the loss of the remaining
executives, who were being heavily recruited by the former CEO, would be devastating to the business and detrimental to the
sale. Robert Davenport, representative of Cerberus, testified in deposition that after the former CEO left Debtor, he started
trying to recruit Kurowska and Miller. Davenport Deposition, DN 214, Exhibit C, at 129. Maximizing the sale proceeds
serves the interests of the creditor body, not just *90 those of Debtor and Cerberus as the secured creditor. No unsecured
creditor will be paid until the secured creditor is paid. In this case, because Cerberus will not be paid its secured claim in full
from this sale, there are no proceeds available to pay other creditors. Thus any bonuses to be paid would necessarily have to
come from Cerberus’s funds, not the estate’s.
This court recognizes that similar arrangements must be closely scrutinized so that they are not used to circumvent § 503(c)
or to compromise the fiduciary duty of insiders. However, the specific and peculiar facts and circumstances of the present
case, where the agreement was negotiated prepetition and before BAPCPA took effect and Debtor expected either to close the
5
sale without filing bankruptcy or to file bankruptcy prior to BAPCPA taking effect, indicate that the Bonus Agreements were
entered into in good faith and for the benefit of the Debtor and the creditor body.
An appropriate order denying the Turnover Motion and overruling the objections to the Transaction Bonuses will be entered.
ORDER
For the reasons expressed in the foregoing Memorandum Opinion, it is Ordered this 3rd day of October, 2006, that the
Motion of the Official Committee of Unsecured Creditors, DN 147, for turnover to the estate of the Transaction Bonuses is
DENIED. It is further Ordered that the Objection of the United States Trustee, DN 92, is overruled.
All Citations
354 B.R. 82, 56 Collier Bankr.Cas.2d 1059, 47 Bankr.Ct.Dec. 52
Footnotes
1
The court’s jurisdiction was not at issue. This Memorandum Opinion constitutes our findings of fact and conclusions of law.
2
DN 147.
3
The bonuses were labeled as “Insider Bonuses” in the Committee’s Motion and titled as a “Transaction Bonus” in the written
Bonus Agreements. DN 214, Exhibit A.
4
Under § 101(2) of the U.S. Bankruptcy Code, “affiliate” means “(A) entity that directly or indirectly owns, controls, or holds with
power to vote, 20 percent or more of the outstanding voting securities of the debtor, other than an entity that holds such
securities—(i) in a fiduciary or agency capacity without sole discretionary power to vote such securities; or (ii) solely to secure a
debt, if such entity has not in fact exercised such power to vote.” 11 U.S.C. § 101(31).
5
According to Debtor’s List of Equity Security Holders, Madeleine and affiliates own 42.43 percent of Debtor’s equity.
6
The bonuses were to be paid following sale regardless of whether or not Airway entered bankruptcy proceedings. See Bonus
Agreements, DN 90, Exhibits A, B; DN 214, Exh. A.
7
Airway Industries Inc.’s Response, DN 215; Cerberus’s Response, DN 214.
8
Sale Hearing Transcript, DN 180.
9
Sale Order, DN 171 at 3.
10
The Committee has not argued that § 503(c)(2) or (c)(3) should govern the bonuses. The U.S. Trustee acknowledged that §
503(c)(3) is inapplicable but suggested that the payments could possibly be deemed severance payments, therefore implicating §
503(c)(2). DN 92: DN 205.
11
“The purpose of this Supplement is to provide the Court and all interested parties with information regarding incentive bonuses and
potential future employment opportunities being provided to certain members of the Debtor’s management team by Cerberus
Capital Management, L.P.” DN 90.
12
Section 503(c) was a last minute addition to BAPCPA proposed by Senator Edward M. Kennedy, D–Mass. The addition of the
Section occurred without any debate and there is no written record regarding the deliberations. A reported statement by Senator
Kennedy explained that the amendment was “designed to stop the travesty of high-level corporate insiders who walk away with
millions while the company’s worker’s and retirees are left empty-handed.” See Mike Casey, “Benefit Inequity Deepens Gap,” The
Kansas City Star, July 24, 2005.
6
13
See Deposition of Robert C. Davenport, DN 214, Exh. C at 129, 132–35.
14
See 2/27/06 Sale Hearing Transcript, DN 180 at 34–65.
15
DN 205 at 4–8.
16
See DN 90 at 3. Debtor’s assertion in its motion to sell is not disputed.
End of Document
7
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UNITED STATES BANKRUPTCY COURT
2
DISTRICT OF DELAWARE
3
4
5
In re:
:
:
6
ENERGY FUTURE HOLDINGS
:
CORP.,
:
et al.,
7
Case No. 14-10979(CSS)
:
Debtors.
8
Chapter 11
:
(Jointly Administered)
______________________________:
9
10
United States Bankruptcy Court
11
824 North Market Street
12
Wilmington, Delaware
13
14
15
October 15, 2014
16
10:15 AM - 5:19 PM
17
18
B E F O R E :
19
HON CHRISTOPHER S. SONTCHI
20
U.S. BANKRUPTCY JUDGE
21
22
23
24
25
ECR OPERATOR:
212-267-6868
LESLIE MURIN
VERITEXT REPORTING COMPANY
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HEARING re Motion of Energy Future Holdings Corp., et al.,
2
for Entry of an Order Authorizing the Debtors to (A) Pay
3
Certain Prepetition Amounts on Account of the Insider
4
Compensation Programs and (B) Continue the Insider
5
Compensation Programs in the Ordinary Course of Business on
6
a Postpetition Basis [D.I. 1792; filed August 8, 2014]
7
8
HEARING re Motion of Energy Future Holdings Corporation for
9
Entry of an Order Authorizing the Debtors to File Under Seal
10
the Certain Portions of Commercially Sensitive Information
11
Set Forth in the Debtors' Motion for Entry of an Order
12
Authorizing the Debtors to (A) Pay Certain Prepetition
13
Amounts on Account of the Insider Compensation Program and
14
(B) Continue the Insider Compensation Programs in the
15
Ordinary Court of Business on a Postpetition Basis [D.I.
16
1795; filed August 8, 2014]
17
18
19
20
21
22
23
24
Transcribed by:
25
and Melissa Looney
212-267-6868
Dawn South, Penny Skaw, Jamie M. Gallagher,
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A P P E A R A N C E S :
2
KIRKLAND & ELLIS
3
Attorneys for the Debtors
4
5
BY:
DAVID DEMPSEY, ESQ.
6
EDWARD SASSOWER, ESQ.
7
MARK MCKANE, ESQ.
8
CHAD HUSNICK, ESQ.
9
10
RICHARDS, LAYTON & FINGER, P.A.
11
Attorneys for the Debtors
12
13
BY:
14
DANIEL J. DEFRANCESCHI, ESQ.
JASON M. MADRON, ESQ.
15
16
FOX ROTHSCHILD
17
Attorney for TECH Unsecured Notes
18
19
BY:
L. JOHN BIRD, ESQ.
20
21
YOUNG CONAWAY STARGATT & TAYLOR, LLP
22
Attorney for Ad Hoc Committee of TCEH First Lien
23
Creditors
24
25
BY:
PAULINE K. MORGAN, ESQ.
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ASHBY & GEDDES
2
Attorney for WSFS, Trustee
3
4
BY:
STACY
NEWMAN, ESQ.
5
6
KLEHR HARRISON
7
Attorney for UMB Bank, Indenture Trustee
8
9
BY:
RAYMOND H. LEMISCH, ESQ.
10
11
UNITED STATES DEPARTMENT OF JUSTICE
12
Attorneys for the U.S. Trustee
13
14
BY:
RICHARD L. SCHEPACARTER, ESQ.
15
ANDREA B. SCHWARTZ, ESQ.
16
TIMOTHY J. FOX, JR., ESQ.
17
JULIET SARKESSIAN, ESQ.
18
19
COUSINS CHIPMAN & BROWN, LLP
20
Attorney for Ad Hoc Committee of EFIH Unsecured
21
Noteholders
22
23
BY:
MARK O. OLIVERE, ESQ.
24
25
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POLSINELLI
2
Attorney for the Committee
3
4
BY:
JUSTIN K. EDELSON, ESQ.
5
6
PACHULSKI STANG ZIEHL & JONES
7
Attorney for Computershare
8
9
BY:
JAURA DAVIS JONES, ESQ.
10
11
ALSO PRESENT TELEPHONICALLY:
12
13
BRIAN S. HERMANN
14
PEG A. BRICKLEY
15
MATTHEW BROD
16
MICHAEL L. DAVITT
17
ADAM M. DENHOFF
18
CRAIG W. DENT
19
MARITA ERBECK
20
BENJAMIN FEDER
21
KEELY HAMLIN
22
MARK F. HEBBELN
23
WILLIAM HILDBOLD
24
NAOMI MOSS
25
NED S. SCHODEK
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APARNA YENAMANDRA
2
ROBERT MALONE
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PATRICK STRAWBRIDGE
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5
6
7
8
9
10
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12
13
14
15
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21
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P R O C E E D I N G S
2
THE CLERK:
All rise.
3
THE COURT:
Please be seated.
4
Anything before we begin?
No?
Good morning.
All right.
5
Ms. Schwartz, call your witness.
6
MS. SCHWARTZ:
Good morning, Your Honor.
7
Schwartz for the United States Trustee.
8
Ms. Sarkessian, will be doing Mr. Panacio's direct.
9
THE COURT:
Okay.
10
MS. SCHWARTZ:
11
THE COURT:
12
THE CLERK:
14
(Witness Sworn)
15
THE CLERK:
Thank you.
Thank you, Your Honor.
Mr. Panacio, please take the stand.
Please raise your right hand.
Please state and spell your name for
the record.
17
18
My colleague,
There you are.
13
16
Andrea
THE WITNESS:
My name is Michael Panacio, P as in
Peter, A-N-A-C-I-O.
19
THE CLERK:
Thank you.
20
MS. SARKESSIAN:
Okay.
Good morning, Your Honor.
21
Juliet Sarkessian on behalf of the U.S. Trustee.
22
DIRECT EXAMINATION
23
BY MS. SARKESSIAN:
24
Q
Mr. Panacio, with whom are you employed?
25
A
The U.S. Trustee's Office.
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Q
And what is your position there?
2
A
I'm a bankruptcy auditor.
3
Q
Okay.
4
A
Fourteen years.
5
Q
Somewhat your education?
6
A
I have a bachelor in science degree in accounting and
7
economics.
8
Q
Do you hold any licenses?
9
A
I hold a CPA license with the State of Pennsylvania in
How long have you held that position?
10
good standing.
11
Q
When was that license issued?
12
A
1995.
13
Q
And approximately how long have you been practicing
14
accounting?
15
A
Accounting since 1982.
16
Q
Now, did you submit a declaration in these cases in
17
connection with the debtors' motion to pay certain bonuses
18
to officers?
19
A
I did.
20
Q
Were there certain exhibits attached to that
21
declaration?
22
A
There were.
23
MS. SARKESSIAN:
Your Honor, I have marked an
24
additional exhibit, which I have provided to opposing
25
counsel.
212-267-6868
I would like to provide the Court with a copy and
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also hand that to the witness, if it pleases the Court.
2
THE COURT:
3
MR. MCKANE:
4
THE COURT:
5
6
Yes.
No objection, Your Honor.
Thank you.
Do you have a copy for
Ms. Werkheiser?
(Pause)
7
THE COURT:
8
MS. SARKESSIAN:
9
Any objection?
Is this an unredacted copy?
That is correct, Your Honor.
Yes, Your Honor, this is an unredacted copy, and this is not
10
something that we have filed, and I will have Mr. -- I will
11
have Mr. Panacio explain exactly what this is.
12
THE COURT:
13
MR. MCKANE:
Very good.
Your Honor, for the purpose of this
14
-- Mark McKane, Kirkland & Ellis for the record.
15
purposes of the record could we have this new Exhibit 36
16
included with the unredacted binder set as to not have any
17
confusion down the road as to whether -- which set it should
18
be included in?
19
20
We can supplement that binder.
THE COURT:
will do so.
No, I have it here.
MR. MCKANE:
22
MS. SARKESSIAN:
I apologize, I realize that the
23
copies are not hole punched.
24
can send over hole punched copies.
THE COURT:
212-267-6868
We will -- we
Thank you.
21
25
For the
If that causes any problem we
It's fine.
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BY MS. SARKESSIAN:
2
Q
3
Trial Exhibit 36 and ask if you recognize that document?
4
A
I do.
5
Q
Okay.
6
do you know who created this document?
7
A
I did.
8
Q
And can you explain whether this document has any
9
relation to any of the exhibits that were attached to your
So, Mr. Panacio, I show you what has been marked as
And can you please -- well first of all who --
10
declaration?
11
A
This is in relation to Exhibit B to my declaration.
12
Q
And can you explain how -- what the relation is?
13
A
Well actually this is a revised updated version of
14
Exhibit B to my declaration.
15
Q
And in what way has it been revised?
16
A
Just two corrections.
17
the Luminant scorecards.
18
part reading those scorecards on the Luminant --
19
Q
20
identify --
The one correction is regarding
There was some confusion on my
Well let's just stop for a minute, I just want to
21
MS. SARKESSIAN:
And actually if I could point out
22
to the Court and opposing counsel as well, we have put in
23
larger font the numbers that have been changed just for ease
24
of reference so everybody knows what that is.
25
THE COURT:
212-267-6868
Oh, thank you.
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MS. SARKESSIAN:
Okay.
2
BY MS. SARKESSIAN:
3
Q
4
that in due course.
5
A
Okay.
6
Q
I just wanted to highlight that there were a few
7
changes.
8
A
Right.
9
Q
Okay.
So actually, Mr. Panacio, I will -- we'll come down to
Now, can you -- what I would like to do with
10
this document is I would like to go from the left column
11
over to the right column.
12
A
Okay.
13
Q
And in each instance I'm going ask you the type of
14
information that is contained there as well as where the
15
information comes from.
16
A
I understand.
17
Q
Okay.
18
to provide any numbers that appear on this chart unless I
19
specifically ask you, and we'll wait and give debtors'
20
counsel a moment if they have any issue with it.
21
understand that?
22
A
I understand.
23
Q
Okay.
24
the heading metric, could you explain what that information
25
is?
212-267-6868
Do you understand?
And I'm going to caution you to be careful not
Do you
So starting with the far left column that has
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A
These are the various performance metrics utilized by
2
the debtor.
3
Luminant, these are the various --
4
Q
5
bit?
6
A
Sorry about that.
7
Q
Okay.
8
A
These are the various performance metrics.
9
Q
Of the debtors, correct?
10
A
Of the debtors, correct.
11
Q
And where did you obtain this information?
12
A
I obtained the information from the specific scorecards
13
for each of the debtors.
14
Q
15
exhibit that is in evidence, it's Trial Exhibit 3 in your
16
binder, it should be the second item of the tab that says 3.
17
And I would ask you, is that the document you are referring
18
to as scorecards?
19
A
Yes, it is.
20
Q
Okay.
21
A
They range from 2009 through 2013.
22
Q
Then moving to the -- to the right we have five
23
columns, this is -- again, this is on Exhibit 36.
24
A
Okay.
25
Q
You have five columns with the heading 2009 actuals
In this particular instance I'm looking at
I'm sorry, Mr. Panacio, could you speak up a little
Okay.
212-267-6868
And I would like to turn your attention to an
And what years do those scorecards cover?
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through 2013 actuals.
2
numbers that appear there, could you explain in general
3
terms what that information is?
4
A
5
in the scorecards, based on the number of metrics were used
6
I calculated an average.
7
Q
Okay.
8
A
Oh, sorry.
9
Q
Okay.
10
A
These are the actual figures taken from the scorecards.
11
Q
Okay.
12
A
Actual performance, right.
13
Q
Okay.
14
Exhibit 3, correct?
15
A
Correct.
16
Q
Now, when we get to the column that says average,
17
again, without mentioning any particular figures, can you
18
explain what that information is and where it came from?
19
A
20
on the number of years the metric has been used.
21
these are numbers taken from the Luminant scorecards.
22
Q
23
with the average?
24
A
For example --
25
Q
I'm sorry, just -- that's a yes or no.
Yeah.
Okay.
Okay.
212-267-6868
And again, without stating any of the
They are the actual amounts that were provided
Well let's -- I'm not at the average yet.
And by actual you mean actual performance?
And scorecards again are referring to Trial
The column represents the actual average based
Again,
Did you do any type of calculation to come up
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1
A
Oh, yes.
2
Q
Okay.
3
A
Again, I'm not going to mention EBIDTA, but for
4
example, EBIDTA was used for five years, I totaled the
5
amount of each of the years, made a total, divided by five,
6
and calculated an average.
7
Q
8
columns headed 2014 threshold, 2014 baseline, and 2014
9
superior.
And then proceed.
Now, moving over further to the right there are three
Can you explain in general terms what -- what the
10
figures under those columns represent?
11
A
12
from the Filsinger table 1- -- I believe it was 1-4.
13
Q
1-4?
14
A
Right.
15
Q
And that's the debtors' expert witness, correct?
16
A
Correct.
17
Q
Okay.
18
explain where those figures came from?
19
A
20
well.
21
Q
22
-- what is your understanding of what that term means?
23
A
24
with the various metrics in calculating their bonuses.
25
Q
Okay.
Yeah.
These were the metric levels that I obtained
Then the next column says weight.
Can you
The figures came from the actual scorecards as
And what -- what does that term weight, what does that
It's my understanding it's the percentage associated
So if you add up the weight column all the figures it
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should total 100 percent, correct?
2
A
It should add -- right, 100 percent.
3
Q
Okay.
4
threshold versus average.
5
whether this is an number that you obtained from a document
6
or whether you calculated this?
7
A
This is a number I calculated.
8
Q
Okay.
9
and what it represents?
Now we get to the next column that says
And could you first clarify
And could you explain how you calculated this
10
A
For this particular column I took a threshold metrics
11
and subtracted from the actual average amounts.
12
Q
Okay.
13
A
For 2014, correct.
14
Q
And then the average is for the five years prior,
15
correct?
16
A
Correct.
17
Q
Okay.
18
clarify.
19
And by the threshold metrics you mean for 2014?
And then the next column -- oh, and let me just
With respect to dollar figures on this -- on this
20
chart do we need to add any zeros to get it to the actual
21
figure?
22
A
Yes.
23
Q
How many zeros do you need to add?
24
A
Regarding dollar figures it's six zeros, I mean
25
billions.
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Q
And the next column says superior versus average.
2
Could you clarify is this a number you calculated or did you
3
receive it from some source?
4
A
5
methodology I did with the threshold versus the average.
6
Q
7
superior target, correct?
8
A
Correct.
9
Q
To the average --
10
A
Correct.
11
Q
-- for five years?
12
A
Correct.
13
Q
And the next column to the right the heading is mid-
14
year June YTD actual.
15
are and where they came from?
16
A
17
Filsinger declaration.
18
Q
19
showing?
20
A
21
30th.
22
Q
23
of the metrics?
24
A
Correct.
25
Q
Okay.
This is number I also calculated using the same
And in this instance you were comparing the 2014
Yeah.
Could you explain what those numbers
These were figures I had taken from the
I believe it was table 1-3.
And what do these figures represent?
What are they
They're showing actual year to date as of June -- June
Performance -- actual year to date performance for each
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And the next column next to that says projection
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for full year.
2
calculated?
3
A
4
It's --
5
Q
Can you explain what it is and how you calculated it?
6
A
Yeah.
7
and multiplying by two.
8
Q
9
numbers for the -- for the full year of 2014?
Yeah.
Could you explain, is that something you
In this column -- I did calculate this column.
It was taken mid-year June year to date actual
And that -- your goal in doing that was to project
10
A
Right.
I took from the standpoint all things
11
considered equal for the first half of the year, I just
12
projected it out to the end of the year.
13
Q
14
versus target.
15
and where this came from?
16
A
17
exceeding the highest metric level whether it be threshold,
18
baseline, or superior.
19
Q
20
that, the projection that you made for the full year --
21
A
Right.
22
Q
-- and you compared that to the 2014 threshold,
23
baseline, and superior?
24
A
Correct.
25
Q
Okay.
And then we come to the final column, it's projection
Could you explain what this intends to show
It's our projection in the column previous to that
Okay.
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So just to clarify, you took the column before
Now, with respect to the EBIDTA figures -- I'm
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sorry, let me back up.
2
You have one chart -- is it correct you have one
3
chart for Luminant and then the second page relates to TXU,
4
correct?
5
A
Correct.
6
Q
And then the third page relates to the Business
7
Services, correct?
8
A
Correct.
9
Q
Okay.
So just keeping with the Luminant page for the
10
time being, when you look at the various metrics that the
11
debtors consider for determining bonuses which item is the
12
most heavily weighted?
13
A
The EBIDTA.
14
Q
Okay.
15
correct?
16
A
Correct.
17
Q
Okay.
18
A
I believe that was 40 percent.
19
Q
Okay.
20
metrics are, I would like you to distinguish, if you can,
21
between those metrics that are revenue driven and those that
22
are cost driven.
23
-- can you break that up a little for us?
24
A
25
EBIDTA, the available generation line items, coal -- the
Yeah.
212-267-6868
And that's the 37.5 percent for Luminant,
And what's the percentage for TXU?
Now, going back to the far left column where the
So looking at this Luminant page can you
I believe that the revenue-driven metrics are
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coal available generation and a nuclear generation line.
2
Q
3
typically want to see those revenue-driven numbers go up or
4
down?
5
A
Obviously going up.
6
Q
Okay.
7
that are listed here that are cross-driven metrics?
8
A
Correct.
9
Q
Okay.
And which ones are those?
10
A
Okay.
They're the Luminant O&M/SGA, the Luminant Cap
11
X, the Luminant fossil fuel costs.
12
Q
13
figures for a couple of years?
14
A
15
that's Cap X or Oak Road and Sandel (ph), I believe it's
16
just used for 2009.
17
Q
18
focus now is on the column that is headed threshold versus
19
average.
20
A
All right.
21
Q
And you've testified that that's a calculation that you
22
did preparing the 2014 thresholds with the average past
23
five-year actual performance, correct?
24
A
Correct.
25
Q
Okay.
So with respect to those numbers would a company
And then are there some items -- some metrics
And the bottom one there it looks like there was only
Yeah, the bottom -- the Luminant management EBIDTA
Okay.
212-267-6868
Now keeping with Luminant what I would like to
Okay?
And I am now going to ask you to focus on
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certain numbers that are in that column, and I'm going to
2
ask debtors' counsel if they have any problem with those
3
numbers being stated in court.
4
the copy that was filed?
5
MR. MCKANE:
They were not redacted on
Your Honor, if I could just confer
6
with my client.
7
because it's a five-year average and I don't think he can
8
back into any one of the -- one of the five-year actuals by
9
comparing a threshold to a five-year average.
10
I don't think that there's a problem
So, I don't
think we have a problem, but I just want to confer.
11
THE COURT:
12
MR. MCKANE:
Well the threshold amount is not.
The threshold amount is not, but if
13
you could -- and basically you can confer -- you can back
14
out what the five-year average is by using the threshold and
15
the difference.
16
THE COURT:
17
MR. MCKANE:
Right, so you have a problem with it.
And then I want to confirm that is
18
the five-year average itself sufficiently problematic?
19
think it is because we redacted it previously, so I'd ask
20
that --
21
MS. SARKESSIAN:
22
MR. MCKANE:
23
Well, no --
-- directionally discussed the
number --
24
25
I
THE COURT:
Ms. Sarkessian (indiscernible -
10:32:17).
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(Bench Conference)
2
THE COURT:
May I make a suggestion?
3
MS. SARKESSIAN:
4
MR. MCKANE:
5
THE COURT:
I think we've figured it out.
Please, Your Honor.
Okay.
Due to the sensitive nature I
6
think I have the numbers in front of me, I think we can
7
identify them by reference without ever actually having to
8
-- with EBIDTA and contribution margin.
9
MS. SARKESSIAN:
Your Honor, I do understand that,
10
I think we -- I think we've clarified.
11
they there certain numbers, the target numbers, they thought
12
those had been disclosed and they have not, they've been
13
redacted and will be filed.
14
any issue.
15
MR. MCKANE:
They thought that
So I think that we don't have
Your Honor, we're more comfortable
16
with the approach that you just recommended given, that it's
17
easier for everyone and it's more precautionary.
18
19
THE COURT:
Right.
Well if you tell me -- if I
know what the average is --
20
MR. MCKANE:
21
THE COURT:
22
MR. MCKANE:
23
THE COURT:
Right.
-- and I know the delta between -That's right.
-- and you tell me what the delta is
24
between average and threshold it's a simple mathematical
25
exercise to know what threshold is.
212-267-6868
So that's the problem.
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MS. SARKESSIAN:
No, Your Honor, because we're not
2
going to say what the average is, we're not going the say
3
what any of the targets are.
4
is what the -- the delta are between the threshold and the
5
average.
6
MR. MCKANE:
The only thing we're going say
And, Your Honor, just to be clear,
7
while it may be a redaction on this page the actual -- the
8
thresholds are -- have been disclosed throughout the
9
hearing.
10
So if you put out what the difference is you can
back into the average.
11
THE COURT:
Yeah, let's not use numbers in
12
connection with EBIDTA and contribution margin.
13
can adequately make your record by referencing what's there.
14
MS. SARKESSIAN:
15
THE COURT:
16
MS. SARKESSIAN:
17
manner.
18
BY MS. SARKESSIAN:
19
Q
I will --
And I can see and follow.
Okay.
I will proceed in that
So --
20
21
Okay, Your Honor.
I think you
MS. SARKESSIAN:
I'm sorry, Your Honor, I just
have to take a moment to make sure --
22
THE COURT:
23
MS. SARKESSIAN:
24
correctly.
25
BY MS. SARKESSIAN:
212-267-6868
That's fine.
-- that I phrase questions
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Q
So, Mr. Panacio, focusing on the EBIDTA number for
2
Luminant and the column that is threshold versus average,
3
okay, and we've already established that for all the dollar
4
figures on this page you need to add six zeros, correct?
5
A
Correct.
6
Q
Okay.
7
in parentheticals can you explain what that means?
8
without giving any figures what that means.
9
A
And if a number that appears in that column is
I want to be careful too.
Again,
It's the difference between
10
threshold and average.
11
Q
So if the number is negative --
12
A
It's a negative.
13
Q
What is that -- if the number is negative what does
14
that mean?
15
A
16
has dropped.
17
Q
18
target for 2014 --
19
A
EBIDTA level has dropped.
20
Q
The target --
21
A
The target levels.
22
Q
-- the target is lower by the number appearing in that
23
column --
24
A
Right.
25
Q
-- as compared with what the average performance was
Well for this particular metric your performance level
Okay.
212-267-6868
The -- well is it the -- you're comparing the
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for the last five years?
2
A
Correct.
3
Q
Okay.
4
5
Now -MS. SARKESSIAN:
Your Honor, if I can have a
moment?
6
THE COURT:
Uh-huh.
7
MS. SARKESSIAN:
Your Honor, I just want to put on
8
the record that with respect to the Luminant page the
9
debtors don't have any issue with any of the other numbers
10
appearing in that column, so --
11
THE COURT:
Okay.
12
MS. SARKESSIAN:
-- since nobody has an objection
13
I'm going to proceed with Mr. Panacio, and I will tell you
14
if you can actually state the figure, okay?
15
THE WITNESS:
Okay.
16
BY MS. SARKESSIAN:
17
Q
18
didn't do the comparison for the next -- next two things,
19
correct?
20
A
Correct.
21
Q
Permanent base load and coal available generation?
22
A
Correct.
23
Q
Because -- what was the reason for that that you didn't
24
do that comparison?
25
A
All right.
Dropping down now to -- there's no -- you
Well a couple reasons.
212-267-6868
One, the weight of the
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percentage scale has changed, or two, there wasn't
2
sufficient enough data to make that complete average.
3
Q
4
as metrics as far as you know based on the scorecards?
5
A
Those two no.
6
Q
Okay.
7
coal available generation June through September 15.
8
see that?
9
A
I do.
10
Q
Okay.
11
threshold versus average can you translate that figure --
12
now you can give the figure -- say what that figure is,
13
please?
14
A
15
19130 --
16
Q
17
no, no, no, no, no, wait.
18
MS. SARKESSIAN:
19
THE WITNESS:
And are they still -- is the debtor still using those
Those specific line items, no.
So then let's go down to the next one, which is
So if we go down to the column that says
Right.
Well yeah, I took the threshold number of
Well, whoa, whoa, whoa, whoa, whoa, whoa, whoa.
Sorry.
I'm sorry, Your Honor.
That's available.
BY MS. SARKESSIAN:
21
Q
That is --
22
A
Not EBIDTA or contribution.
23
Q
That's not EBIDTA.
24
number.
25
it's better to be a little extra careful.
Excuse me.
No,
Oh, wait, that's not --
20
212-267-6868
You
Okay.
I'm sorry.
You can say that
Sorry, I'm a little extra paranoid, but
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Okay.
So I'm sorry, you said that under 2014
2
threshold, right, that number is what, translated with the
3
extra zeros?
4
A
It's 19,138,000.
5
Q
Okay.
6
A
And the average of 20,299,000.
7
Q
Okay.
8
do you get?
9
A
It's about 1.1 negative.
10
Q
1.1 billion --
11
A
In the negative.
12
Q
-- negative.
13
that the threshold for 2014 for that metric is $1.1 billion
14
less than average actual for the last five years, correct?
15
A
Correct.
16
Q
Okay.
17
available generation, January through May and September 16
18
through December.
19
A
I do.
20
Q
Okay.
21
36 billion and change, correct?
22
A
Correct.
23
Q
Okay.
24
number?
25
A
And you compared that number to --
And when you'd make that comparison what number
It was a negative --
And when you say negative then that means
Going down to the next metric, which is coal
Do you see that?
So then the 2014 threshold for that is -- that's
And you compared that to again the -- what
The -- in this case we did a two-year average of
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37 billion -- 37.7 billion.
2
Q
3
information, correct?
4
A
Correct.
5
Q
Okay.
6
difference, again, shown in the column that says threshold
7
versus average?
8
A
9
negative $1.4 billion.
And that was because you only had two years of
And when you do that math what is -- what is the
Again it's -- I'm kind of rounding the number -- it's a
10
Q
Okay.
So again, that's showing that the 2014 threshold
11
is 1. -- approximately 1.4 billion less than the average
12
five-year actual performance of the debtors, correct?
13
A
Correct.
14
Q
Okay.
15
and again, if you could just explain the figure that appears
16
there.
17
A
18
19 -- like 19 billion and change, subtracting from the
19
average or 19.8 --
20
Q
And that --
21
A
-- and the difference is a negative 818,000,000.
22
Q
So again, the threshold in that instance is 818- less
23
than the average actual performance for the last five years,
24
correct?
25
A
And then the next item is nuclear generation,
What's that number?
Okay.
I believe these are units, not dollars.
It'd be
Correct.
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1
Q
Okay.
2
see that, correct?
3
A
I do.
4
Q
Okay.
5
threshold versus average there?
6
A
7
threshold amount, subtracted from the average, and I obtain
8
a positive 70 -- well, a positive 70.25.
9
Q
Okay.
10
A
Seventy million.
11
Q
Right.
12
number, correct?
13
A
That -- correct.
14
Q
Okay.
15
want that number to be higher or lower?
16
A
17
enhance performance.
18
Q
19
70 million higher than the average last five years, correct?
20
A
Correct.
21
Q
Okay.
22
Cap X.
23
A
Correct.
24
Q
Okay.
25
is one where you'll see under average that the font is
Okay.
Now when we move down to Luminant O&M/SGA.
You
Now, could you explain the number that's
Again, I took the threshold amount -- 2014
And that would be 70 million?
Seventy million.
Now that is -- that's a cost
So is that a number -- cost number, would you
Ideally you want the number obviously to be lower to
So in this instance the threshold is actually
212-267-6868
Now we get to the next column which is Luminant
Now let me just pause for a minute, because this
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bigger indicating this was something that was corrected,
2
right?
3
A
This was corrected, yes.
4
Q
Okay.
5
explain the 685-, what is that an average of?
6
A
7
2013.
8
Q
9
four, correct?
And could you explain -- well first of all
Well the 685- is an average from the year 2010 through
Okay.
And you added those together and divided by
10
A
Yeah, then divide by four, correct.
11
Q
Okay.
12
why the number was different previously?
13
A
14
card for 2009, I mistakenly included Luminant management
15
EBIDTA less Cap X.
16
negative 410- and that was again I wanted to make the
17
correction.
18
Q
19
Luminant Cap X on the scorecard?
20
A
That particular item they did not, right.
21
Q
Now, if you look here for that line item, threshold
22
versus average --
23
A
Yes.
24
Q
-- that is a negative 123 million, correct?
25
A
Correct.
Now previously can you just explain what the --
It's based on a scorecard, I guess the original score
Okay.
212-267-6868
The very last line item I included a
Because in 2009 they actually did not track the
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Q
Okay.
Now that's a figure you would want to be lower,
2
correct?
3
A
Right, reducing cost, right.
4
Q
Okay.
5
Cap X is actually lower than the average actuals for the
6
past four years, correct?
7
A
Correct.
8
Q
Okay.
9
this page, which is Luminant fossil fuel costs, and this is
So in this instance the threshold for Luminant
And then we get to the very last one here on
10
-- again, this is a cost, correct?
11
A
Correct.
12
Q
And the number that appears under threshold versus
13
average is .04 and that's a positive number, correct?
14
A
Correct.
15
Q
Okay.
16
slightly higher than the average for the past five years,
17
correct?
18
A
Correct.
19
Q
Okay.
20
we leave the Luminant chart --
21
A
All right.
22
Q
-- and focus on the last three columns to the right.
23
And I will remind you that the EBIDTA numbers shall not be
24
stated, okay?
25
A
And that means that the 2004 threshold is
Now, I also want to just go for a moment before
Correct.
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Q
And I just want -- going to your last column where
2
you've testified you've compared the projection that you
3
made for the full year by taking the half year and
4
multiplying it by two, and you compared that to the
5
threshold, the baseline, and the superior.
6
So with respect to Luminant what did that end up
7
being in terms of exceeding -- let's see -- either being
8
above or below the threshold, baseline, superior numbers?
9
A
Yeah.
Well we had four of the performance metric line
10
items where they exceeded either baseline or threshold or
11
superior.
12
Q
Okay.
13
A
Correct.
14
Q
Okay.
15
TXU.
16
A
Okay.
17
Q
And some of these metrics are different, correct, than
18
the Luminant?
19
A
Yes.
20
Q
Okay.
21
reminding you that no -- no numbers shall be stated.
22
A
Right.
23
Q
But focusing on your column threshold versus average.
24
This is a -- we've established that the numbers in
25
parentheticals mean less -- that the threshold is less than
212-267-6868
And that's what's indicated in that column?
Now, I'd like to turn to the next page, which is
So let's start with the EBIDTA numbers, again,
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the average, correct?
2
A
That's correct.
3
Q
Okay.
4
correct?
5
A
Correct.
6
Q
Okay.
7
superior and average the same thing, right?
8
A
Correct.
9
Q
Okay.
And you add the six zeros to every number,
And then you do the similar with respect to
Now let's go down to TXU total energy costs.
So
10
now, first let's clarify, is this a revenue-driven item or a
11
cost-driven item?
12
A
It is a cost-driven item.
13
Q
Okay.
14
those numbers to be lower rather than higher, correct?
15
A
Right, ideally you want them lower, right.
16
Q
Okay.
17
can be stated, so in this instance when you compare the
18
threshold to the average you have -- you're showing that the
19
threshold for 2014 is actually $53 million lower than what
20
the average was for the last five years, correct?
21
A
Correct.
22
Q
Okay.
23
correct?
24
A
Correct.
25
Q
Okay.
212-267-6868
So with respect to cost-driven items you want
So in this instance, and these are numbers that
And then the superior is 105 million below,
When we get to contribution margin, and these
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are numbers that we're not going to say, but the
2
contribution margin, is that revenue driven or cost driven?
3
A
It's revenue driven.
4
Q
Okay.
5
the higher number --
6
A
A higher number.
7
Q
-- than the lower number, right?
8
without saying the number we see what the number is in that
9
line.
So in that instance you would want a positive --
Okay.
And we --
10
A
Right.
11
Q
Going down to residential ending customer account.
12
you have a general understanding of what that is?
13
figure -- what that represents essentially?
14
A
15
which you want to enhance.
16
Q
Right.
17
A
And more customers, right.
18
Q
Okay.
19
-- the threshold for 2004 against the average actual for the
20
last five -- no three years -- four years, excuse me.
21
A
Four years.
22
Q
Four years, the threshold is actually 168 units less
23
than the average, correct?
24
A
Correct.
25
Q
And then for the superior versus the average the
Right.
212-267-6868
Do
What that
I would -- it's a metric or performance metric
We want to have more customers not --
So there when you compared the threshold against
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superior figure is 125 units less than the average, correct?
2
A
Correct.
3
Q
Okay.
4
that would be something you would want to increase, right?
5
A
Right.
6
Q
Okay.
7
against the -- let's see -- the average for -- I'm sorry.
8
I'm starting to -- I think I need to take a ruler to make
9
sure they're right.
10
Now the next item is customer satisfaction, so
So here when you compare the threshold for 2014
Make sure I'm getting the right numbers
here.
11
Okay.
So there when you made a comparison the
12
threshold is slightly less, 2.82 as compared with the
13
average for the last five years, correct?
14
A
Correct.
15
Q
Okay.
16
is, right?
17
A
Slightly above, right.
18
Q
Okay.
19
you have an understanding of whether that's a number that we
20
would want higher or lower?
21
A
22
tax or collection.
23
Q
Okay.
24
A
That's my understanding.
25
Q
All right.
And superior is slightly above what the average
Now the TXU average day sales outstanding, do
Well you want that lower as far as -- regarding AR to
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And here's it's -- the average is slightly
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-- slightly higher than the -- I'm sorry -- the threshold is
2
slightly higher than the average, correct?
3
A
Correct.
4
Q
TXU energizing event success, that's the next metric.
5
Is that something you want higher or lower in your
6
understanding?
7
A
My understanding is it'd be obviously something higher.
8
Q
Okay.
9
higher compared to the average, correct?
And it's here the threshold is very slightly
10
A
Correct.
11
Q
Okay.
12
this is one where a number was corrected for the 2014
13
threshold, correct?
14
A
That's correct.
15
Q
Okay.
16
the number you were using previously?
17
A
We were -- we used the non-insider metric.
18
Q
Okay.
19
A
That was accidental.
20
Q
Okay.
21
want that number lower rather than higher, right?
22
you did not --
23
A
Right.
24
Q
-- you went through an average here because --
25
A
Right.
212-267-6868
Then we get to the TXU customer complaints.
Now
And previously you had a number that -- what was
That was -- was that on purpose on an accident?
Customer complaints I think we'd all agree you'd
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Q
-- right, because there wasn't -- I see --
2
A
Yeah, sufficient --
3
Q
-- sufficient --
4
A
-- historical data, and we didn't do that.
5
Q
And one --
6
THE COURT:
I'm sorry.
Wait a minute, I'm sorry,
7
you talked over each other and you tailed off at the end,
8
so.
9
MS. SARKESSIAN:
I'm sorry, let me ask the
10
question again.
I apologize, Your Honor.
11
BY MS. SARKESSIAN:
12
Q
13
a comparison of the threshold versus average or superior
14
versus average, correct?
15
A
That's correct.
16
Q
And why didn't you do that comparison?
17
A
Because in 2012 there's actually a percentage figure
18
stated on a scorecard, in 2013 there was an actual number.
19
Q
Okay.
20
A
But it wasn't consistent so I didn't feel comfortable
21
doing any type of average on that.
22
Q
23
that a number you would want to have a higher number or a
24
lower number?
25
A
So in this instance for this number you did for the do
Okay.
So you --
Then when we get to TXU system availability, is
Higher number.
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Q
Okay.
And here we when you compared threshold versus
2
average it's very slightly lower than -- the threshold is
3
very slightly lower than the average, correct?
4
A
Correct.
5
Q
Okay.
6
column, which is again the projection for the full year
7
versus the targets, you've indicated in a number of cases
8
whether it exceeds a particular threshold, correct?
9
A
And then just stopping momentarily on the last
Right.
The highest metric -- the highest threshold --
10
the highest level above the metric.
11
Q
12
Business Services.
13
but -- and I would focus your attention on the column that
14
says threshold versus average, and this shows you the
15
difference between the 2014 threshold target and the average
16
performance for the last five years, correct?
17
A
Correct.
18
Q
And you add six zeros to the end, right?
19
A
Correct.
20
Q
Okay.
21
I'm sorry -- the next two metrics, Luminant's scorecard
22
multiplier and TXU's scorecard multiplier, and these are in
23
percentages, right?
24
A
Correct.
25
Q
Okay.
Then we're going turn to the last page, which is for
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Again we won't mention EBIDTA numbers,
Correct.
We then have the next -- the next two figures --
And if you compare -- do you have a -- do you
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have a general understanding of what these metrics are meant
2
to reflect?
3
A
A general understanding, yes.
4
Q
Okay.
5
terms of --
6
A
7
understanding it's taking into consideration the various
8
weighted scales on those Luminant performance metrics, and
9
the same scenario with the TXU Energy scorecard as well.
Could you -- could you just explain that in
Well the Luminant scorecard multiplier it's my
10
Q
So when you look at the targets for like 2014
11
threshold, for example, Luminant's scorecard multiplier is
12
50 percent, that is -- you're showing that as being 80
13
percent lower than what the average was for the last five
14
years, right?
15
A
Correct.
16
Q
And then when you go down to the last total, the EFH
17
total spend and the EFH Business Services SG&A direct costs,
18
those are dash those are cost-driven figures, correct?
19
A
Correct, they're cost driven, right.
20
Q
Okay.
21
than higher, right?
22
A
Right.
23
Q
And in fact for the EFH total spend the numbers -- when
24
you compare the threshold to the average and the superior
25
average it is actually lower, correct?
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So you want those figures to be lower rather
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A
They are actually lower, right.
2
Q
Okay.
3
it's a little bit higher, right?
4
A
Slightly higher, right.
5
Q
Okay.
6
But then when you get down to the direct cost
You can put that exhibit aside for the moment.
I would like to ask you, did you do any
7
calculations relating to the debtors' metrics for EBIDTA
8
that were not reflected on the charts?
9
A
I did.
10
Q
Okay.
11
A
I compared the actual EBIDTA to the threshold,
12
baseline, and superior targets for each of the years of 2009
13
through 2013 for Luminant, TXU, and Business Services.
14
Q
Okay.
15
A
Yes.
16
Q
Okay.
17
actual results with the threshold, baseline, superior
18
targets that were set for that particular year, right?
19
A
Correct.
20
Q
Okay.
21
got those figures and then did you average them in some
22
fashion?
23
A
24
threshold amount, and obtain a difference, and I did that
25
for each, you know, consecutive years.
And what did you compare?
So you looked at each year separately, right?
And you -- for each year you were comparing the
How did you -- so -- okay.
So you put -- you
Right, I took the actual EBIDTA, subtracted the
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Took a five-year
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average and converted it to a percentage.
2
Q
Okay.
3
4
MS. SARKESSIAN:
Your Honor, may I ask counsel a
question?
5
THE COURT:
6
Yeah.
(Pause)
7
BY MS. SARKESSIAN:
8
Q
9
these numbers -- testifying to these numbers.
So I've clarified it's not a problem with you giving
So I'm going
10
to ask you, could you tell us when you -- when you looked at
11
the Luminant EBIDTA -- when you looked at the actual results
12
compared to the threshold targets for each year and then you
13
average them over the five years what -- what figure did you
14
get?
15
A
16
EBIDTA it exceeded threshold amounts by 20.86 percent.
17
Q
Okay.
18
A
20.86.
19
Q
All right.
20
baseline, when you compared the baseline target for each
21
year against the actual and then averaged it out what was
22
that number?
23
A
It exceeded by 4.74 percent.
24
Q
Okay.
25
the target?
Yeah, for the Luminant -- for Luminant management
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By 20.86?
And how about the -- how about the
The target -- I'm sorry -- the actuals exceeded
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A
The actuals exceeded baseline target, right.
2
Q
Okay.
3
A
The superior was not met.
4
Q
Okay.
5
when you looked at the actual EBIDTA for each separate year
6
and you compared it to what the threshold target was and
7
then you average it over the five years what -- what number
8
did you get?
9
A
And then how about for the superior target?
And then the same question with respect to TXU
Well the TXU EBIDTA exceeded threshold levels by 42.42
10
percent.
11
Q
And how about the baseline?
12
A
Exceeded baseline by 13.54 percent.
13
Q
And how about superior?
14
A
3.52 percent.
15
Q
Okay.
16
respect to TXU the actuals in every instance exceeded not
17
only the threshold, baseline, and superior as well?
18
A
For TXU, yes.
19
Q
Okay.
20
when you compared -- when you did that calculation for the
21
threshold targets what did you find?
22
A
23
metric amounts by 22.68 percent.
24
Q
Okay.
25
A
2.26 percent.
So the -- just to clarify, so on average with
Now with respect to the Business Services EBIDTA
The EBIDTA exceeded threshold amount -- the threshold
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And how about baseline targets?
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Q
Is that exceeded or on --
2
A
Exceeded.
3
Q
Okay.
4
A
And the superior was not met.
5
Q
If you looked at -- now you were just talking about
6
your averages over the last five years, but if you looked at
7
each one of the five years separately for 2009 to 2013 was
8
there any year in which Luminant, TXU, or Business Services
9
did not -- that their actual performance did not exceed the
It actually exceeded the baseline.
And then how about superior?
10
threshold EBIDTA target?
11
A
12
year.
13
Q
Okay.
14
A
But never below threshold.
15
Q
Okay.
16
separately were there any years in which Luminant, TXU, or
17
Business Services did not meet the baseline EBIDTA target,
18
the next higher target?
19
A
20
baseline target.
21
Q
But the rest of the years they did --
22
A
Yeah.
23
Q
-- exceed baseline?
24
A
Yes.
25
Q
Okay.
Threshold -- they met the threshold consistently every
So -- but never below the threshold?
And then again looking at each five years
Yeah, I believe TXU Energy in 2011 did not meet the
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Right.
Now, Mr. Panacio, I'm going draw your attention
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to an exhibit that I believe has already been entered into
2
evidence, Exhibit 34 -- Trial Exhibit 34, and that should be
3
in your binder.
4
A
Okay.
5
Q
Okay.
6
A
I do.
7
Q
Okay.
8
A
I do.
9
Q
Okay.
10
A
I did.
11
Q
Does it have any relationship to any of the documents
12
that were attached to your declaration?
13
A
It's an exhibit attached to my declaration I believe.
14
Q
Are there any changes in this version as compared to
15
what was attached to your declaration?
16
A
17
and there was one entity, we had a transposition error on
18
Exelon Corporation, you do see the corrected amount for 2012
19
at 2.5-.
20
Q
Okay.
21
A
Million.
22
Q
Now can you explain in general terms what -- what this
23
document shows?
24
A
25
insider compensation PowerPoint presentation they referred
Do you have that?
Do you recognize this document?
And who created this document?
There was some changes regarding rounding differences
Net income of 2.5 million.
Reading the Frisky (ph) declaration and reading the EFH
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to peer group companies using the basis for -- you know, for
2
generating their bonus programs.
3
these peer group companies were actually comparable to EFH.
4
Q
5
of the first page that is EFH, correct?
6
A
That's correct.
7
Q
Okay.
So the -- in other words the company that's on the top
8
9
And -THE COURT:
Are we -- I missed what exhibit we're
on.
10
11
MS. SARKESSIAN:
THE COURT:
13
MS. SARKESSIAN:
That's my fault.
THE COURT:
16
MS. SARKESSIAN:
17
THE COURT:
my apologies.
It's the MOR?
Okay.
No, okay.
No, it's -I see it.
Thank you.
Sorry,
You better actually back up then.
19
MS. SARKESSIAN:
20
THE COURT:
21
MS. SARKESSIAN:
22
BY MS. SARKESSIAN:
23
Q
Yeah, we'll back up.
My apologies.
Okay.
So, I think -- let me back up too.
24
25
-- 34, which my understanding has
already been admitted into evidence on consent.
15
18
Oh, I'm sorry, Your Honor, it's
Exhibit --
12
14
But I wanted so see if
So what -- is you already testified that this
document was attached to your declaration but it just had a
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few corrections, right?
2
A
Correct.
3
Q
Okay.
4
this document is.
5
document, if you could just repeat that for the judge now
6
that he has it in front of him.
7
A
8
and EFH insider compensation PowerPoint presentation, I
9
think it was August 6th, they reference peer group
Sure.
So -- and then I asked you what the intention of
What do you -- what do you show on this
Based on my reading of the Frisky declaration
10
companies, which EFH kind of mirrors developing their own --
11
the bonus programs for executives.
12
these peer group companies are actually comparable to EFH.
13
Q
14
have EFH, correct?
15
A
I do.
16
Q
Okay.
17
here, where did you get the names of these companies?
18
A
19
declaration and from the EFH insider compensation PowerPoint
20
presentation.
21
Q
22
document, which is also in evidence as Exhibit 5, that
23
should be in your binder.
24
compensation document you were referring to?
25
A
Okay.
So I wanted to see if
So on the first page at the top you actually
Now the rest of the companies that are shown
Well the names -- two places actually.
From the Frisky
And I'm just going call your attention to that
And ask if this is the insider
Yes.
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Q
Okay.
And do you recall what page actually showed the
2
-- the peer group companies?
3
A
It is page 63.
4
Q
Okay.
5
I would also ask you is there a page in this document that
6
indicates from the companies that are listed on page 63 what
7
type of metrics they use?
8
as a metric.
9
document --
Now, I'd like to, while you're on that document,
For example, if they use EBIDTA
Do you recall there being something in this
10
A
In this particular document, page 61 --
11
Q
Uh-huh.
12
A
-- the energy related companies use these various
13
metrics as a model in calculating their bonus programs.
14
Q
15
percentage of the companies -- these -- what we'll call peer
16
group companies --
17
A
Uh-huh.
18
Q
-- used EBIDTA as a metric in connection with the bonus
19
program?
20
A
21
particular page from the Towers Watson's study looking at
22
the year 2013, 20 percent of these companies use EBIDTA.
23
Q
24
which is Exhibit 34.
25
A
Okay.
Right.
Okay.
And what does it show in terms of what
Well again, understanding the -- this
Now going back to the document you created,
Okay.
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Q
So the information with respect to the debtors and the
2
various other companies that are listed there, the operating
3
revenues, the net income or loss, and the long-term debt,
4
where did you get that information from?
5
A
From the SEC 10-K reports.
6
Q
Okay.
7
peer groups in the -- excuse me -- EFH insider compensation
8
materials from August 6, 2014?
9
that you did not conclude on this chart?
And were there any companies that were listed as
Where there any in there
10
A
I did not include American Electric Power Company and
11
the Dominion Resources, Inc.
12
Q
And why did you not include them?
13
A
I could not find any information on the -- you know,
14
regarding the SEC reports, the 10-Ks.
15
Q
16
obviously numbers that are in parentheticals indicate
17
losses, correct?
18
A
Correct.
19
Q
And are these numbers also in billions?
20
A
They are in billions.
21
Q
Okay.
22
years shown, correct?
23
A
Correct.
24
Q
Okay.
25
you know, peer group, that show net losses for any of these
Now looking at the column for net income or loss,
212-267-6868
And the debtor shows net losses for those three
Are there any other companies listed from this,
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years?
2
A
3
had a net loss.
4
Q
Okay.
5
A
But for the most part consistently they had a net
6
income.
7
Q
8
think the only other one I see on the last page is NRG --
9
I'm sorry, second to the last page -- NRG Energy has a loss
There are a few companies in specific years that have
Okay.
So I see Cap Line for 2011 had a loss, and I
10
in 2013, correct?
11
A
Correct.
12
Q
And the rest of them for all the rest of the years
13
they're showing a net income gain, correct?
14
A
Correct.
15
Q
Okay.
16
have the same -- approximate same amount of long-term debt
17
as the debtor does?
18
A
The closest on comparable is Duke Energy Corporation.
19
Q
Okay.
20
A
That's the bottom of the first page, yeah.
21
Q
All right.
22
Duke Energy versus EFH and the numbers are -- look to me to
23
be exactly the same, right?
24
A
Virtually the same, right.
25
Q
38.2 billion, correct?
212-267-6868
Now are there any companies on this chart that
And that's the bottom of the first page, right?
And if you compare the years 2013 for that
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A
Correct.
2
Q
Okay.
3
net income for the last three years, correct?
4
A
Correct.
5
Q
Okay.
6
to look at net income for these companies, these other
7
companies?
8
A
9
these comparable companies, did they have the ability to
Yet Duke Energy has shown net income -- positive
So can you just explain why it was that wanted
Well, I wanted to see the -- the financial condition of
10
consistently pay bonuses of various -- to the various
11
executives, and I wanted to see if they actually can -- to
12
be able to service their long-term debt as well.
13
Q
14
Exhibit 28, so that should also be in your binder?
I'm going to ask you to turn to what's been marked as
15
THE COURT:
16
MS. SARKESSIAN:
17
THE COURT:
18
28?
28.
Thank you.
(Pause)
19
MS. SARKESSIAN:
20
THE COURT:
21
MS. SARKESSIAN:
22
THE COURT:
Has Your Honor found that?
I have.
Okay.
Thank you.
23
BY MS. SARKESSIAN:
24
Q
Mr. Panacio, have you seen this document before?
25
A
Yes.
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Q
And who created this document?
2
A
I did.
3
Q
Okay.
4
the exhibits that were attached to your declaration?
5
A
Yes.
6
Q
Okay.
7
A
Correct.
8
Q
Okay.
9
to this as far as you know?
And does this document have any connection to
This was Exhibit D to your declaration, correct?
And were there any changes that have been made
10
A
This particular exhibit, no.
11
Q
Okay.
12
that's on this exhibit, what this shows?
13
A
14
Competitive Holdings Company, which has an indirect
15
ownership interest in Luminant and TXU.
16
Q
And then you also show information for EFH as well?
17
A
And information from the year 2009 through the year
18
2013 providing operating revenues, net income, in this case
19
net losses for most part, the working capital, and the long-
20
term debt.
21
Q
22
reviewed to put together the exhibits to your declaration
23
and also the information that is reflected in your
24
declaration, which some of which you've testified to today.
25
And I assume nobody has any objection he will actually look
Now, could you just explain the information
Well EFCH obviously it stands for Energy Future
Mr. Panacio, I'd like to ask you what documents you
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at his declaration to refresh your recollection.
2
would that be helpful?
3
A
That'd be helpful, yes, it would.
4
Q
Okay.
5
Exhibit 24.
6
A
Right.
7
Q
Okay.
8
currently for purposes of using it in court.
9
A
Okay.
Is that --
So your declaration is -- is marked as
That is not in evidence.
It's just marked
I looked at the debtors' motion to pay certain
10
prepetition amounts on accounting insider compensation
11
programs, and continuing insider compensation programs in
12
the ordinary course of business.
13
insider compensation discussion materials PowerPoint
14
presentation.
15
Q
And we've identified that as Exhibit 5, correct?
16
A
Correct.
17
Q
Sorry.
18
A
I took a look at the declaration of Todd Filsinger in
19
support of the debtors' motion, the declaration of Douglas
20
Frisky in support of the debtors' motion, and --
21
Q
Maybe you could summarize --
22
A
-- and I looked over various scorecards for Luminant,
23
TXU, and business services from 2009 through 2013.
24
Q
Okay.
25
A
The SEC reports, 10-Ks.
212-267-6868
I looked at the EFH
Go ahead.
Anything else?
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Q
Okay.
If you'd just look at the top of page 3 just to
2
refresh your recollection, did you look the those documents
3
of paragraph 4?
4
A
5
-- obviously look at table 1-4 and 1-3.
6
Q
And that had what kind of information?
7
A
That had the actual (indiscernible - 11:12:14) June
8
results for the second half of the year and actually had the
9
insider metric performance levels.
Oh, correct.
With the Filsinger declaration I did look
10
Q
Okay.
11
A
That's it.
12
Q
Okay.
13
make sure your answer was.
14
Is that it?
I'm sorry, I'm not finished yet, I just want to
Okay.
Mr. Panacio, were you in court last Wednesday when
15
Mr. McFarland testified?
16
A
Mr. McFarland, yeah, I was.
17
Q
Okay.
18
hedging gains -- or gains from -- hedging gains for the
19
years 2012 and 2013?
20
on that?
21
A
I do recall that.
22
Q
Okay.
23
gave?
24
A
25
it was somewhere in the neighborhood of like 1.8 billion,
Do you recall him testifying to the amount of
Do you recall he gave some testimony
Do you recall in particular what numbers he
Again, just based on memory, I believe in the year 2012
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and in 2013 I guess -- I think it was close to a billion
2
dollars.
3
Q
4
debtors' public filings that would refer to gains made in
5
connection with hedging?
6
A
The only document I noticed that was in the 10-K --
7
Q
Okay.
8
A
-- 2013.
9
Q
Okay.
Okay.
10
11
Now do you recall seeing anything in any of the
MS. SARKESSIAN:
And, Your Honor, I would like to
provide copies of that to the Court and the witness, please.
12
THE COURT:
13
Okay.
(Pause)
14
BY MS. SARKESSIAN:
15
Q
16
as Exhibit 37, is -- could you identify this document,
17
please.
18
A
19
Holdings Company LLC.
20
Q
21
previously?
22
A
Yes, previously.
23
Q
Okay.
24
there's no objection I would like to call the witness's
25
attention to particular pages so he doesn't have to rifle
So the document that I've handed you, which I've marked
This is the form 10-K for Energy Future Competitive
Okay.
212-267-6868
And do you recall seeing this document
Because this is such a large document and if
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through.
2
THE COURT:
3
MR. MCKANE:
4
BY MS. SARKESSIAN:
5
Q
THE COURT:
By either of us.
I apologize.
(Laughter)
8
9
No objection.
Now, I'd first like to call your attention --
6
7
No objection.
MR. MCKANE:
You stole my line.
BY MS. SARKESSIAN:
10
Q
I'd first I call your attention -- I would like to
11
first call your attention to page 159 -- it's 159 of 325 it
12
says in the upper right corner.
13
A
Okay.
14
Q
Just give everybody a minute to get there.
15
I got it.
And is there any information -- well first of all
16
what are we -- what are we looking at on this page?
17
A
We are looking at the income statement.
18
Q
Okay.
19
A
For Energy Future Competitive Holdings Company LLC.
20
Q
Okay.
21
relates to gains or losses from hedging activity?
22
A
23
hedging and trading activities.
24
Q
Okay.
25
A
A loss of $54 million.
So is there any information on this page that
The third line item net gain loss from commodity
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Q
Okay.
2
A
A gain -- or a net gain of $389 million.
3
Q
Okay.
4
that Mr. McFarland testified to, right?
5
A
Yes.
6
Q
Okay.
7
page, which in the upper right-hand corner says page 93 of
8
325.
9
So these numbers are different than the ones
And I'd like to call your attention to another
THE COURT:
10
11
And what number does it have for 2012?
I'm sorry, what number?
MS. SARKESSIAN:
Ninety-three of 325 in the upper
right corner.
12
THE WITNESS:
Okay.
13
BY MS. SARKESSIAN:
14
Q
15
relates to hedging?
16
A
17
sentence, "Natural gas positions have resulted in the
18
reported gains losses as follows."
19
Q
20
you're looking at the little chart in the middle of the
21
page, right?
22
A
Correct, I'm looking at the little chart, right.
23
Q
So then the line that says net realized gains, what
24
does that show for 2013/2012?
25
Q
Okay.
And is there any information on this page that
I guess about the middle of the page there's a
Okay.
And then where it says net -- the first --
2013 is 998 million, and 2012 is $1.8 billion.
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Q
So that's similar to the numbers Mr. McFarland
2
testified to, right?
3
A
Yes.
4
Q
Okay.
5
that show?
6
A
7
reversals of previously recorded amounts related to position
8
(indiscernible - 11:17:27).
9
Q
And then below that what's the next line below
It showed the unrealized net losses, including
And those are various negative numbers in the billions,
10
correct?
11
A
12
right.
13
Q
14
those two lines, correct?
15
A
Correct.
16
Q
And what does that show for 2013/2012?
17
A
2013 has a loss of 35 million.
18
Q
And how about 2012?
19
A
2012 is a $293 million net gain.
20
Q
Okay.
Yeah, they're -- right, they're offsetting the losses,
And then when you -- the third line is the total of
21
MS. SARKESSIAN:
Your Honor, I would just ask the
22
Court's preference as to moving in my -- I have a few
23
exhibits that have not been moved into evidence.
24
to do that now or after they finish their cross-examination?
25
THE COURT:
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Do we want
Let's -- well let's see if we can move
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them in now.
2
MS. SARKESSIAN:
3
THE COURT:
All right.
And if there are any issues we can
4
identify them and we may wait for cross to see if they're
5
resolved.
6
MS. SARKESSIAN:
Okay.
So first I would like to
7
move in the Exhibit 36, which is the corrected charts that
8
were previously attached to Mr. Panacio's declaration as
9
Exhibit D.
10
MR. MCKANE:
11
THE COURT:
12
13
All right.
It's admitted without
objection.
(Trial Exhibit No. 36 was admitted)
14
15
We have no objection to 36.
MR. MCKANE:
And just for the purposes of the
record we'd ask that the file copy be redacted for 36.
16
THE COURT:
Yes, of course.
17
MR. MCKANE:
18
MS. SARKESSIAN:
The next exhibit I have is --
19
well Trial Exhibit 34, which was Exhibit C to Mr. Panacio's
20
declaration.
21
admitted into evidence, correct?
My understanding that it's already been
That's the peer company --
22
THE COURT:
23
MS. SARKESSIAN:
24
And then I would move for admission of Trial
25
Yes.
-- right?
Okay.
Exhibit 28, which was Exhibit D to Mr. Panacio's
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declaration.
2
MR. MCKANE:
3
THE COURT:
4
No objection.
Okay.
5
MS. SARKESSIAN:
And finally I would move for
6
admission of the 10-K of Energy Future Competitive Holding
7
Company LLC.
8
THE COURT:
9
MR. MCKANE:
10
THE COURT:
11
37.
37, no objection.
All right.
12
MS. SARKESSIAN:
13
THE COURT:
14
You're welcome.
(Pause)
15
MR. MCKANE:
16
THE COURT:
17
MR. MCKANE:
May I proceed, Your Honor?
Yes.
For the record, Mark McKane of
18
Kirkland & Ellis on behalf of the debtors.
19
CROSS-EXAMINATION
20
BY MR. MCKANE:
21
Q
Good morning, Mr. Panacio.
22
A
Good morning, Mr. McKane.
23
Q
Now, sir, you've worked at the UST -- the United States
24
Trustee's Office for about 14 years, correct?
25
A
Correct.
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Q
And you've been an auditor in that capacity during that
2
time?
3
A
I have.
4
Q
And you've been an accountant for over 30 years?
5
A
Correct.
6
Q
And in your 30 years of experience as an accountant you
7
have not designed any compensation plans, have you?
8
A
I have not.
9
Q
And you've not worked in the energy industry before?
10
A
I have not.
11
Q
And you've never been involved in the budgeting process
12
of a power company, correct?
13
A
I have not.
14
Q
Okay.
15
incentive compensation plans, have you?
16
A
I have not.
17
Q
And you did not review the 2014 budget for EFH,
18
Luminant, or TXU Energy in preparing to testify today?
19
A
I have not.
20
Q
And, sir, you do not consider yourself an energy or
21
power expert do you?
22
A
I'm not an expert, no.
23
Q
And you don't consider yourself an expert in executive
24
compensation packages either do you?
25
A
And you have not chosen metrics to use with
Right, correct.
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Q
And, sir, in your role as an accountant you've read the
2
entire Filsinger declaration, right?
3
A
Excuse me.
4
Q
And, sir,
5
declaration that you found incorrect?
6
Yes.
is there anything in the Filsinger
MS. SARKESSIAN:
7
an expert in the area.
8
BY MR. MCKANE:
9
Q
Objection, Your Honor, he's not
Well, sir, let me just ask you another way.
10
Is there anything in the Filsinger declaration
11
report that you found incorrect as an accountant?
12
A
No.
13
Q
Okay.
14
that you did, specifically regarding an evaluation of the
15
metrics in relation to a five-year historical average, okay?
16
A
Okay.
17
Q
All right.
18
conclusions as to whether the debtors' metrics are
19
incentivizing are you?
20
A
I am not.
21
Q
All you're doing is trying to present data for others
22
to make that conclusion, correct?
23
A
That is correct.
24
Q
And, sir, the average of the historical numbers you
25
compared them, you took that five-year historical average
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Sir, let's turn to the first set of analysis
Sir, you're not providing any opinions or
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and did a comparison to this year's metrics, correct?
2
A
That is correct.
3
Q
And you just took a standard average, correct?
4
A
That's correct.
5
Q
And then in comparing the five-year average to the
6
actuals you only looked to see if the metric was above or
7
below the actuals, correct?
8
A
That is correct.
9
Q
In essence you prepared a variance report, right?
10
A
That's correct.
11
Q
And to perform the analysis that you did you didn't
12
actually need to understand any of the underlying analysis
13
that led up to those metrics, correct?
14
MS. SARKESSIAN:
15
THE COURT:
16
MS. SARKESSIAN:
17
Objection.
Basis?
I think the question is
confusing.
18
THE COURT:
19
question, Mr. Panacio?
20
THE WITNESS:
Well, I don't -- do you understand the
Sorry, can you repeat the question
21
one more time?
22
BY MR. MCKANE:
23
Q
Sure.
24
A
Right.
25
Q
-- right, you understand that they were set by
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professionals at EFH, right?
2
A
That is correct, right.
3
Q
And you understand that there was a considerable
4
process that led up to the decision to make one metric a
5
threshold, the actual numbers within the metrics, you
6
understand that?
7
8
MS. SARKESSIAN:
Objection, it's outside of this
witness' knowledge.
9
THE COURT:
10
MR. MCKANE:
Where are you trying to go with that?
Sir, I just want to establish to do
11
the analysis that he did it's absolutely wholly independent
12
of this company or this process.
13
couple different ways.
14
15
THE COURT:
Well why don't you just -- all right,
I see where you're headed.
16
MR. MCKANE:
17
THE COURT:
18
I can -- I can do this a
Well, actually -Try to phrase it precisely, if you
could.
19
MR. MCKANE:
Sure.
20
BY MR. MCKANE:
21
Q
22
understand the underlying performance of the company,
23
correct?
24
A
That's correct.
25
Q
And you didn't need to understand how market conditions
To do the variance analysis you did you didn't need to
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for this company may have changed over the years, correct?
2
MS. SARKESSIAN:
Your Honor, I'm still going to
3
object to the form of question as to what he needed to
4
understand.
I think it's confusing.
5
THE COURT:
6
MS. SARKESSIAN:
7
10
He could ask what he took into
account and what he didn't take into account perhaps.
8
9
I don't --
THE COURT:
Yeah, I don't like the use of the
words understand, I think it's a way to -- or a loaded word,
so.
11
MR. MCKANE:
I'll rephrase.
12
BY MR. MCKANE:
13
Q
14
account for any changes in market conditions over time,
15
correct?
16
A
Correct.
17
Q
And to perform the averaging you did it was wholly
18
independent of the type of company EFH is, right?
To perform the analysis that you did you did not
19
MS. SARKESSIAN:
20
THE COURT:
21
THE WITNESS:
Objection to form.
Overruled.
Well, I strictly used the data on
22
the particular scorecards, right.
23
BY MR. MCKANE:
24
Q
25
of the company or the industry that EFH is in, right?
Right.
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A
Correct.
2
Q
Now, sir, in performing that analysis you did not take
3
into account any impact on any of the numbers from the
4
company's hedging program; is that right?
5
A
That is correct.
6
Q
And you did not consider the impact of the hedging
7
program on a number like EBIDTA because you did not know
8
what that impact was, right?
9
A
I did not know specific details of the impact, correct.
10
Q
Right.
11
United States Trustee's Office you know that the United
12
States Trustee's Office gets involved in bankruptcies even
13
before the bankruptcy filing occurs, correct?
14
A
Correct.
15
Q
And you understand that representatives from the United
16
States Trustee's Office was in court on the first day for
17
the first day hearing?
18
A
Right.
19
Q
And --
20
21
MR. MCKANE:
24
25
Your Honor, I request to approach and
mark an exhibit.
22
23
Now, sir, based on your experience at the
THE COURT:
All right.
identification purposes.
We'll mark this 38 for
Thanks.
(Trial Exhibit No. 38 was marked)
BY MR. MCKANE:
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Q
Mr. Panacio -- Panacio, I apologize.
2
marked for identification purposes as Exhibit 38 was the
3
first day presentation by Mr. Sassower.
4
mark because there's no pages --
5
A
Okay.
6
Q
-- no page numbers, excuse me -- because there's no
7
page numbers I've put a flag on the page that I'd like to
8
cover.
9
A
Okay.
10
Q
Do you see it, sir?
11
A
I do.
12
Q
It's the -- it's a slide from Mr. Sassower's
13
presentation that discusses how the company used a long-term
14
hedging program to stabilize cash flows and minimize
15
downside risks from natural gas prices.
16
sir?
17
A
I see that.
18
Q
And, sir, do you see the cash flows from hedging
19
activities that are identified on that page, sir?
20
A
I do.
21
Q
And, sir, the amounts presented for 2011, '12, and '13,
22
do you recognize those, sir?
23
A
I do.
24
Q
And, sir, those -- you were here for Mr. McFarland's
25
testimony?
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What has been
I'd ask that you
Do you see that,
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A
Yes.
2
Q
Are those the numbers for '11, '12, and '13 consistent
3
with Mr. McFarland's testimony?
4
THE COURT:
5
THE WITNESS:
If you know.
The year 2012 I recognize that --
6
2011 is it slightly off a bit, but it's in the ballpark,
7
right.
8
BY MR. MCKANE:
9
Q
It's in the ballpark.
10
A
Right.
11
Q
And, sir, did anyone from the United States Trustee's
12
Office provide you with Mr. Sassower's presentation for your
13
consideration in preparing to testify today?
14
A
No.
15
Q
Sir, you referred to the 10-K for EFCH in your
16
testifying -- when discussing the hedging program; do you
17
recall that, sir?
18
A
Yes.
19
Q
And in particular I believe you focused part of your
20
testimony on page the 93.
21
A
Okay.
22
THE COURT:
23
MR. MCKANE:
Where are we?
It's page 93, Your Honor, of
24
Exhibit 37, it is the multi 100-page document that is the
25
2013 10-K.
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2
THE COURT:
All right.
It was previously -- okay,
I'm here.
3
MR. MCKANE:
4
THE COURT:
All right.
I'm there.
5
BY MR. MCKANE:
6
Q
7
that -- one of the pages that I believe was covered in his
8
direct examination.
And, sir, if we could go to page 93, which is the page
9
THE COURT:
Got it.
10
BY MR. MCKANE:
11
Q
Are you with me, sir?
12
A
Yes.
13
Q
Sir, from an accounting perspective do you understand
14
there's a difference between mark to market accounting and
15
accounting for realized and unrealized gains?
16
A
In general terms I'm familiar with those terms.
17
Q
In general terms.
18
A
Yes.
19
Q
So do you know whether EFH presents mark to market
20
accounting in its 10-K or whether it presents it as realized
21
and unrealized gains?
22
A
23
gains -- realized and unrealized gains.
24
Q
25
accounting in the analyze of its cash flows would that
It was my -- it was my understanding it was realized
And sir, you've marked -- as represented mark to market
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account for the difference between the presentation in the
2
SEC program and Mr. Sassower's presentation?
3
A
I believe it would, yeah.
4
Q
Sir, I was going to ask you about Exhibit B to your
5
declaration, but though I think the best document to use is
6
the modified version of that that is Exhibit 36.
7
A
Okay.
8
Q
Can you get that, sir?
9
A
Okay.
10
Q
And, sir, I'd like to ask you some questions about the
11
first page of that document, specifically regarding Luminant
12
Cap X.
13
A
Got it.
14
Q
All right.
15
let me just confirm for the record.
16
earlier version of your Exhibit B, correct?
17
A
Right.
18
Q
Right.
19
the Luminant Cap X that's reflected in the average, correct?
20
A
There was.
21
Q
And it was revised up to exhibit -- to the 685 number
22
that's represented in Exhibit 36, correct?
23
A
Correct.
24
Q
All right.
25
actuals, sir --
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Are you with me, sir?
Now, in the -- in the -- in Exhibit 36 -Exhibit 26 is the
And Exhibit 26 there is a different number for
Now the NA that was presented in the 2009
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A
Right.
2
Q
-- right.
3
your analysis, correct?
4
A
I did.
5
Q
But the underlying documentation did not present it as
6
a zero; is that right?
7
A
Right.
8
Q
Right.
9
is Exhibit 3?
10
Originally you had that as a zero number in
And, sir, can we go to the documentation?
MS. SARKESSIAN:
Your Honor, objection based on
11
relevance.
12
testified the number was wrong and he corrected it.
13
14
We've already -- the witness has already
THE COURT:
it.
That
Well, he's allowed to cross-examine on
Exhibit 3?
15
MR. MCKANE:
It's Exhibit 3, Your Honor.
It's
16
almost -- it's near the end of the documents.
17
the second to last page, it says on the top 2009 Luminant
18
funding scorecard.
19
THE COURT:
In fact it's
Okay.
20
BY MR. MCKANE:
21
Q
Sir, you are me?
22
A
Yes, I am.
23
Q
And let me direct you attention to the last performance
24
metric, the one that says, "Luminant management EBIDTA less
25
Cap X, for Oak Grove and Sandel."
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A
I see that.
2
Q
Is it the 443 that's reflected -- sorry, excuse me.
3
it the 410 that's reflected in the 2009 actuals as a
4
negative number that originally -- that caused this
5
confusion?
6
A
Yes, it was.
7
Q
Now, sir, this negative number is a difference between
8
two numbers, correct?
9
Is
Let me ask it another way.
The metric -- is Luminant management EBIDTA less
10
Cap X.
11
A
Right.
12
Q
Right?
13
A
Right.
14
Q
Now, sir, you know that there's a problem when you see
15
a negative number in a capital expenditure, right?
16
A
Of course, right.
17
Q
Right.
18
A
Right.
19
Q
Does looking at the underlying data here indicate to
20
you that in 2009 Luminant had positive Cap X but yet that
21
number was greater than the amount of management EBIDTA for
22
Oak Grove and Sandel?
23
A
That's right.
24
Q
Now, sir, did you ask anyone at the company to clarify
25
this issue for you?
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A
I did not.
2
Q
And, sir, did you look to any secondary sources to
3
determine whether -- what the Cap X number would have been
4
for 2009 for Luminant?
5
A
I did not.
6
Q
Sir, in the 2009 10-K for EFCH would you expect Cap X
7
to be a line item in the financial statements?
8
A
Sure.
9
10
MR. MCKANE:
Your Honor, may I approach to mark
another exhibit?
11
THE COURT:
12
Yes, I'm sorry.
(Trial Exhibit No. 39 was marked)
13
THE COURT:
This is marked 39 for identification.
14
BY MR. MCKANE:
15
Q
16
page document.
17
A
Okay.
18
Q
And for the record, sir, do you recognize Exhibit 39 as
19
the form 10-K for Energy Future Holding that was filed with
20
the SEC for the year 2009?
21
A
Yes.
22
Q
And it's page again for the record 200.
And, Mr. Panacio, I recognize again it's a multi 100Could I direct you attention to page 200?
23
THE COURT:
24
MR. MCKANE:
25
Here.
Did you mark it for her?
I did put a tab on it.
I didn't?
I thought we had tabs for everyone.
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THE COURT:
It's about half through.
2
MR. MCKANE:
3
THE COURT:
4
MR. MCKANE:
Yes.
Almost exactly.
Okay.
5
BY MR. MCKANE:
6
Q
Mr. Panacio, you have a tab on yours?
7
A
I do.
8
Q
Sir, do you see the line items on page 200 of the 2009
9
10-Ks for EFCH that reflects capital expenditures?
10
A
I do.
11
Q
And, sir, do you see the specific line item as it
12
relates to I believe competitor electric capital
13
expenditures?
14
A
I do.
15
Q
Sir, what do you understand that line item to be?
16
A
It's about $1.3 billion.
17
Q
$1.3 billion.
18
capital expenditure compare to the other Cap X years that
19
you used in Exhibit 36 of your chart?
20
A
21
figures.
22
Q
23
correct?
24
A
Right.
25
Q
And, sir, do you know in 2009 whether EFH was
And, sir, how does that $1.3 billion of
Well in the following years it was the declining Cap X
Right.
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completing the construction of two power plants?
2
A
I do not recall that, no.
3
Q
And, sir, would the inclusion of 1.3 actually skew the
4
numbers considerably higher for Cap X?
5
A
It would.
6
Q
All right.
7
time event that you might try to exclude from a five-year
8
average?
9
A
I certainly would footnote it, yes.
10
Q
And, sir, to be precise in your -- going back to 36,
11
your average once you do the bid four-year average?
12
A
Yes, I got it.
13
Q
Okay.
14
use the 685 average for the four years it altered your
15
conclusion as to the relationship between the historical
16
average and the metrics for 2014?
17
A
It did.
18
Q
And in fact it went from being below the metrics to
19
above all of the metrics?
20
A
Above it, right.
21
Q
Now, Mr. Panacio, you took a separate approach where
22
you took the half year results and multiplied them by two,
23
correct?
24
A
Correct.
25
Q
Now if I refer to the half year forecast, if I use that
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And is that kind of a one -- a type of one-
Am I correct that when you made the revision to
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term would you understand what I mean?
2
A
Yes.
3
Q
All right.
4
that half year forecast was an appropriate means by which to
5
evaluate Luminant EBIDTA?
6
A
7
first half of the year applying to the second half of the
8
year.
9
Q
And, sir, is it your belief that applying
I took the approach considering all things equal of the
Okay.
And you thought that was an appropriate means by
10
which to evaluate Luminant EBIDTA?
11
A
12
considered from 2009 to 2013 for EBIDTA.
13
would stay consistent, right, for the second half of this
14
year, right.
15
Q
16
would remain the same you thought it was appropriate?
17
A
It was certainly my viewpoint doing this exercise, yes.
18
Q
Okay.
19
this exercise for TXU Energy's EBIDTA, correct?
20
A
Yes.
21
Q
And you understand, sir, that the debtors don't take
22
this type pro rata approach in performing its own budgeting,
23
right?
I was taking the viewpoint all the variables were
Right.
24
25
Those variables
And based on that assumption that the variables
And you took that same approach in performing
MS. SARKESSIAN:
Objection, it's outside of the
witness's knowledge.
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THE COURT:
2
THE WITNESS:
Well he's been here.
Overruled.
I'm (indiscernible - 11:39:10)
3
specifically to methodologies, but understand, yes.
4
BY MR. MCKANE:
5
Q
I'm sorry, can you --
6
A
Can you repeat the question, again?
7
Q
Sure.
8
do not employ the same approach of making a pro rata
9
projection off of a portion of the year?
Sir, is it your understanding that the debtors
10
A
Right.
11
Q
Sir, in performing this half year forecast you did not
12
take into consideration -- or let me -- I'll say it again.
13
You did not account for any changes in market conditions
14
over the course of the year, correct?
15
A
Correct.
16
Q
And, sir, you understand that the debtors' EBIDTA is
17
impacted by power prices, right?
18
A
Correct.
19
Q
And you did not account for current power prices in
20
this half year forecast, right?
21
A
In this half -- right, correct.
22
Q
And you understand, sir, that the debtors' EBIDTA is
23
impacted by current costs, right?
24
A
Yes.
25
Q
And you did not account for current fuel or emission or
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other variable costs changes in doing this forecast; is that
2
right?
3
A
Yes.
4
Q
And, sir, you agree with me that limited -- for limited
5
to generate earnings it has to generate revenue, right?
6
A
Sure.
7
Q
And to generate revenue it has to sell power, right?
8
A
Correct.
9
Q
And to sell power it has to produce power, right?
10
A
Right.
11
Q
And you agree with me that if seasonality impacts
12
limited's ability to sell power it impacts its ability to
13
generate EBIDTA, right?
14
A
Right.
15
Q
And, sir, you don't know whether Luminant and TXU
16
Energy project the same amount of income for each quarter do
17
you?
18
A
No.
19
Q
And a half year forecast does not account for any
20
seasonality in Luminant's or TXU Energy's business, correct?
21
A
They do not.
22
Q
And, sir, I believe you covered this, but EBIDTA is the
23
highest weighted target -- excuse me.
24
weighted metric for Luminant, correct?
25
A
Not specifically each quarter, no.
EBIDTA is the highest
Correct.
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Q
And EBIDTA is the highest weighted metric to TXU
2
Energy, correct?
3
A
Correct.
4
Q
And based on your half year forecast you concluded that
5
the forecasted results for 2014 would be higher than
6
superior for competitive EBIDTA, right?
7
A
You mean (indiscernible - 11:41:24) or --
8
Q
No, so let me go to the third page of Exhibit 36.
9
help you, sir.
I'll
I apologize.
10
A
Okay.
11
Q
Are you with me?
12
A
Yes.
13
Q
Now the first line item on the third page refers to EFH
14
management/competitive EBIDTA, right?
15
A
Right.
16
Q
And, sir, you understand that that line item for
17
competitive EBIDTA is the sum of the Luminant and the TXU
18
Energy EBIDTA, right?
19
A
Right.
20
Q
And, sir, you saw that in the far right-hand column
21
based on your projection of the half year results you
22
believed that had they would exceed superior -- the superior
23
target.
24
A
Yes, I do.
25
Q
And -- and you believe, sir, then unless there's any
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type of unforeseen event it would be appropriate to use a
2
half year forecast to project out a full year's expected
3
results, right?
4
A
5
yeah, I projected it out, for the second half of the year as
6
well.
7
Q
8
unforeseen or one-time event, correct?
9
A
Correct.
10
Q
And so those are two different things.
11
a one-time event or an unforeseen event.
12
A
Correct.
13
Q
And if you had one of those events you would back that
14
out from your analysis, correct?
15
A
I would.
16
Q
Now, sir, at the time you prepared this analysis you
17
did not know whether in the first half of 2014 there was a
18
significant one-time event that impacted competitive EBIDTA,
19
correct?
20
A
Correct.
21
Q
And, sir, you did not investigate whether there was,
22
you know, any such one-time event, correct?
23
A
Correct.
24
Q
And you didn't ask anyone at the company whether there
25
were any such one-time events?
All things being equal in the first half of the year,
Right.
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But one thing you might exclude for is a
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A
I did not.
2
Q
Now, sir, for example, you did not in this analysis of
3
the half year account for any scheduled outages for -- at
4
Comanche Peak, the nuclear power plant that are scheduled
5
for the fourth quarter of the year; is that right?
6
A
I -- right, correct.
7
Q
And that would be a one-time event, right?
8
A
Right.
9
Q
And at the time you prepared the analysis you weren't
10
aware whether bankruptcy was an event of default under
11
certain hedging agreements, right?
12
A
Correct.
13
Q
And, Mr. Panacio, you were here and you heard
14
Mr. McFarland testify that the cancellation of the hedging
15
from the bankruptcy filing caused a one-time realized event
16
of over 400 million in revenue, right?
17
A
Right, correct, heard that.
18
Q
And, sir, by doubling the -- that one-time event of
19
400 million in EBIDTA happened in the first half of the
20
year, right?
21
A
Right.
22
Q
And, sir, by doubling the first six months of the
23
year's EBIDTA you doubled the impact of that event, correct?
24
A
Correct.
25
Q
Actually if we could go back to Exhibit 36, that third
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page again.
2
A
Okay.
3
Q
You see where you projected exceeds superior's, sir?
4
A
The first line, yes.
5
Q
Yeah.
6
A
I won't.
7
Q
-- do you recognize was it the projections you have for
8
the year are?
9
A
Yes.
10
Q
All right.
11
A
Right.
12
Q
And the baseline and the superior?
13
A
Right.
14
Q
Sir, if you removed $462 million from the calculation
15
because it was a one-time event that occurred due to the
16
bankruptcy filing what impact would that have on whether
17
your projected forecast is above or below the threshold
18
level?
19
A
Using 462- it would be below.
20
Q
So in other words it would change your conclusion from
21
having the projected forecast exceed superior to be reduced
22
down, so that would be below threshold?
23
A
Right, (indiscernible - 11:45:12) but it would be.
24
Q
And I don't want to say the exact amount because I --
25
A
I don't want to.
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Without saying the amount --
And you see the threshold levels, right?
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Q
Thank you, sir.
2
And so you agree, sir, that major unanticipated
3
events can have a direct impact on EBIDTA?
4
A
Sure, yes.
5
Q
Okay.
Sir, let's talk for a minute about power prices.
6
Sir, based on your review of the Filsinger report
7
and being in the court you understand that power prices can
8
vary, right?
9
A
I understand.
10
Q
And, Mr. Panacio, based on your review of the Filsinger
11
report did you see that power prices in a 60-day span from
12
the end of May to the -- to nearly the end of July dropped
13
by $10?
14
A
I did see that.
15
Q
You did see that.
16
from $43 down to $33, right?
17
A
Right.
18
Q
And that was a drop of nearly 25 percent?
19
A
Right.
20
Q
And, sir, you didn't incorporate what impact a decline
21
of that magnitude in power prices would have on EBIDTA did
22
you?
23
A
I did not.
24
Q
And, sir, your analysis also didn't incorporate any
25
related shifts in gas prices did you?
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And so that drop of $10 was a drop
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A
It did not.
2
Q
And, for example, from your review of Mr. Filsinger's
3
record you saw that there was an equivalent $6 change in gas
4
prices during that same time period, right?
5
A
Right.
6
Q
And you did not account for what impact that $6 change
7
in gas prices would have on EBIDTA for Luminant or TXU
8
Energy, correct?
9
A
Correct.
10
Q
And, sir, you also did not account for any changes in
11
heat rates during the first half of the year, right?
12
A
I did not.
13
Q
Now, sir, by performing this analysis you're not
14
suggesting in any way that you're in a better position than
15
the professionals at EFH to develop a full year forecast are
16
you?
17
A
I am not.
18
Q
And, sir, you don't have any reason to believe that the
19
EFH management team did not exercise their sound business
20
judgment in developing the company's 2014 forecast are you?
21
A
I am not.
22
Q
Mr. Panacio, if we could I'd like to turn to the next
23
part of you testimony, which I believe related to Exhibit D
24
of your declaration, which is Exhibit 28.
25
A
Okay, I'm there.
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Q
2
All right.
(Pause)
3
THE COURT:
4
MR. MCKANE:
5
THE COURT:
Oh, I'm sorry -May I proceed?
-- are you waiting for me?
6
Thank you.
7
BY MR. MCKANE:
8
Q
9
loss was for years 2009 through 2013, correct?
I'm good.
I apologize.
Now, sir, in Exhibit 28 you presented what EFH's net
10
A
Correct.
11
Q
In fact it had a net income in 2009 and then had net
12
losses in the subsequent years, correct?
13
A
(Indiscernible - 11:48:42) years, right.
14
Q
Okay.
15
analysis you went back to see whether those companies had
16
net losses as well, right?
17
A
Right.
18
Q
And you extracted this information from your reviews of
19
EFH's SEC filings, correct?
20
A
Correct.
21
Q
In your analysis of those filings did you come to any
22
conclusion as to why EFH had a net loss in 2010 through
23
2013?
24
A
25
main driving factor is their debt service.
And, sir, when you developed your peer company
Well obviously for various reasons, but I guess the
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Q
The main driving -- I'm sorry --
2
A
The main driving factor for net loss is due to their
3
debt service.
4
Q
5
EBIDTA or net income/loss is a better metric to use for
6
incentive compensation have you?
7
A
I have -- I have not.
8
Q
And, sir, in developing your analysis you didn't review
9
the peer group's compensation programs did you?
And, sir, you haven't rendered an opinion as to whether
10
A
I did not.
11
Q
And you didn't perform any analysis of the incentive
12
programs to that peer group, right?
13
A
For those peer groups, no.
14
Q
And you didn't independently review what compensation
15
programs those companies may or may not have, right?
16
A
Right.
17
Q
So you don't know, for example, what the specific
18
metrics are that are used by any one of the 13 companies
19
that you evaluated?
20
A
That's correct.
21
Q
So to the extent, sir, that you were drawing any
22
conclusions under what circumstances incentive compensation
23
might be paid at those peer companies you weren't looking at
24
the underlying programs themselves, right?
25
A
I was not -- right, correct.
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Q
And, sir, do you know any reason why EFH if it wanted
2
to could not have used a net income metric with a negative
3
number to incentivize its management team?
4
MS. SARKESSIAN:
5
THE WITNESS:
6
question, sir.
7
BY MR. MCKANE:
8
Q
9
there's a net loss --
I'm sorry --
I'm sorry, I don't understand the
Let's say it another way.
So you identified that
10
A
Right.
11
Q
-- right?
12
there's net income in some of the peer companies but every
13
once in a while there's a net loss as well, right?
14
A
Right.
15
Q
But you don't know even evaluating that amount how that
16
squares with any of the company's compensation programs,
17
right?
18
A
Right.
19
Q
So to the extent that there's a net income or net loss
20
metric you don't know whether that's a positive or negative
21
number, right?
22
A
Right.
23
Q
Now, sir, you testified that only 20 percent of energy
24
companies use EBIDTA in incentive compensation; do you
25
recall that?
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A
Yes.
2
Q
All right.
3
study of energy companies that you performed, right?
4
A
Correct.
5
Q
That's based on a review of a slide -- of a summary of
6
Towers Watson's work?
7
A
Yes.
8
Q
All right.
9
page 61.
Now that conclusion is not based on any
Let's go to that.
10
THE COURT:
11
MR. MCKANE:
12
THE WITNESS:
That's Exhibit 5,
Go ahead.
Okay.
13
BY MR. MCKANE:
14
Q
15
August presentation in preparing your declaration and
16
preparing to testify today, right?
17
A
Yes.
18
Q
And this slide summarizes a recent Towers Watson study,
19
right?
20
A
Right.
21
Q
And Towers Watson found that a majority of companies in
22
the energy industry used earnings-based goals in their
23
annual or long-term incentive plans, right?
24
A
Right.
25
Q
And you don't have any reason to doubt the accuracy of
And, sir, you reviewed this slide, slide 61 of the
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that conclusion do you?
2
A
No.
3
Q
All right.
4
that 20 percent of the companies use EBIDTA, right?
5
A
Right.
6
Q
And, sir, it's not that 80 percent of the companies use
7
net income; is that right?
8
A
Right.
9
Q
Only 32 percent use net income in 2013, correct?
10
A
Right.
11
Q
And sir, just stepping back for a second, you -- just
12
from the basics -- you agree with me that EBIDTA excludes
13
interest expense, right?
14
A
Yes.
15
Q
But net loss does not?
16
A
Right.
17
Q
And in preparing Exhibit C to your declaration, which
18
is Exhibit 27, you concluded -- yeah, let's take it out for
19
a second.
20
A
Okay, I'm there.
21
Q
All right.
22
Yes.
Exhibit 27.
(Pause)
23
24
And in fact you used this slide to know
MR. MCKANE:
Apologize, Your Honor, one moment.
(Pause)
25
MR. MCKANE:
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All right, why don't we do it this
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way.
2
BY MR. MCKANE:
3
Q
So, sir, Exhibit 34, let's go there.
4
A
34.
5
Q
It's the end of the binder.
6
A
Okay.
7
Q
All right.
8
9
Exhibit 34 is --
THE COURT:
I'm sorry, I need to -- can you give
me just a moment.
10
MR. MCKANE:
11
THE COURT:
12
Do you need to go off the record?
No, I -- yes.
Yes, we need to -- I'm
sorry, need to take a short recess.
13
MR. MCKANE:
14
Of course.
(Recess at 11:54 a.m.)
15
THE CLERK:
All rise.
16
THE COURT:
Please be seated.
17
34.
Thank you.
Sorry.
I'm back.
18
MR. MCKANE:
For the record Mark McKane of
19
20
CROSS-EXAMINATION (Resumed)
21
BY MR. MCKANE:
22
Q
23
looking at the same time at Exhibits 27 and 34.
24
A
Right.
25
Q
Right.
Mr. Panacio, we were at -- before we broke we were
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And, sir, Exhibit 34 is just a collective
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version of 27; is that right?
2
A
3
EFH.
4
Q
5
iteration of the same -- for the same --
6
A
Correct.
7
Q
That's correct?
8
A
Right.
9
Q
And the corrections are primarily to account for
I have Exhibit 34 as the comparable companies versus
Yes, sir, and I believe Exhibit 27 is the earlier
10
rounding errors and one set of transposed numbers?
11
A
Right.
12
Q
So let's look at 34.
13
the Court, Mr. Panacio, you include columns for operating
14
revenue, net income or loss, and long-term debt, right?
15
A
Right.
16
Q
And you did so because you wanted to present the
17
ability to service long-term debt, right?
18
A
Right.
One of the reasons, right.
19
Q
Right?
But in evaluating long-term debt it's also
20
appropriate to evaluate what interest expense you have on
21
that long-term debt, right?
22
A
That's correct.
23
Q
And, sir, EFH in 2011 had interest expense of
24
approximately $4.3 billion, right?
25
A
Now in preparing Exhibit 34 for
Right.
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Q
And EFH in 2012 had interest expense of approximately
2
$3.5 billion, right?
3
A
Right.
4
Q
And in 2013 it had interest expense of $2.7 billion,
5
right?
6
A
Right.
7
Q
And in preparing Exhibit 34 you looked at the 13 peer
8
companies that you could find information for and evaluated
9
their income statements as reflected in their 10-Ks,
10
correct?
11
A
Yes.
12
Q
And you looked at their operating revenues and their
13
net income and their long-term debt, and the interest
14
expense was also available there as well, correct?
15
A
Yes.
16
Q
All right.
17
based on your review of the Ameron 10-K am I correct that
18
Ameron's interest expense was less than EFH's by over
19
$2 billion?
20
A
21
statement, but I do recall it, yeah.
22
Q
23
the trees, but if you need to I can refresh your
24
recollection of any of the 10-Ks.
25
A
Let's start with Ameron for a minute.
Sir,
Do you recall that?
Well actually -- actually not seeing the actual income
All right.
And, sir, you know, it's unfortunate for
That's fine.
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Q
All right.
2
THE COURT:
3
The trees are already gone.
(Laughter)
4
MR. MCKANE:
It's true.
5
BY MR. MCKANE:
6
Q
7
the years 2011, '12, and '13, would they have generated a
8
net income?
9
A
They would have a net loss.
10
Q
And, sir, Calpine was another of the peer companies,
11
right?
12
A
Right.
13
Q
And Calpine's interest expense is also less than EFH,
14
right?
15
A
It was.
16
Q
It was less by billions of dollars for each of the
17
years '11, '12, and '13, right?
18
A
Right.
19
Q
And if Calpine had the interest expense of EFH in those
20
years it would not have had a net income, right?
21
A
It would not have, right.
22
Q
And, sir, the same is true with Duke Energy, right?
23
Let me be specific.
24
'11, '12, and '13, that was also lower than EFH's, correct?
25
A
And, sir, if Ameron had the interest expense of EFH for
Duke Energy had interest expense in
That was right, correct.
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Q
In fact even though Duck Energy's long-term debt in
2
2013 was of a similar size to EFH's, its interest expense
3
was billions less, correct?
4
A
Correct.
5
Q
And if Duke Energy had the interest expense of EFH for
6
'11, '12, and '13, it also would not have net income,
7
correct?
8
A
It would not have net income, right.
9
Q
And, sir, you looked at Edison International as well,
10
right?
11
A
Right.
12
Q
And Edison International's interest expense was in the
13
millions, not the billions, correct?
14
A
Right.
15
Q
And if Edison International had the interest expense of
16
EFH it would not have net income in '11, '12, or '13,
17
correct?
18
A
They would not.
19
Q
And, sir, you looked at Energon as well, right?
20
A
Excuse me.
21
Q
And Energon's interest expense for '11, '12, and '13
22
were all over $2 billion less than EFH's, correct?
23
A
Right.
24
Q
And you agree if Energon had the interest expense of
25
EFH for '11, '12, and '13 it wouldn't have a net income
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Yes.
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either, correct?
2
A
Correct.
3
Q
And the same is true for Exelon, right?
4
A
Right.
5
Q
If I went through every one of these, if any of these
6
peer companies had the interest expense of EFH they all
7
would not have net income for '11, '12, and '13, correct?
8
A
Correct.
9
Q
And, sir, you prepared Exhibit 34 because you wanted to
10
demonstrate that the peer companies had the ability to
11
service their debt, right?
12
A
It was one of the reasons, right.
13
Q
You thought it was important for the Court to consider
14
whether the peer group had the ability to service their debt
15
in connection with today's motion, it was a factor you
16
wanted the Court to consider?
17
A
Correct.
18
Q
Now, sir, you've been a bankruptcy analyst for 14
19
years, you would agree with me that a number of our
20
corporate debtors that file for bankruptcy do so because
21
they do not have the ability to service their debt, right?
22
A
That's correct.
23
Q
And, sir, you would agree with me that that's why they
24
file for bankruptcy, it's in part because many of these
25
companies, including EFH, could not continue to service that
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debt, correct?
2
A
Correct.
3
4
MR. MCKANE:
confer with my co-counsel?
5
THE COURT:
6
MR. MCKANE:
7
Your Honor, can I have one moment to
Yes, you may.
Your Honor, we have no further
questions.
8
THE COURT:
9
MS. SARKESSIAN:
10
Thank you.
Redirect?
Yes, Your Honor.
have a moment?
11
THE COURT:
12
Sure, of course.
(Pause)
13
MS. SARKESSIAN:
And for the record Juliet
14
Sarkessian on behalf of the U.S. Trustee.
15
REDIRECT EXAMINATION
16
BY MS. SARKESSIAN:
17
Q
Mr. Panacio --
18
19
Could I just
THE COURT:
please.
Could you adjust the microphones,
Thank you.
20
MS. SARKESSIAN:
21
THE COURT:
22
MS. SARKESSIAN:
23
THE COURT:
24
MS. SARKESSIAN:
25
THE COURT:
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Is that better?
Yeah, both of them, it helps.
Oh.
Get you in stereo there.
Is that better?
Yep, thank you.
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MS. SARKESSIAN:
Point it downward.
2
BY MS. SARKESSIAN:
3
Q
4
as Exhibit 38, it's a PowerPoint presentation that you were
5
looking at.
6
looks like this.
7
A
Okay.
8
Q
There are you go.
9
page that had been tabbed for you?
I'd like to turn your attention back to what was marked
It's not in your binder, it would be loose.
It
Colorful.
Okay.
And could you turn to the
And on that page is that
10
the one with the green graph at the top and it says,
11
"Beginning in 2006 the company used a long-term hedging
12
program"?
13
A
Okay, I'm there.
14
Q
Okay.
15
2006 the company used a long-term hedging program to
16
establish -- to stabilize -- excuse me -- cash flow and
17
minimize downward risk in natural gas prices."
18
that?
19
A
I see that.
20
Q
And then the line that's above the actual graph says,
21
"Cash flows from hedging activities."
22
A
I see that.
23
Q
Now, is cash flow the same thing as EBIDTA as the same
24
number?
25
it the same thing?
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Do you have that right page?
So I'm going to read that to you.
"Beginning in
Do you see
I see that.
Do you see that?
Is that -- can we compare cash flow with EBIDTA, is
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A
You could have cash flows from operating activities,
2
investing activities, financing, activities, but essentially
3
you're backing out all the interest and amortization, et
4
cetera, it could be cash flows, yeah.
5
Q
Okay.
6
A
Right.
7
Q
-- of the EBIDTA?
8
A
Right.
9
Q
But it could also not be?
10
A
Right.
11
Q
Okay.
12
ask this.
13
So cash flows could be the same number --
What would that depend on?
Is there -- let me
Is this a standard calculation for EBIDTA among
14
every company that they use the same way to calculate
15
EBIDTA?
16
A
17
taxes, appreciation, and amortization.
18
standard if you're calculating -- all companies will
19
calculate in the same -- I assume in the same manner.
20
Q
21
"Beginning in 2006 the company used a long-term hedging
22
program."
23
A
I see that.
24
Q
Okay.
25
hedging activities," it doesn't specify cash flows from
Well, again, EBIDTA is your earnings before interest
Okay.
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So that's kind of
Now, at the top of the page where it says,
Do you see that?
But the chart below it says, "Cash flows from
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long-term hedging programs?
2
MR. MCKANE:
3
THE COURT:
Objection, leading, Your Honor.
Overruled.
4
BY MS. SARKESSIAN:
5
Q
6
from hedging activities is limited to the hedging activities
7
related to the long-term hedging program that the company
8
started in 2006?
9
A
Do you know whether this chart that shows cash flows
From this chart, no, I don't know the specific details,
10
I do not know.
11
Q
12
that was the 10-K large for 2009 for Energy Futures Holding
13
Corp.
Now, I'd like to turn your attention to Exhibit 39,
14
THE COURT:
15
MS. SARKESSIAN:
16
THE COURT:
17
MS. SARKESSIAN:
Okay.
18
MS. SARKESSIAN:
For 2009 the 10-K.
19
Which exhibit?
It's 39.
I'm sorry, 39, right?
It's the 10-K.
Got it.
2009 for
Energy Futures Holding Corp.
20
THE WITNESS:
Okay.
21
BY MS. SARKESSIAN:
22
Q
23
for you that's page 200?
24
A
Okay.
25
Q
Do you recall being asked certain questions here about
Okay.
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And could you turn to the page that was tabbed
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the capital expenditure figures?
2
A
Right.
3
Q
Now, do you know those capital expenditure figures, is
4
that divided between Luminant and TXU?
5
between the two?
6
A
It is not.
7
Q
Okay.
8
be for the capital expenditures?
9
12:15:05) electric, et cetera, if that's not broken down
Is it broken out
So what would you understand then that figure to
Like the (indiscernible -
10
then --
11
A
12
the capital expenditures this relates to.
13
reading this page.
14
might identify the entity, but this specific page I cannot
15
tell.
16
Q
Could it be consolidated?
17
A
It could be.
18
Q
You can put that aside.
Well it doesn't specifically say -- state which entity
19
Again, just
If there's a narrative beforehand it
I'd like to turn your attention to Exhibit 36,
20
this is in your binder.
21
A
Okay.
22
Q
It's the chart that is the updated chart from Exhibit B
23
to your declaration.
24
A
Okay.
25
Q
Okay.
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Now you were asked a lot of questions on cross-
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examination about the last three columns of the chart
2
relating to taking the mid-year figures and then projecting
3
them for the full year.
4
A
Yes.
5
Q
And you were asked, you know, various questions about
6
whether you considered certain one-time events and outages
7
and various things like that.
8
A
Right.
9
Q
Okay.
10
Do you remember that?
Do you recall that?
I just want to clarify now.
The information that is on those last three
11
columns to the right, which is the mid-year actual, the
12
projection for the full year, and then comparing the
13
projections to the target, do those columns have any effect
14
from the columns that are headed to the left of those
15
columns, threshold versus average and superior versus
16
average?
17
A
No.
18
Q
And I think just to remind everyone, those columns,
19
threshold versus average and superior versus average, the
20
average you're comparing it to is the five-year actual,
21
correct?
22
A
Correct.
23
Q
Okay.
24
exhibit for a moment.
25
asked -- specifically asked a question about whether when
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For the five years 2009 through 2013?
Now with respect to -- we'll keep with that
With respect -- I believe you were
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you projected for the full year for EBIDTA whether you took
2
into consideration any scheduling outages that might be a
3
one-time event, correct?
4
A
Right.
5
Q
Okay.
6
EBIDTA for 2009 to 2013 is it possible that those actual
7
figures, that they were scheduling outages during those
8
years as well?
9
A
10
With respect to looking at past performance of
It's possible, right.
(Pause)
11
Q
Now moving on to your comparison of the -- what we'll
12
call the peer group companies against the debtor, which is
13
Exhibit 34, but I'm not going to ask you about the
14
exhibit --
15
A
Okay.
16
Q
-- I just want to just focus a minute generally on
17
comparing the peer group to the debtor.
18
You were asked a lot of questions, do you recall,
19
about you know, what information you considered concerning
20
the bonus programs of the peer groups; do you recall those
21
questions?
22
A
Yes.
23
Q
Okay.
24
programs, you don't have that -- you didn't consider that,
25
correct?
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And you testified no, you didn't see their bonus
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A
Correct.
2
Q
Okay.
3
reviewed Mr. Frisky's declaration and Mr. Filsinger's
4
declaration in connection with this bonus motion, connect?
5
A
Correct.
6
Q
Okay.
7
with the motion, right?
8
A
Right.
9
Q
In those documents did you see any information, any
Did you -- I believe you testified that you
And various -- the documents that were filed
10
specifics about the bonus programs of the various companies
11
that the debtor is treating as its peer companies?
12
A
13
companies, no.
14
Q
15
which is the EFH insider compensation discussion materials
16
for August 6th, 2014.
17
A
Okay.
18
Q
Okay.
19
you looked at in connection with preparing your exhibits to
20
your declaration, correct?
21
A
Right.
22
Q
Okay.
23
they were looking at metrics considered by other energy
24
industry companies, correct?
25
A
I did not see specific details of those comparable
And turning to Exhibit 5, which is in your binder,
You looked at -- this was one of the documents
And you pointed out on page 61, correct, where
Right.
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Q
Okay.
Now other than that information in this
2
particular document, Exhibit 5, is there any other detail
3
provided about the particular bonus plans of these other
4
companies or any other information about exactly what
5
metrics each company uses?
6
A
No.
7
Q
Okay.
8
A
Okay.
9
Q
And sticking on this page 61, you previously testified
10
that 20 percent of the peer companies looked at EBIDTA for
11
2013, correct, as a metric, correct?
12
A
Right.
13
Q
Okay.
14
look at EBIDTA according to this chart?
15
A
Well, I think immensely the 80 percent --
16
Q
Okay.
17
A
-- would not be using EBIDTA.
18
Q
Sorry, 80 percent --
19
A
Eighty percent would not be using this particular
20
metric EBIDTA.
21
Q
22
that EBIDTA metric is the highest weighted metric, correct?
23
A
24
So what percentage of the peer companies did not
And that EBIDTA metric -- with respect to the debtors
Correct.
(Pause)
25
MS. SARKESSIAN:
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That's all I have on redirect,
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Your Honor.
2
3
THE COURT:
sir.
Okay, thank you.
Thank you.
4
THE WITNESS:
5
MS. SARKESSIAN:
6
THE COURT:
7
Yes?
MS. SARKESSIAN:
Your Honor, would it be possibly
for Mr. Panacio to be excused from the courtroom?
10
THE COURT:
11
MR. MCKANE:
12
THE COURT:
13
MS. SARKESSIAN:
14
THE COURT:
15
Your Honor --
I haven't been allowing recross just
so the record is clear.
8
9
You may step down,
Any objection?
No objection, Your Honor.
Very good.
Thank you, sir.
Thank you for making
time for the Court.
16
Do we want to deal with the exhibits that were
17
identified for identification that have not been admitted?
18
I think that only 38 and 39.
19
MR. MCKANE:
20
do move into evidence Exhibits 38 and 39.
21
of our rebuttal case.
22
THE COURT:
23
MS. SARKESSIAN:
24
All right.
The debtors
It will be part
Any objection?
Your Honor, I have no objection
to Exhibit 39, which is the 2009 10-K.
25
I do have an objection to Exhibit 38.
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among other things I haven't had an opportunity to review
2
it, but there's a tremendous amount of information in here,
3
and I don't -- I don't think we've had a witness that has
4
testified to this.
5
6
MR. MCKANE:
Your Honor, the focus of our use of
38 is solely the one page slide on the hedging program.
7
8
It's hearsay.
THE COURT:
I mean it was a demonstrative at the
first day.
9
MR. MCKANE:
10
THE COURT:
11
MR. MCKANE:
It was.
Isn't it hearsay?
Well, Your Honor, in some ways what
12
it does is it a -- it is a summary of corporate records, and
13
therefore it would be an exception to the hearsay rule
14
because it was prepared, you know, for that purpose.
15
really is a compilation of --
16
THE COURT:
It
It wasn't prepared by the business
17
people, it was prepared by -- well, I don't know who
18
prepared it, that's part of the problem.
19
Mr. Sassower presented it, but I expect he didn't prepare
20
it.
21
22
MR. MCKANE:
I'm not going to comment on
Mr. Sassower's preparation.
23
24
I mean
THE COURT:
Well create.
(Laughter)
25
MR. MCKANE:
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We'll stipulate the that, Your Honor.
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2
THE COURT:
evidence, I'm not going --
3
MR. MCKANE:
4
THE COURT:
5
admitted.
6
7
-- yeah, it's -- it will not be
39 is the admitted without objection?
39 is the without objection.
THE COURT:
Thank you.
10
11
Fine, Your Honor.
MS. SARKESSIAN:
8
9
I don't think it's appropriate
THE COURT:
You mentioned a rebuttal case you're
going the --
12
MR. MCKANE:
No, Your Honor, we -- I was only
13
referencing that for -- anticipating an argument that we had
14
closed our case in chief.
15
THE COURT:
16
MR. MCKANE:
17
And my point is only that, you know,
we -- at this point we have no additional evidence.
18
19
Oh, oh, oh.
THE COURT:
Okay.
Very good.
Thank you.
right.
20
Any further evidence by any party?
21
MS. SARKESSIAN:
22
THE COURT:
23
None.
No, Your Honor.
Very good, that'll close the evidence
share record.
24
25
All
I have a hearing at 1:00, so let's break for
lunch, reconvene at 1:30, and I'll hear closing, then we'll
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probably have to take a recess of some time and I'll put --
2
I predict that after closings and a recess I'll be able to
3
present a ruling.
4
We'll recess until 1:30.
If you could clear the tables, please, I'd
5
appreciate it, since I have a hearing at 1:00, although it
6
should be short.
7
MR. SASSOWER:
8
Just to give you a sense, I anticipate my closing
9
10
will probably go about a half hour, just so you can budget
it.
11
12
THE COURT:
to give me a time.
It is what it is, I won't ask anyone
That's fine.
13
MR. SASSOWER:
14
MS. SARKESSIAN:
15
Okay.
Thank you.
(Recess at 12:25 p.m.)
16
THE CLERK:
All rise.
17
THE COURT:
Please be seated.
18
Settle down over
there.
19
(Laughter.)
20
THE COURT:
21
MR. SASSOWER:
Mr. Sassower.
Good afternoon, Your Honor.
For
22
the record, Edward Sassower of Kirkland and Ellis, LLP,
23
counsel for the debtors.
24
25
Your Honor, with your permission, I'd like to
proceed with the closing.
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THE COURT:
Yes.
2
MR. SASSOWER:
Your Honor noted in Furniture Brans
3
that the U.S. Trustee, and I quote, "stands to defend the
4
system as a whole and to ensure that the debtor and the
5
committee or any parties that are coming in front of the
6
Court are not agreeing on something that while it sounds
7
great to them, maybe is not so great for the system as a
8
whole, or even the debtors."
9
Furthermore, in your ruling on the motion to
10
exclude Mr. Panacio's testimony, Your Honor also noted that
11
the role of the United States Trustee in, and again I quote,
12
"preserving the integrity of the bankruptcy process."
13
Ms. Schwartz similarly stated in her opening
14
remarks that, again, I quote, "the U.S. Trustee, like the
15
Court, is dedicated to protecting the integrity of the
16
system and making sure that all parties in the bankruptcy
17
proceedings adhere to comply with the Bankruptcy Code" and
18
concluded those opening remarks by saying that, unless the
19
debtors can address all of the U.S. Trustee's issues to the
20
Court's satisfaction, then the U.S. Trustee requests the
21
Court deny the motion.
22
Your Honor, we fully respect the important role
23
that the United States Trustee plays in the Chapter 11
24
process.
25
have addressed all of their issues and it's clear that we've
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But after last week and today, we think that we
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met what's required under the law and what's require in
2
terms of evidence.
3
Your Honor knows the relevant legal standard
4
better than anybody as given the significance of your many
5
decisions and ruling in the employee compensation context.
6
The first thing the debtors must establish is that the
7
contemplated payments do not fall within Section 50(c)(3)(1)
8
of the Bankruptcy Code.
9
payments are primarily incentivizing and not primarily
10
In other words, that the potential
retentive.
11
The debtors have submitted a mountain of evidence,
12
including testimony from Mr. Burke, Mr. McFarland and
13
Mr. Filsinger demonstrating that the applicable performance
14
metrics are not guaranteed and are not time-based but,
15
instead, are challenging financial operational and other
16
business targets that make the plans primarily
17
incentivizing.
18
One thing Ms. Schwartz argued in her opening is
19
that the debtors did not submit any evidence regarding the
20
satisfaction of the stringent requirements of 50(c)(1).
21
That's because we are confident that 50(c)(3)(1) does not
22
apply --
23
24
THE COURT:
503(c)(1).
You keep saying
50(c)(3)(1).
25
(Laughter.)
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MR. SASSOWER:
2
THE COURT:
3
That's okay.
You're getting me
confused.
4
MR. SASSOWER:
Your Honor has heard over the last
5
few days how the debtors' metrics provide exactly the type
6
of difficult to achieve hurdles that courts have repeatedly
7
blessed as incentivizing.
8
testified that as for nuclear available generation, the
9
debtors' nuclear facilities must hit top quartile to hit
For example, Mr. McFarland
10
thresholds and must do so in a year with two refueling
11
outages, which occurs once every three years.
12
And Mr. Burke testified that TXU Energy must hit
13
industry leading performance to meet threshold on bad debt,
14
customer complaints and contribution margin.
15
customer complaints, TXU must achieve its second best
16
performance in the last six years.
17
been market by unusually extreme weather.
18
And as for
In a year that's already
Furthermore, Mr. Burke, Mr. Friske and
19
Mr. Filsinger, correction, Mr. Burke, Mr. McFarland and
20
Mr. Filsinger all identified substantial risks that would
21
cause TXU, Luminant and EFH to miss these tough targets
22
given year-to-date performance.
23
testified that Luminant must keep its current nuclear outage
24
to 24.5 days despite already being behind and already
25
needing to beat top quartile performance by almost 7 days.
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And Mr. McFarland further testified that all told,
2
Luminant had 125 planned outage days left in the year and if
3
those go long, it will affect Vatrix and EBIDTA.
4
You also heard testimony from Mr. Filsinger that
5
some of the metrics require near perfection and therefore at
6
some point the plans have to stop requiring continued
7
improvement, which would be virtually impossible, but rather
8
needs to compensate management for continued excellence,
9
which should not be taken for granted.
In attaining that
10
near perfect performance and continually exceeding industry
11
averages requires a tremendous amount of effect, experience
12
and talent each and every year and those results deserve to
13
be rewarded.
14
then the level of performance would undoubtedly decrease.
15
If management take their eye off the ball,
Also, to clarify a related point, part of the
16
cross-examination of Mr. Filsinger focused on the degree to
17
which the company has previously beaten industry averages.
18
Mr. Filsinger was simply using industry averages as a basis
19
for comparison.
20
the company considers when setting its targets, it's by no
21
means the sole or most important factor.
22
its targets, the company ultimately is trying to determine
23
what is the very best the company can do regardless of its
24
peers.
25
While industry averages are a factor that
When determining
The U.S. Trustee's various arguments as to why the
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payments are primarily retentive and bring the motion within
2
the requirements of 503(c)(3)(1) all miss the mark.
3
Ms. Schwartz seems to suggest that the use of the phrase,
4
retain, in any document automatically converts the primary
5
purpose of the plan to retention.
6
For starters, there are no documents referencing
7
the word, retention award, that are before the Court today.
8
And only one of the plans that's before the Court today
9
mentions the word, retain, and that is the EAIP, which also
10
uses the words, motivates, and the phrase, "rewarding
11
performance that satisfies established performance goals" in
12
the same sentence as the word, retain.
13
More importantly, labels don't matter.
14
matters is the actual substance of the plan and all of the
15
plans before the Court today require management to achieve
16
financial, operational and other business targets in order
17
to receive a payment.
18
just for the employee sticking around.
19
What
None of the plans provide a payment
The U.S. Trustee also attempts to make much of the
20
requirement that an employee must remain with the debtors
21
for a short period of time after the quarter in order for
22
the debtors to calculate whether the metrics have been met
23
and process the payment.
24
every incentive plan is somewhat retentive because you need
25
to continue to work at the company in order to hit the
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As the case law repeatedly notes,
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incentive target.
2
Taken to its logical extreme, the U.S. Trustee's
3
argument would require an employee to be paid incentive
4
compensation each and every day for that payment not to be
5
retentive or at least the debtors must make the payments
6
immediately at the end of the performance period, which is
7
not practical.
8
More importantly, an employee must hit the metrics
9
in order to earn a payment and that, in and of itself, makes
10
the plans primarily incentivizing.
11
testified that 90 percent of other company's compensation
12
plans have similar language about remaining through the
13
performance period.
14
Furthermore, Mr. Friske
The U.S. Trustee also tries to argue that the
15
metrics are not incentivizing because the debtors' average
16
five year historical performance exceeds some of the
17
performance metrics in effect for this year.
18
Trustee also argues that multiplying the first half of 2014
19
performance by two, to conclude that the four year 2014
20
metrics will be easily achieved.
21
grossly over simplifying what is a very complicated process
22
that takes up to four to six months to complete.
23
The U.S.
The U.S. Trustee is
The point of this process is to try to compare
24
apples to apples, to isolate operational performance by
25
excluding items like onetime events, like the long term
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hedging program and items like debt service costs that are
2
not relevant to evaluating performance of the debtors'
3
employees.
4
Let me first address the point about the five-year
5
historical averages.
Circumstances change year over year
6
and the five-year historical average of the metrics is not a
7
good predictor of likely performance in the next year.
8
example, looking only at historical averages ignores the
9
fact the value of the corporate hedge program declined
For
10
sharply over the last four years as Mr. Filsinger testified.
11
These hedges were put in place before the prices of gas
12
cratered.
13
the value of the hedges as they roll off.
Now, as a result, the debtors cannot replicate
14
The corporate hedge program contributed
15
approximately $1.8 billion to EBIDTA IN 2012, approximately
16
$1 billion to EBIDTA in 2013, approximately $462 million to
17
EBIDTA during the first half of 2014 and will contribute
18
zero dollars to EBIDTA going forward, during the second half
19
of 2014 or beyond.
20
As another example, looking at historical averages
21
ignores the fact that environmental regulations change and
22
impact performance of the business in varying degrees year-
23
to-year.
24
with respect to the TXU customer satisfaction metrics and as
25
Mr. McFarland testified with respect to the coal generation
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And yet another example, as Mr. Burke testified
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metrics, the company sometimes change the way in which they
2
measure the metrics, which sometimes makes historical
3
performance not comparable.
4
The failure to recognize this point, particularly
5
the importance of the hedges rolling off, is exactly what
6
Mr. Evans was trying to explain when he was telling the U.S.
7
Trustee in connection with his deposition why an uninformed
8
observer might conclude that the metrics could look like a
9
lay-up if the observer was only looking at year over year
10
performance.
11
Let me next address by the U.S. Trustee's
12
multiplication of the first half of 2014 performance by two
13
doesn't make sense.
14
ignores a variety of factors, including the seasonality of
15
the debtors' businesses as testified to by Mr. Burke,
16
Mr. McFarland and Mr. Filsinger, the impact of counterparty
17
terminations of contracts associated with the corporate
18
hedging program, the long term corporate hedging program
19
triggered by the bankruptcy filing, which was a onetime
20
event that skews the first half of 2014 EBIDTA by $460
21
million, approximately, I think that's 464, 462,
22
approximately $462 million as testified to by Mr. McFarland
23
and Mr. Filsinger and schedule plant outages that will occur
24
in the second half of this year as testified to by
25
Mr. McFarland.
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One final point on the trustee's claim that these
2
programs are retentive, in the U.S. Trustee's opening
3
argument, Ms. Schwartz referenced Hawker and made reference
4
about how retention plans can sometimes be dressed up to try
5
to look like incentive plans but any comparison to Hawker is
6
entirely misplaced.
7
In Hawker, the keep (ph) awarded a payment so long
8
as Hawker consummated a transaction that had largely been
9
negotiated prior to the (indiscernible - 1:55:04) date.
10
Here, the debtors' compensation programs have been around
11
for many years and are premised on the achievement of hard
12
to meet financial, operational and other business goals.
13
Before I turn to ordinary course and the Dana
14
factors, I want to address the U.S. Trustee's critique of
15
the use of EBIDTA as a key metric in the compensation plans
16
which is really an attempt by the U.S. Trustee to try to
17
replace the debtors' business judgment with its own.
18
The debtors have used EBIDTA as a metric for many
19
years.
20
testified that the majority of companies use an earnings-
21
based target in their annual or long term incentive plans.
22
But the exact earnings-based
23
whether it's earnings per share or net income or EBIDTA or
24
cash flow tends to vary based on a variety of factors,
25
including whether the company is public and it's level of
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EBIDTA as a metric for many years.
Mr. Friske
target the company chooses,
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interest expense.
2
Mr. Friske further testified that 20 percent,
3
which is a healthy percentage, of the plans reviewed by
4
Towers Watson for energy companies use EBIDTA and that
5
EBIDTA was used even more frequently by debtors in Chapter
6
11.
7
were reviewed used net income.
By comparison, only 32 percent of the companies who
8
In the debtors' business judgment, as testified to
9
by Mr. Burke, Mr. McFarland and Mr. Filsinger, EBIDTA is the
10
proper measure of operational performance and ensures that
11
the evaluation of the debtors' employees is not impacted by
12
factors outside of their control like debt services.
13
(Indiscernible - 1:56:47) arguments also
14
essentially -- such an argument that insider compensation
15
plans should rarely be approved in Chapter 11 because many
16
debtors file for -- file for bankruptcy because of their
17
over leveraged capital structure and therefore do not have
18
net income.
19
The U.S. Trustee also argued that using the same
20
metrics in the key leader performance program and in the
21
EAIP is somehow inappropriate and seemed to be suggesting
22
that the debtor should have one incentive plan instead of
23
two.
24
debtors' business judgment.
25
testified it's common for companies and debtors to have
But, again, having multiple plans is a function of the
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In addition, Mr. Friske
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multiple incentive plans; typically, one or more for short
2
term incentives and one or more for long term incentives.
3
And, as Mr. Friske further testified, using similar metrics
4
across multiple plans is commonplace.
5
The second thing the debtors must establish under
6
the law is that the compensation programs are either
7
ordinary course, business transactions or a reasonable
8
exercise of the debtors' business judgment that is supported
9
by the facts and circumstances of the case.
10
Other courts have held that the facts and
11
circumstances test is essentially the same as the business
12
judgment analysis under Section 363 of the Bankruptcy Code,
13
so probably too much is being made of this prong.
14
said that, when evaluating compensation plans under the
15
facts and circumstances test, courts rely on the Dana
16
factors.
17
Having
The debtors have established that the compensation
18
programs are both ordinary course and meet the facts and
19
circumstances test.
20
continuation of the compensation programs are ordinary
21
course transactions by satisfying both the horizontal test
22
and the vertical tests.
23
because the structure and design of the debtors' plans are
24
consistent with comparable companies and the total potential
25
compensation is consistent with market practices in the
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The debtors have demonstrated that the
The horizontal test is satisfied
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energy industry.
2
conclusion and his testimony has gone unrebutted.
3
Mr. Friske's testimony supports this
The vertical test is satisfied because the
4
compensation programs have existed in substantially similar
5
form for years and comport with the debtors' "pre-petition
6
business practices and conduct" and the testimony from
7
Mr. Burke -- Mr. McFarland covered this point well.
8
9
The U.S. Trustee makes a couple of arguments as to
why the payments are not ordinary course.
None of those
10
have any support in the case law.
11
debtors utilized outside advisors in developing the 2014
12
metrics.
13
in the middle of the year.
14
plans that were modified still used the same compensation
15
targets, had the same participants, and the same metric
16
categories before and after they were revised.
17
changes were to make some of the targets tougher to achieve,
18
some of the performance goals tougher to achieve, to remove
19
any payments that are triggered solely based on continued
20
employment past a specific date and to make the performance
21
period under the key leader performance program, one of the
22
plans, quarterly instead of two years, as it was under its
23
predecessor plan, the owner-operator plan.
24
25
First, is that the
And the second is that certain thresholds changed
Just to clarify this point, the
The only
Let me pause on the mid-year adjustment for a
minute, Your Honor.
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The U.S. Trustee made much of the fact
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that Mr. Evans testified that the adjustments were made mid-
2
year because it appeared that six months after actual
3
performance of the metrics could be viewed as "lay-ups."
4
But as Your Honor now knows from watching the video,
5
Mr. Evans was simply explaining the same thing that you
6
heard Mr. Burke and Mr. McFarland testify to, which is that
7
on advice of professionals, the company looked at the actual
8
performance year-to-date and toughened up the metrics for
9
the balance of the year to eliminate any doubt that the
10
actual performance made the metrics too easy to hit.
11
testifying that the metrics before the Court are not lay-
12
ups.
13
He was
Moreover, during her opening remarks, the U.S.
14
Trustee seems to suggest that it was somehow surprising that
15
Mr. Evans was using the terms in his deposition that have a
16
specific or unique meaning under the bankruptcy compensation
17
case law terms, like lay-up.
18
the compensation committee of a company that's going through
19
a major restructuring and has hired restructuring
20
professionals 18 months before it filed it filed for Chapter
21
11.
22
standard that must be satisfied in order to retain these
23
programs in Chapter 11.
Mr. Evans is the chairman of
It's hardly surprising that he spent time studying the
24
Even if Your Honor were to conclude that the
25
programs were not ordinary course for some reason, the
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motion should still be approved because the evidence
2
overwhelmingly shows that the compensation programs are
3
justified by the facts and circumstances of these cases
4
under the standards set forth in Dana.
5
The U.S. Trustee has not even attempted to argue
6
the Dana factors.
I'll quickly run through the six factors.
7
The first factor is that the insider compensation programs
8
must be calculated to achieve the desired performance.
9
explained by Mr. McFarland, Mr. Burke and Mr. Filsinger, the
As
10
programs are tied directly to financial, operational and
11
other business objectives that trigger payments only if the
12
debtors satisfied difficult to attain targets that would
13
generate value for the debtors' stakeholders.
14
Factor two, the cost of the programs must be
15
reasonable.
Mr. Friske testified that the compensation for
16
EFH's insiders is reasonable even taking into account the L-
17
tip payments that are covered by the LCs that are not before
18
your Court today.
19
compensation paid to insiders and he determined that the
20
overall target total, direct compensation is below the 50th
21
percentile for the debtors' peer group.
So he evaluated -- he took all of the
22
He also testified, Mr. Friske, that is, that the
23
aggregate cost of these short-term incentive plans and the
24
long-term incentive plans are within the range of observed
25
market practice as percentage of revenue.
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Factor three under Dana is that the scope of the
2
programs is fair and reasonable.
3
several of the plans mirror plans offered to non-insiders
4
that have already been approved by Your Honor and all of the
5
programs -- all of the debtors' employees participate in
6
some sort of incentive compensation program.
7
As explained by Mr. Burke,
Factor four is that the programs are consistent
8
with industry standards.
As explained by Mr. Friske, the
9
programs rely heavily on objective financial performance
10
metrics and the total compensation is in line with market
11
practice.
12
Factor five is that the debtors perform due
13
diligence in developing these programs.
14
testified, and as explained by other witnesses, the targets
15
were developed on top of the budget as part of an extensive
16
and rigorous process.
17
As Mr. Evans
And the last factor, factor six, is that the
18
debtors receive independent counsel in developing the
19
programs.
20
engaged Kirkland and Ellis, Filsinger Energy Partners and
21
Towers Watson to advise the debtors concerning pre and post-
22
petition compensation programs.
23
And as the trustee has acknowledged, the debtors
Your Honor, I now want to talk to you about the
24
letters of credit.
25
letters of credit are not before you today, we do want to
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clear up some confusion regarding the LCs because the U.S.
2
Trustee is arguing that the LCs make the SPCL tip program
3
outside the ordinary course.
4
The LCs were put in place many years ago prior to
5
the start of the restructuring.
To understand the impetus
6
of the LCs, one needs to put him or herself in the mindset
7
of the board at the time.
8
time when power prices were cratering as a result of the
9
shale revolution.
The LCs were put in place at a
It's difficult to overstate the impact
10
that the cratering of power prices had on the industry as a
11
whole and the company, in particular.
12
As Your Honor will recall from my first day
13
presentation, the settled price of gas contracts was $6.42
14
per MM BTU in 2007 at the time of the debtors' LBL.
15
rose, effectively doubled to $13.11 per MM BTU within a year
16
and then it fell all the way down to $2.04 per MM BTU by
17
2012.
18
equity declined precipitously and called into question the
19
effectiveness of the equity-based compensation programs.
And it
As a result of this fall, the value of the company's
20
In the wake of this fundamental change, the board
21
decided to implement the SPCL tip to help maintain
22
management's focus on operational excellence and incentivize
23
superior performance.
24
multi-year long performance periods, and given the
25
perception of maximum uncertainty that existed at that time,
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the debtors decided to create a mechanism that would provide
2
employees with the comfort of knowing that payments would
3
actually be made if the employee, if the employee hit the
4
performance metrics under the L tip.
5
As Mr. Burke testified, a plan would not be
6
incentivizing if the employee was worried that he or she
7
would not be paid even if they hit the metrics.
8
existence of the LCs does not bear on whether the L tip
9
itself is ordinary course.
The
The LCs are simply a funding
10
mechanism for some of the potential payments under that plan
11
if the metrics are achieved.
12
get the payments covered by the LCs, the debtors still have
13
to hit the performance metrics.
In other words, in order to
14
Furthermore, you heard from Mr. Friske who
15
testified that implementing a mechanism that assures
16
payments under incentive compensation plan is not uncommon.
17
Mr. Friske testified that 50 percent of long-term incentive
18
plans incorporate mechanisms like secular or rabbi trusts.
19
There's no evidence in the record the SPCL tip program
20
itself is anything other than ordinary course.
21
term incentive program put in place more than four years
22
ago.
23
that doesn't change that fact.
It's a long-
And as to the LCs which are just a funding mechanism
24
More important, as Your Honor is well aware, the
25
only SPCL tip payments at issue before the Court today are
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the potential payments that, if earned, are not covered by
2
the letters of credit.
3
letters of credit are a red herring.
4
So, again, we submit that the
Another important point I want to clarify to avoid
5
any confusion, our motion specifically asks Your Honor only
6
to approve certain payments that arise under the four plans.
7
We are not asking Your Honor to approve the debtors'
8
compensation plans as a whole now and forever.
9
intend to come back to this Court soon for authorization to
In fact, we
10
implement incentive programs for the 2015 period and
11
potentially beyond.
12
Lastly, all of the debtors major creditors, the
13
economic stakeholders in this case, in these cases, have
14
evaluated the debtors' compensation plans and decided not to
15
object to the relief request or, in some cases, the Court
16
relief requested.
17
presented over the last several days on all these issues,
18
the debtors respectfully request that the Court overrule the
19
United State Trustee's objection and approve the debtors
20
insider compensation motion.
21
Based on the overwhelming evidence
Your Honor, one thing we've done is we culled the
22
transcript and taken certain quotes from some of the
23
witnesses and some of the language from some of the
24
documents.
25
record, again, at the podium, I'd like to just simply hand
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up this presentation which has previously been emailed to
2
the U.S. Trustee.
3
THE COURT:
4
MR. SASSOWER:
5
All right.
So you can consider that
(indiscernible - 2:09:57).
6
THE COURT:
Thank you.
7
MR. SASSOWER:
With that, Your Honor, I'd like to
8
just reserve some time to rebut.
9
over.
10
11
THE COURT:
Thank you.
Do you have a copy of this
for Ms. Werkaiser (ph) --
12
MS. SASSOWER:
13
THE COURT:
14
Beyond that, my closing's
That's fine.
15
Yes.
-- if you don't mind.
Thank you very much.
MS. SCHWARTZ:
Thank you.
Ms. Schwartz.
May it please the Court.
For the
16
record, I am Andrea Schwartz, representing Robert DeAngelis,
17
the United States Trustee.
18
As Your Honor knows, I certainly haven't been the
19
only one representing Ms. DeAngelis in this case.
20
here are my fine colleagues, Mr. Schepacarter,
21
Juliet Sarkesian (ph), Timothy Fox and another analyst,
22
Mike West.
23
With me
Your Honor, in preparing for today's closing
24
arguments, I spent a good deal of time thinking about where
25
to begin and what evidence I should highlight for the Court
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to assist the Court in understanding and sustaining the U.S.
2
Trustee's objection.
3
new, something I had not argued before, whereas here, the
4
U.S. Trustee is the sole objector and the debtors have urged
5
the Court to weigh that fact heavily.
6
reasons why the Court should not do that a little later.
7
I wanted to come up with something
I will address the
I was, however, unable to come up with anything
8
new because the truth is that the U.S. Trustee, like the
9
Court, is charged with preserving the integrity of the
10
bankruptcy system and ensuring that the rule of law is
11
upheld.
12
part of my opening in his opening.
13
things happen all the time.
14
I certainly didn't expect my adversary to be using
I guess, different
Here, the law upon which the disputed bonus plans
15
center is Section 503(c) of the Bankruptcy Code which was
16
part of the amendments to the Code under the Bankruptcy
17
Abuse Prevention and Consumer Protection Act.
18
noted in In re. Global Home Products, and which language has
19
often been cited by the many courts that have considered
20
these types of plans, Section 503(c) was enacted to:
21
"eradicate the notion that executives were entitled to
22
bonuses simply for staying with the company through the
23
bankruptcy process."
24
Nutriceutical, Section 503(c) severely restricts the
25
debtors' ability to pay retention, severance and other
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As the Court
And, as this Court noted in Nelson
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amounts.
2
So, in addition to the reasons that I have stated
3
above, the U.S. Trustee's objection is also grounded in an
4
effort to prevent abuse where executive bonus plans are
5
proposed, consistent with Congress's intent in enacting the
6
BAPCPA.
7
forth a legal question for the Court; that is, whether the
8
Court could authorize the debtors to pay more than $20
9
million in bonuses to 26 senior executives who are insiders
In our brief and our opening statement, we set
10
of the debtors and who represent less than one percent of
11
the debtors' workforce.
12
We set forth several objections to each of the
13
three executive bonus plans, which objections all have
14
merit.
15
I would like to first address our objections to
16
the key leader performance plan because the evidence adduced
17
from the witnesses and contained in the actual plan
18
documents demonstrate that this Court is subject to Section
19
503(c)(1) and that the Court is without discretion to
20
approve it unless the debtors, through a subsequent motion,
21
since they have not addressed this Code Section here, can
22
meet the high hurdles that Congress put in place for
23
approval of plans like the key leader performance plan.
24
25
The burden of proof is not in dispute.
with the debtors.
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It rests
In addition, the debtors concede that
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each of the 26 individuals eligible under these plans are
2
insiders as that term is defined in Code Section 10131.
3
And, with respect to the debtors' burden of proof, Your
4
Honor, we urge the Court not to accept the expansive
5
treatment and sometimes over used language of the late
6
Judge Lifland in Dana where he states that every
7
compensation plan has a retentive element.
8
9
But here the Court should deeper into these plans
to determine their true nature.
Are they truly
10
incentivizing?
11
the key leader performance plan, strikes and elucidates the
12
concern that the Court in Hawker v. Trapp noted.
13
the debtor there had dressed up a key employee retention
14
plan to look like a key employee incentive plan with the
15
hope that it will pass muster under the less demanding
16
"facts and circumstances" standard under 503(c)(3).
17
Or are they primarily retentive?
The plan,
And that
We urge the Court to be wary of attempts to
18
characterize what is essentially an insider retention plan
19
as incentive, as an incentive plan, to bypass the
20
requirements of Section 503(c)(3)(1) and should -- and we
21
ask that the Court consider the circumstances under which
22
the particular proposals are made along with the structure
23
of the compensation packages when determining whether the
24
compensation programs are subject to 503(c)(1).
25
Judge Glenn in In re. Residential Capital, LLC
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also, as we refer to it as ResCap (ph) stated, a debtors'
2
label of a plan as incentivizing to avoid the strictures of
3
Section 503(c)(1) must be viewed with skepticism.
4
circumstances under which the proposal is made and the
5
structure of the compensation package control.
6
at 478 BR. 154 Bankr. SDNY 2012.
The
And that's
7
The debtors have asserted that the three executive
8
bonus plans at issue in these cases represent a continuation
9
of the debtors' pre-petition compensation practices.
With
10
respect to the key leader performance plan, the debtors
11
assert that this plan is a continuation of its owner-
12
operated -- owner-operator plan.
13
documents during discovery or accepted into evidence contain
14
this name, the plan to which the debtors refer is included
15
at Tab 17 and, if Your Honor would turn to that tab please.
16
THE COURT:
17
MS. SCHWARTZ:
18
Hold on.
Your Honor, if we had more time, we
would have separated these --
19
20
Although none of the plan
THE COURT:
That's fine.
a lot to move around.
I got it.
That's fine.
Number 17.
It's just
Yes, ma'am.
21
MS. SCHWARTZ:
22
And as Your Honor will see, this is the owner-
23
operator plan.
24
called the EFH Corp. Retention Award Plan.
25
says labels mean nothing.
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Well, what does it look like?
Hmmm.
It's
Now Mr. Sassower
Well, I think, Your Honor, the
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law is pretty clear that Your Honor should look at how this
2
entire compensation package was arrived and here, at Tab 17,
3
I will just read that the purpose, the section number 1,
4
called Purpose and Effectives Dates, states:
5
retain the services of certain key employees, Energy Future
6
Holdings Corp., a Texas corporation, the company, has
7
adopted this EFH Corp. Retention Award Plan to incentivize
8
such key employees to "continue providing services to the
9
company and its affiliates."
in order to
10
Your Honor, I will also point out for you in the
11
other plan documents that there's no language, as there is
12
in other plan documents, that talk to this EFH Corp.
13
Retention Award Plan as being a performance-based plan.
14
Frankly, the plain language says, that is, to incentivize
15
such key employees to "continue providing services."
16
plan language suggests it's a retention plan.
17
The
Now, in his opening statement, Ms. Sassower made
18
the point that these are old plans.
19
BAPCPA then.
20
retention, et cetera.
21
Retention plan that the debtors disguise as the owner-
22
operator plan, is dated 12-20-10.
23
the BAPCPA and, as is plain, paragraph one, the debtors seem
24
to know how to use the word incentivize because there it is,
25
contained in paragraph one.
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They didn't have the
They didn't know about incentivize versus
Well, the actual plan, this EFH Corp.
That is five years after
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At paragraph four, which is on page three, this
2
sets forth who's eligible under the plan and what does it
3
say?
4
administrator are eligible employees to receive a retention
5
award under this plan in accordance with the terms of the
6
individual participation agreement provided for each
7
eligible employee.
8
know, how it gets approved from the SPC, et cetera.
9
going to read the entire provision, but I'm highlighting for
It says that those key employees designated by the
And it goes on to say about whether, you
I'm not
10
the Court that it is, in fact, referencing a retention
11
award.
12
Paragraph five of this EFH Corp. Retention Award
13
plan talks about payment of the retention award.
14
goes on, terms of the retention award,
15
will be eligible to receive a retention award in accordance
16
with Section 5, each participation agreement shall provide
17
the amount of the retention award, the time for the payment,
18
vesting or forfeiture provisions and any other terms or
19
conditions that the administrator or the committee
20
determines to be appropriate for the eligible employee's
21
retention award.
22
And it
an eligible employee
Paragraph seven sets forth in amendment and
23
termination of the plan that at 7(c) or (c) in the hole, it
24
says:
25
terminate this plan at any time provided that such an action
the O&C committee shall have the right to amend or
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does not materially and adversely impact any eligible
2
employee without the written consent of the eligible
3
employee, provided, however, that the O&C shall have the
4
right to amend or terminate the plan, at any time without
5
the consent of the eligible employees, if the administrator
6
has determined in its sole discretion that such an action is
7
appropriate in light of changes in any applicable law or if
8
such an action is required by law.
9
So this is -- this provision is akin to a
10
guarantee.
11
consent of the eligible employee.
12
paragraph 7(e) it talks about the non-transferability of the
13
retention award.
14
award cannot be transferred.
15
They cannot terminate this plan without the
Similarly, Your Honor, at
This plan provides that the retention
Now, this plan has another document that goes
16
along with it which is the individual participation
17
agreement and that can be found at Tab 19 of the binder.
18
THE COURT:
Yes.
19
MS. SCHWARTZ:
Now, again, we're talking about
20
what the debtors have called something other than the EFH
21
Corp. Retention Award Plan.
22
example of an individual participation award letter that was
23
provided to us by the debtors and redacted to keep out
24
certain information.
25
another important document that shows that this was a
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This is the -- this is an
But I think this is an important --
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retention award and it was, in fact, guaranteed.
2
The actual individual participation agreement
3
provides in the second paragraph amounts and payments dates
4
and it says, the full amount of your potential retention
5
award will equal $550,000, the retention award.
6
retention award will be payable in two separate payments,
7
the first on September 28, 2012 and the second on September
8
30th, 2014.
9
I'll get to the stay provision but it's based on two years.
10
Your
So you have to stay for a two-year period.
And then it says, each payment will be equal to
11
the amount with results from a formula based upon one half
12
of your retention award and multiplied by a percentage that
13
reflects the company's financial performance during the
14
applicable period to which your payment relates, see
15
formulas below, in each case, subject to certain minimum and
16
maximum levels.
17
a cash, lump sum, et cetera.
Then it says, each payment will be paid in
18
Then you look at the formula and the formula says,
19
that for the first retention payment, the formula will be 25
20
percent times the retention award, which is already defined
21
at $550,000 times the 2010 EBIDTA percentage plus 25 percent
22
times the retention award times the 2011 EBIDTA percentage.
23
The document defines EBIDTA percentage and it says: for the
24
applicable year shall be defined as a percentage equal to or
25
between 50 percent and 100 percent that will be determined
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by the level of budgeted earnings before interest, taxes,
2
depreciation, amortization, EBIDTA, actually achieved for
3
that year.
4
Now, Your Honor, what's interesting in this
5
document is on the next page.
On the next page, the top
6
paragraph talks about this EBIDTA percentage and how it
7
applies.
8
EBIDTA percentage -- there's a target and it's not met,
9
there's no retention award.
This is not the case, Your Honor, where if the
What the plan provides is, in
10
the middle of the paragraph, at the top of the page,
11
provided however that in no event shall the EBIDTA
12
percentage be less than 50 percent or greater than 100
13
percent.
14
budgeted EBIDTA amount for 2010 is determined to be four
15
billion, and actual EBIDTA for 2010 is 3.5 billion, the
16
percentage that must be used for the 2010 EBIDTA percentage
17
portion of the first retention payment formula above will be
18
50 percent.
19
guarantee.
20
And it explains, for example, if the threshold
So it can't go below 50 percent.
And it's a
This is clearly a retention plan.
So, what happened?
What happened, Your Honor?
21
Mr. Evans testified that in June of 2012, the debtors
22
retained Kirkland and Ellis.
23
months, they retained Mr. Filsinger and Filsinger Energy
24
Partners.
25
compensation expert and that these professionals were
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A little later in the coming
They expanded the scope of Towers Watson, their
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retained to, in fact, evaluate, look at the plans, and
2
determine how these plans would be treated in bankruptcy.
3
Mr. Evans testified that never before had they had
4
hired an energy expert or expanded the scope of Towers
5
Watson or retained counsel to review their plans.
6
solely because of the fact that they were going into
7
bankruptcy.
8
9
This was
Now there should be no doubt that, in this Court's
mind, that Mr. -- that K&E and Mr. Friske are fully versed
10
in how executive compensation plans are treated in
11
bankruptcy.
12
application and has already represented to the Court that
13
they did provide this independent advice and Mr. Friske
14
testified that he's been involved with structuring and
15
designing hundreds of these plans in and out of bankruptcy.
K&E includes these services in its retention
16
So -- and, in addition, Your Honor, in a
17
declaration that was submitted in support of the non-insider
18
comp motions by Ms. Carey Kirby, the senior executive vice
19
president for human resources, which can be found at Tab 4
20
of your binder, but you don't need to go there, Ms. Kirby
21
confirms that the modifications that they made to change the
22
existing EFH Corp. Retention Award Plan were done with the
23
input of Towers Watson.
24
25
So what did the debtors do?
Well, there were, at
the time, a hundred and twenty-eight employees eligible
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under the plan.
For those whom the debtors contended and
2
the U.S. Trustee with healthy discussions which we've had
3
throughout this case, determined not to object, those
4
employees were non-insiders, approximately a hundred at the
5
time.
6
called, the key leader plan.
7
evidence has borne out that the plan for the non-insiders do
8
not have an incentive component.
9
strictly a retention plan.
They had their own plan.
Their plan was similarly
Debtors do not dispute and the
They are strictly -- it is
In support of the motion that I
10
had mentioned, the non-insider plans, Ms. Kirby, in her
11
declaration states that they "modified" the owner-operator
12
plan to -- and that again is the EFH Corp. Retention Award
13
Plan, I think, Your Honor understands that.
14
say that every single time.
15
quarterly payments to focus more on retention and that these
16
quarterly payments were more appropriate than a multiple
17
year program given the uncertainty of the debtors'
18
restructuring process.
19
I don't have to
But that plan to include
Ms. Kirby states at paragraph 23 that the
20
quarterly payments would improve employee morale and "create
21
stronger retention incentives."
22
Honor, was with respect to these non-insiders, the debtors
23
just did a new plan, called it the key leader plan, but made
24
it a straight retention plan.
25
insiders to that plan.
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So what happened, Your
And they added 30 other non-
Now, why did they do that?
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Ms. Kirby tells us the answer.
They added them to ensure
2
that they do not lose key employees who would be
3
particularly difficult to replace during this critical
4
period.
5
which is at Tab 4.
That's at paragraph 22 of Ms. Kirby's declaration
6
So now the debtors have taken care of this hundred
7
non -- these are executives, higher level key people, to
8
take care of those hundred and they add 30 more people in
9
and they say, okay.
It's a retention plan but we don't have
10
to call it anything other than that.
11
it's anything other than that because they're non-insiders
12
and the Bankruptcy Code treats non-insiders differently than
13
it does insiders.
14
We don't have to say
So, now, what to do with the 19 remaining
15
participants under the former EFH Corp. Retention Award
16
Plan.
17
we're going to call this now the key leader performance plan
18
and we're going to institute the same quarterly payments
19
that we did for the other 130 non-insiders, which I will
20
repeat, that Ms. Kirby stated was done to, among other
21
things, create stronger retention incentives.
22
well, we're going to add an incentive component to this
23
plan.
Well, what do the debtors do?
24
25
They say, okay, well,
And they say,
Now the key leader performance plan is at Tab 16
and I would ask the Court to please turn to that.
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Well, here we are again with a plan that doesn't
2
contain the name that is used in all the papers but at least
3
here it's recognized to be a performance bonus plan.
4
what is the purpose?
5
Energy Future Holdings Corp. 2013 Performance Bonus Plan is
6
designed to align the interests of the company and eligible
7
key employees of the company and its subsidiaries.
8
effective date, at paragraph two, is October 7th, 2013.
9
is a brand new plan, Your Honor.
10
And
It says, the amended and restated
This is not a continuation, as they say.
Its
It
So when
11
the word, continuation, works for the debtors to show that
12
it's a historical plan, there are no changes, it's the same
13
people, da, da, da, da da.
14
actual document shows it's a brand -- and, also, those
15
points are made to show, Your Honor, or to support the
16
argument that it's ordinary course.
17
don't think this is ordinary course and the facts in the
18
documents that the Court has accepted into evidence do not
19
support that.
20
effect October 7th, 2013.
21
That's okay.
But then when the
Well, Your Honor, I
This is a brand new plan.
It comes into
At paragraph four, little (f), there's a
22
definition:
23
says performance goals means the performance goals
24
established for the company's annual incentive plan by the
25
committee with respect to a calendar quarter commencing
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performance goals.
And what does it say?
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during the term.
2
So, what they do, is they say, okay.
We want to
3
still give this compensation to these 19 executives.
4
know if we have to call it what it is, we're going to have
5
to meet the standards of 503(c)(1).
6
we have no information, Your Honor, so I won't say one way
7
or the other, but I think one reason that they haven't
8
addressed that in this motion is there is the possibility
9
that they cannot satisfy those rigorous standards.
10
In fact, during Mr. Evans' testimony, he
11
testified, there's only one person that left the company and
12
that was two years ago.
13
ceiling motion, Mr. Dempsey stated that there were other
14
people who left the company but as Ms. Sarkesian
15
appropriately noted, Mr. Dempsey is not a witness and that
16
statements by counsel are not evidence.
17
We
I don't believe -- and
Now, in oral argument on the
With respect to paragraph six, it talks about the
18
term of the participation and it says, subject to the
19
provisions of this plan, commencing with the calendar
20
quarter March 31, each plan participant shall earn a
21
quarterly performance bonus at the end.
22
this is the way get it, if, one, such participant remains
23
employed by the company group through the last date of the
24
applicable period and, two, the extent the performance goals
25
established for such performance period have been achieved,
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And that -- and
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provided that if the terms ends after the commencement and
2
before the end of the calendar quarter, each participant who
3
is then employed by the company shall earn a prorated amount
4
of the quarterly performance bonus for the quarter in which
5
the term ends.
6
It also says, as is different than what was
7
testified to by Mr. Burke, Mr. Burke testified that, well,
8
the participant has to be there, you know, for 30 days after
9
the quarter.
So that would be four months.
So if -- they
10
shortened the period of having to be there; however, the
11
plan allows for catch up.
12
not met, then they can still get it if the overall annual
13
performance metric is met.
14
So if the performance metric is
But here's what the document says.
It says, any
15
quarterly performance bonus required to be made under this
16
plan shall be paid by the company within 60 days after the
17
date of the participant earned -- after the date the
18
participant earned the right to such payment.
19
five months, Your Honor.
20
half a year, close to half a year, five months.
So that's
Now, we're starting to get into
21
And it also says a participant who's employment
22
with the company group terminates, and this is important,
23
for any reason, shall forfeit the right to any quarterly
24
performance bonus that has not been paid as of the date of
25
such termination.
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I will go through with Your Honor in the other
2
plans and not try to not be interesting in doing that but
3
pointing out, you know, important provisions.
4
plans, there are certain circumstances under which you could
5
get a pro-rated portion of your award, not here.
6
But, in other
The other thing that's interesting about this
7
document is paragraph seven which says that before the
8
commencement of each performance period, the committee shall
9
establish one or more performance goals that must be
10
achieved to earn a quarterly performance bonus for that
11
performance period.
12
required to, establish minimum targets and maximum targets
13
with respect to selected performance goals that provide for
14
the payment of a fraction or multiple of a participant's
15
quarterly performance bonus.
16
The committee may, but shall not be
So, in this plan, they don't have to meet every
17
single one of the 21 metrics in the -- for the EAIP.
18
plan requires only one.
19
they can change it before the next term.
20
Your Honor, is that this key leader performance plan, which
21
certainly is an outgrowth of the former EFH Corp. Retention
22
Plan and it's just a way to try to get the same compensation
23
to these professionals, simply inserts performance, maybe
24
one or more, the debtors have the burden of proof to show
25
what they do for each, and they have not.
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And they can also change it.
This
So --
So what I suggest,
But it certainly
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shows that they just inserted a performance metric that
2
already has to be met under another plan.
3
additional performance that's required in order for the 19
4
people under this plan to receive their bonuses.
5
There's no
One thing for clarification, Your Honor, and that
6
is that it's been stated in testimony of some of the
7
witnesses and Mr. Sassower in his opening that the cost of
8
the plan is something like 2.5 million.
9
email from Will Gerary (ph), who's an attorney at Kirkland
But there is an
10
and Ellis at Tab 22, that sets forth the actual cost of the
11
key leader performance program at 3,351,500 at target and
12
says this is also the max.
13
So just to clarify the record so we have the
14
numbers correct, these are the numbers that were provided to
15
us from the debtors.
16
statement that the SPC long-term incentive plan is 1.825
17
million.
18
We don't agree, Your Honor, with the
And I will now turn to that plan.
However, Your Honor, just before I get there, I'm
19
just trying to go back and forth the documents and my notes.
20
I just want to mention also, Your Honor, that with respect
21
to the key leader performance plan, there's also an
22
individual participation agreement that goes with that.
23
It's similar to the participation agreement that was with
24
the EFH Retention Award.
25
Your Honor will see, among other things, that at the top of
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It's at Tab 15, Your Honor, and
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page two, it provides that with respect to the performance
2
period, the eligible participant will have the ability to
3
earn between 50 percent and 100 percent of the baseline
4
quarterly performance attained -- both on attainment of the
5
threshold performance goal or the baseline performance goal
6
as applicable.
7
Well, I don't know what that is, Your Honor, and
8
the debtors haven't put that into evidence.
I don't know
9
whether they're using the threshold or the baseline.
But,
10
as I will get to when I discuss the EAIP, there certainly
11
are questions about the thresholds that have been set.
12
In addition, Your Honor, in this individual
13
performance agreement on page three, there's a section
14
called Terminations of Employment and it includes that in
15
the event that your employment with the company group is
16
terminated for any reason, you will forfeit your right to
17
receive any unearned portion of your performance award.
18
This plan, Your Honor, the key leader performance plan, is
19
truly a disguised perk and, Your Honor, should not permit
20
the debtors to make payments under it without having to meet
21
the strictures of 503(c)(1).
22
Certainly, they could have an opportunity to go
23
back, regroup, figure it out and, Your Honor knows the U.S.
24
Trustee worked with long hours with many of the fine lawyers
25
at Kirkland and Ellis on the non-insider compensation motion
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that was presented to Your Honor without objection and took
2
care of the compensation for over 5500 of the company's rank
3
and file.
4
them to the extent that they choose to do that and the Court
5
so finds.
And we certainly would be willing to speak with
6
But it is clear that this is a plan, is one of
7
those plans, that judges who have looked at these plans,
8
have said that the Court should scrutinize very carefully.
9
And I apologize if it's somewhat tedious going through the
10
actual provisions of the plans but that's what they plans
11
say and they are what they say, retention award plans.
12
simply including a performance metric from another plan
13
that's already in existence doesn't then convert a retention
14
plan into an incentive plan.
15
And
The long-term incentive plan retention awards.
16
This is the next -- you have to find this one too.
17
It's an exhibit to the employment agreements.
18
will turn to Tab 6 in the binder, I'm using this as an
19
example but debtors have represented to me and of the five
20
employment agreements that have been -- well, actually, I'm
21
not sure if all seven are in, I know that two of them are
22
redacted.
23
are for those SPC numbers, the strategy and policy committee
24
members, the top seven employees, there's not a page number,
25
Your Honor, but this is the amended and restated employment
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I did.
If Your Honor
But at least with respect to the five, and these
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agreement for James A. Burke.
2
It is dated March 31, 2014.
And if Your Honor, pushes back a little bit, that
3
document is 17 pages and the next document is called Exhibit
4
1.
5
6
THE COURT:
I'm sorry.
I missed the exhibit
number.
7
MS. SCHWARTZ:
Certainly, Your Honor.
8
Exhibit 1.
9
the amended and restated employment agreement of
10
It's
This is Tab 6 and the first document in Tab 6 is
James Burke.
11
THE COURT:
All right.
12
MS. SCHWARTZ:
It's 17 pages.
So if you get
13
through the 17 pages, you come to a document called Exhibit
14
I.
15
THE COURT:
I got it.
16
MS. SCHWARTZ:
17
THE COURT:
18
MS. SCHWARTZ:
Okay.
Thank you.
That document -- this is the SPC
19
long term incentive plan.
Now, again, Your Honor,
nowhere
20
on this document is it called the SPC long term incentive
21
plan.
22
and it talks in terms of three retention awards, Your Honor.
At paragraph A it talks again about a retention award
23
The first retention award for Mr. Burke has
24
already been paid and so has the second retention award.
25
what we're looking at now, under the SPCL tip, as they call
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it, are -- is the third retention award.
2
at -- that's letter "A", III.
3
earn an additional long term cash bonus award in an amount
4
between 500,000 and one million per fiscal year determined
5
by the company's performance as indicated by the level of
6
the competitive management EBIDTA actually achieved for the
7
fiscal years ended December 31, 2012, December 31, 2013 and
8
December 31, 2014, relative to the competitive management
9
EBIDTA threshold and target amounts set by the board for
10
And that's Roman
And it says, executives shall
each respective fiscal year, the "third retention award".
11
For the achievement of the threshold level of the
12
competitive management EBIDTA in respect of such year, the
13
executive shall earn $500,000 for the achievement of at
14
least the target level of the competitive management EBIDTA
15
in respective of -- and each year.
16
one million, the third retention target award, for the
17
achievement of competitive management EBIDTA in between
18
threshold and target levels in respect of any such year.
19
Executives shall earn an amount between 500,000 and a
20
million as determined by linear interpellation.
21
The executive shall earn
The third retention award, if earned, shall be
22
paid to executives in a lump sum on March 13, 2015 provided
23
that "subject to the provisions of subparagraph (a)(5) of
24
this Exhibit I, executive is employed by TXU Energy, the
25
company, or an affiliate thereof, on March 13, 2015."
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Now there's a little circuitous route that one has
2
to go through in reading the plan provisions but if you look
3
at (a)(5), it says that, in the event executive's employment
4
is terminated pursuant to Section 7(b), 7(c), 7(d) or 7(e),
5
you can get a pro rata award.
6
say?
7
agreement and look at what paragraph 7(a) says.
8
paragraph 7(a) refers to is where if there's termination of
9
employment by the company for cause or the executive due to
10
But what does paragraph 7(a)
Well, you got to flip back to the actual employment
And what
voluntary resignation without good reason.
11
So, Your Honor, the employee has to stay with the
12
company for three years in order to get this retention
13
award.
14
don't stay for the three years and they resign, they don't
15
get it.
16
They're going to stay.
17
on March 31st, 2015 is $8.1 million.
18
$3 million.
19
$2.5 million.
20
Mr. O'Brien, Your Honor, has those numbers.
21
what they are.
22
And, Your Honor, with respect to this award, if they
And, Your Honor, the retention awards are big.
Mr. Young's retention award payable
Mr. Keglevic's (ph) is
Mr. Burke's is $3 million.
Ms. Doray's (ph) is
Mr. McFarland's is $3 million.
Ms. Kirby and
They're also
They're sealed.
But I'm telling you, Your Honor, these are big
23
numbers and these executives are going to stay to get these
24
amounts.
25
looking for third -- it might be a little earlier, which I
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They're also
contained, Your Honor, at -- just
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think is a good demonstrative for the Court to look at --
2
(inaudible - 2:49:51).
3
Now, as I'm looking for that, Your Honor, I will
4
say that when Mr. Sassower stated in his opening remarks
5
that the relief that the debtors seek are only related in
6
2014, related to 2014, and that the amount sought under the
7
SPC, which, as Your Honor knows is 1.85 million, well, that
8
doesn't actually reflect the total cost of the plan.
9
doesn't reflect the total that's going to be payable in
It
10
March of 2015.
11
that he has found other -- first of all, Mr. Friske stated
12
that he's never before seen, never, none, before seen
13
letters of credit obtained by companies to assure payment of
14
bonuses.
15
And, Your Honor, Mr. Friske may have said
I've never heard of it but I'm not an expert in
16
that area.
17
hundreds of plans has never seen it, I think that it's fair
18
to say, Your Honor, that's not -- that's not common in the
19
industry.
20
Mr. Dempsey that he has seen other instruments, like rabbi
21
trusts used to secure payments, but he never -- he's never
22
seen letters of credit.
23
cuff -- well, it was testimony.
24
I've been practicing bankruptcy law for 21 years, I've never
25
seen it.
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But certainly an expert who has reviewed
He may have said on cross-examination by
And, Your Honor, it was an off the
He said about 50 percent.
I don't believe that in the industry the evidence
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the debtors have carried their burden to show that it's
2
consistent in the industry.
3
I think it's problematic, Your Honor, that the
4
debtors did not include in their motion, or actually, let me
5
say it this way.
6
excepted from their motion authorization to be able to make
7
those payments.
8
that they don't need to.
9
already been obtained, et cetera.
10
I think it's problematic that they
They'll make an argument before Your Honor
It's ordinary course.
The money's
That will be for another
day.
11
But what they're asking for you, asking you for
12
today is 1.85 million for two of their top seven executives.
13
And why are they asking you for that, Judge?
14
going to make those payments today.
15
until March, 2015.
16
make that because they want to make sure that those two
17
people stay.
18
They're part of the top seven.
19
afterward and the debtors, for whatever reason, in their
20
business judgment, did not decide to provide that certainty,
21
that Mr. Evans testified to, over and over again in his
22
deposition testimony as to why he has to deliver to these
23
people so that they don't worry about going home and how
24
they're going take care of the families.
25
that more than one time.
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They're not
They're not making that
They're asking you for authorization to
Their bonuses are not in letters of credit.
They joined the SPC
He testified to
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He put into evidence, Your Honor, I mean, as is
2
clear in the evidence and the document submitted, all of the
3
top seven SPC, are paid very high salaries.
4
salaries for -- the actual salary for Ms. Doray is in one of
5
the exhibits.
The actual
Let me see if I can get that for you.
6
THE COURT:
It's --
7
MS. SCHWARTZ:
8
THE COURT:
9
MS. SCHWARTZ:
Okay.
It's at Tab 23.
Yeah.
At Tab 23, Ms. Doray's base salary
10
for 2014 is $600,000.
11
census data as part of the evidence that shows that the
12
median household income for a family of four in Texas is
13
about $53,000.
14
propriety of the salary et cetera.
15
draw the difference about having to take care of your
16
families, that there is an extreme difference, at least ten
17
times the salary that this executive's being paid, is ten
18
times the median income for a family of four.
19
Your Honor, we put into evidence
So I'm not making a comment as to the
But certainly one can
Your Honor, with respect to the L tip program, in
20
addition, you have the same scenario.
21
compensation program with the same exact party.
22
Honor, as has been shown on the exhibit that was prepared by
23
Mr. Panacio that has been used by every party in this case,
24
the debtors' actual performance for the past five years,
25
they have met that number every year.
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It's another
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The competitive management EBIDTA as was testified
2
to is a roll-up of those EBIDTA numbers and they've met it
3
for the past five years.
4
low of a threshold to show that that's a primarily
5
incentivizing plan.
6
Again, Your Honor, it's just to
It's a retention plan.
And, Your Honor, in addition, I don't want to
7
forget this -- I'll go quickly, Your Honor.
I don't want to
8
forget this under 503(c)(3), giving the debtors authority to
9
pay that 1.8 million, which will, they say, it's been
10
earned.
11
earned -- well, they might say it's earned, but it cannot be
12
paid, it cannot be paid until March 31st, 2015.
13
Honor, if Ms. Doray or Ms. Kirby get poached, as the term
14
was used by Mr. Dempsey, they're not going to get that
15
bonus.
16
going to get $2.5 million.
17
No, it hasn't been earned, Your Honor.
It's not
So, Your
They're not going to get the -- Ms. Doray's not
I submit to Your Honor although this is a very big
18
case and I find that in bankruptcy cases, this happens all
19
the time, of course, as -- we get desensitized to these
20
numbers.
21
That's huge dollars, 2.5 million.
Okay.
In addition, Your Honor, it's not ordinary
22
course.
23
ordinary course.
24
before seen these letters of credit.
25
were put in place five years ago, in 2009, I don't believe
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Mr. Friske -- for the reasons I stated, it's not
Mr. Friske has stated that he had never
Although the plans
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it is ordinary course to obtain letters of credit.
2
believe that those actions were taken to provide assurance,
3
as Mr. -- we'll use Mr. Evans' testimony and his words, to
4
provide certainty, certainty, that they would, in fact, be
5
compensated as -- for these bonuses.
6
And I think there is certainty.
I
The thresholds
7
are low.
They're low enough and based on the actual
8
performance in the past history, it's going to be met.
9
for all the time that the debtors, on the other side, have
10
side, these are not guaranteed.
11
There's no language that says they're guarantees,
12
guaranteed.
13
five years of performance.
14
So,
I think that's right.
But they certainly are likely based on the past
Lastly, Your Honor, I'd like to address the
15
executive annual incentive plan.
16
Court and I'd like to thank my adversaries with respect to
17
the courtesies to allow and to permit the schedule for
18
Mr. Panacio and I think what we heard today, Your Honor, was
19
-- there were no surprises.
20
I'd like to thank the
Mr. Panacio put together a chart which is now an
21
exhibit at Exhibit No. 36 and included in that chart
22
information provided by the debtors.
23
He puts it on a spreadsheet.
24
accountant.
25
He's an accountant.
He uses Excel.
My dad's an
He writes me letters on -- in Excel.
(Laughter.)
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MS. SCHWARTZ:
2
THE COURT:
3
MS. SCHWARTZ:
He'll kill me for that one.
Uh-huh.
Anyway, so he put his spreadsheet
4
because he wanted to see, well, where do these numbers play
5
out.
6
And this was, I submit, a very helpful document.
7
asked to be used by the debtors' witnesses.
8
for everybody to get a look.
What do they look like?
9
How can I understand that?
It was
It's helpful
Now, it's true, Your Honor, that the debtors have
10
spent a lot of time trying to persuade the Court that a
11
straight calculation, taking the average of all the actual
12
performance, and comparing it to the threshold is not
13
appropriate.
14
the right numbers and it's not a fair reading.
15
You shouldn't do that because you don't get
I think, Your Honor, that the debtors bear the
16
burden of proof to show that, and I may have not done that,
17
and I want to tell you why we think they have not done that.
18
First of all, with respect to the EBIDTA numbers, I mean,
19
Ms. Sarkisian went through this chart in step by step,
20
logical progression with Mr. Panacio and she elicited from
21
him all the numbers and what the percentages were in terms
22
of comparing the thresholds to the average of the actual
23
performance for the past five years, without disclosing the
24
EBIDTA numbers or the contribution margin.
25
those numbers.
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Your Honor has
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It is fair to say that the 2014 thresholds are
2
below the actual average or above depending upon whether
3
it's a cost or a revenue side, for the past five years and
4
sometimes substantially.
5
why that was with respect to EBIDTA by commenting on the
6
debtors' hedging program.
7
today, Your Honor, the debtors have not met their burden of
8
proof to show that the hedging program is a dollar for
9
dollar reduction on the EBIDTA numbers.
Mr. McFarland sought to explain
However, as we -- as I stand here
The debtors have
10
not met their burden to show which hedging program they're
11
really talking about.
12
length, to obtain from Mr. Friske, the corporate hedge book
13
that he was discussing and talking about and had mentioned
14
in a chart in his 67 page report, Mr. Filsinger was unable
15
to give all the details with respect to the corporate hedge
16
book.
17
off the top of his head, that seemed to be consistent with
18
the first day presentation that Mr. Sassower had presented
19
on first day, as a demonstrative, at first day hearings.
20
However, Your Honor, as Your Honor knows, this
When Mr. Schepacarter attempted, at
Mr. McFarland, who was able to give the Court numbers
21
company has a large hedging and trading component, a very
22
large one.
23
the Court for their hedging and trading programs.
24
U.S. Trustee spent a lot of time with them because as part
25
of that hedging and trading program, they also had what the
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And, Your Honor, we had -- they made a motion to
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debtors were calling proprietary trades.
2
acknowledge that it was one of the most complicated motions
3
to get the U.S. Trustee to understand, would be consistent
4
with the law, and reasonable under 345 and all of the other
5
Code sections that would apply.
6
Your Honor, we don't know what hedging they're talking
7
about.
8
9
So -- and they
But as we stand here today,
Now, Mr. Sassower says in his closing that he'd
like to clarify the hedging for the Court.
Again, Your
10
Honor, Mr. Sassower's not a witness.
11
although it may be helpful, is not evidence.
12
if -- when Mr. McFarlane says, "well, we made 1.8 million on
13
this particular corporate hedge book, and the next year we
14
only made 1 million, and therefore that affects the EBITDA."
15
He didn't say it was a dollar after dollar reduction.
16
don't know.
17
have not met their burden to show the Court that that is the
18
factor that affects their actual target and can show the
19
Court that the target -- that on their face, and as
20
demonstrated in Mr. Panacio's Exhibit 36 fall well below the
21
average actual performance for the past five years.
22
And what he says,
We don't know
We
We just don't know, Your Honor, and the debtors
Okay, now in addition, I would note, Your Honor
23
that -- another issue was that also was not fully put before
24
the Court was the impact that the hedging that Luminant does
25
really affects the TXU EBITDA.
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Mr. Burke said, or
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Mr. Filsinger said it affects it because TXU buys its power
2
from Luminant.
3
down, it affects it.
4
believe that the debtors have met their burden of proof to
5
explain why the hedging program, which is a Luminant hedging
6
program, affects the TXU EBITDA numbers such that they would
7
not, in fact, fall below the average performance for the
8
past five years.
9
So, if the amount of Luminant EBITDA is
I'm sorry, Your Honor, but I don't
And they have the obligation to do that.
Now, another comment that was made by the debtors
10
was that there's a mountain of evidence before the Court.
11
There's a lot of evidence before the Court, but just because
12
there's a quantity of evidence doesn't mean that the debtors
13
have satisfied and explained these questions as to why their
14
thresholds should not be found by this Court to be too low,
15
and that the plan be found to be not primarily
16
incentivizing.
17
(Indiscernible).
In addition, Your Honor, another
18
issue that Mr. Panacio had looked at had to do with
19
Mr. Friske's use, and the debtor's use of these peer groups,
20
the peer group.
21
testified to the Court that the peer group was not invented
22
by him.
23
had used this peer group for a long period of time.
24
Mr. Friske, "well, Mr. Friske, how did you determine that
25
these peer groups were, in fact, peer groups?"
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And as Your Honor may recall, Mr. Friske
It was the debtor's peer group.
And the debtors
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I asked
And he said
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he looked at the operations; he looked at various factors;
2
etcetera.
3
brought out to him, well, you know, it appears that -- we
4
asked him, have -- I asked him, "have any of the peer groups
5
used comparables that you're saying to support the debtors'
6
argument that it's consistent with industry standard?
7
any of these comparables in these companies, have they had
8
net income losses for the past four years?"
9
tell you?
10
Now one of the things that he said when we
Are
And what did he
I don't know and it doesn't matter.
Well, that's for the Court -- I think that's for
11
the Court to decide because we think it does matter as to
12
whether or not those are, in fact, comparable companies.
13
What he said was it's about talent, not about the
14
performance of the company.
15
generating a profit.
16
and he didn't consider that, but that it's about talent.
17
if you're (indiscernible - 3:07:26) company and somebody's
18
had a lot of experience, etcetera, that's what he looks for.
19
So I think that that is a problem with respect to the notion
20
that these are, in fact, peer groups and it's consistent
21
with industry standard.
22
It's not about whether they're
You don't really need to look at that,
So
The other thing, Your Honor, is -- and I think it
23
was asked on cross of Mr. Panacio was an attempt to
24
criticize Mr. Panacio's analysis or diminish its usefulness
25
to the Court was did Mr. Panacio look -- did he look at the
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compensation plans for all of these other companies?
2
said, frankly, no.
And he
Well, neither did Mr. Friske.
3
If Your Honor looks at Mr. Friske's declaration,
4
you're not going to see that he looked at the compensation
5
programs for all of these other companies.
6
that's not his testimony.
7
operations.
8
what he looked at when he looked at the peer groups to see
9
if they, in fact, had the same compensation plans as the
He didn't.
And
What he said was, he looked at
He's done a lot of these plans, but that's not
10
debtors.
He said it's common to have more than one plan.
11
Compensation package, it's common that there's more than one
12
plan.
13
all the plans of the peer group companies.
14
fair to say, Your Honor, if their expert in compensation
15
didn't look at that, I'm not sure what weight Your Honor
16
should give that with respect to Mr. Panacio.
But he didn't say that he went and looked at the --
17
So I think it's
And let's see -- Your Honor, I want to talk about
18
for a minute -- I want to talk about the risks.
19
been a lot of talk about the risks, and there's been a lot
20
of talk about how they can affect the metrics.
21
There's
Now Mr. Filsinger's role in all of this, as
22
debtors concede, is very, very narrow.
23
to look at the metrics.
24
actual numbers of June because the debtors knew that in
25
order to get this executive annual incentive plan approved,
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His role was solely
And what did he do?
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He took the
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they were going to have to show that this plan was in fact
2
incentivizing.
3
June numbers.
4
numbers and did their own calculation as to what year to
5
date would be, notwithstanding that they didn't think that
6
Mr. Panacio's extrapolation of doubling the numbers was
7
appropriate and cited a couple of instances why that might
8
not have been, but they increased the thresholds, Your
9
Honor, of 18 -- of 21 of the metrics.
10
They had a problem.
They already had their
And so, when they looked at their June
Mr. Evans testified they've never done that before
11
and he's been with the company since its beginning seven
12
years ago.
13
He's the chairman of the ONC for seven years.
14
did a mid-year review where they did a wholesale revision.
15
They did it, as he said, for the purpose of bankruptcy.
16
makes sense, Your Honor, that they did it because they have
17
very -- they have lots of professionals that want to be able
18
to get these plans approved by the Court, but it's not
19
ordinary course.
20
historical practice to do a mid-year, wholesale revision of
21
18 of the targets.
22
He's the chairman of the board for seven years.
They never
It
It's not something they do in their
I might be jumping around a little, Your Honor.
23
I'm tired and I'm trying to just get to the end of my -- the
24
points that I want to make sure I --
25
THE COURT:
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MS. SCHWARTZ:
2
So I wanted to talk about the risks, Your Honor.
3
And that is -- you saw Mr. Evans and he testified that the
4
risks that are included in the debtors' motion, which when
5
one would read would say wow, that's a lot of variables as
6
to whether or not these metrics can and cannot be met.
7
Mr. McFarlane and Mr. Burke and Mr. Filsinger all provided
8
testimony about the risks and how the various,
9
uncontrollable aspects could affect the metrics.
We heard a
10
lot about the weather and how they can't control the
11
weather.
12
And
And as a layperson and not an energy expert, I
13
asked Mr. Evans, I said, "well, you have all of these risks,
14
right?"
15
read every single one of them.
16
all of the risks?"
17
Now, Mr. Burke said, "well, you know, you can't really look
18
at it that way because these risks play out differently."
19
And he tried to explain -- you did explain how weather could
20
play out differently, or outages will play out differently,
21
and there was some testimony about being -- maybe it
22
Filsinger that said they're eight hours behind on one of the
23
metrics and how critical that is.
24
25
And he -- and as I said in my opening, he made me
And I said, "well, are these
And he said, "yes, it's a good list."
But at the end of the day, Your Honor, they have
these risks every single year.
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And whether one plays out
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one way in one year and one plays out another way in another
2
year, the facts in evidence show you, Your Honor, that based
3
on the actual five year performance, and an average of that,
4
the thresholds that they've set under the EAIP, which
5
remember are the same numbers they're using for these other
6
two plans, are not -- they're lower.
7
So one of the things that Mr. Panacio did, and I
8
think it's helpful to the Court, it's certainly helpful to
9
show why there's a real question about whether these
10
thresholds are too low, is that in his declaration, and I'm
11
just going to grab it, in his declaration, I hope I have it
12
-- declaration, he took the numbers in his chart and he
13
compared based on the debtors' information in their
14
scorecards, which are at Tab 3 in the binder, he took the
15
information there and he compared the actual for 2009 EBITDA
16
of Luminant against the threshold for 2009 EBITDA for
17
Luminant.
18
2009, '10, '11, '12, '13.
19
took the numbers and he averaged it.
20
And he did it across the board for each year,
He got those comparisons.
He
And what did he find?
He found what he has said in footnote five of his
21
declaration, which is the following, "Luminant Management
22
EBITDA exceeded threshold and baseline by 20.86 percent and
23
4.74 percent respectfully -- respectively.
24
met.
25
and superior, by 42.42 percent, 13.54 percent, and 3.52
Superior was not
TXU EBITDA exceeding -- exceeded threshold, baseline
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percent respectively.
2
Mr. Burke explained is a roll up of these other EBITDAs,
3
exceeding threshold and baseline by 22.68 percent and 2.26
4
percent respectively, superior was not met."
5
And business services EBITDA, which
Well, with those percentages, it appears, Your
6
Honor, that that is significant evidence to show that these
7
thresholds are too low, and that they do not support a
8
finding by the Court that the threshold targets,
9
notwithstanding the well means and substantial efforts of
10
Mr. Filsinger to modify those targets in June and enhance
11
them, increase them, so that the debtors would stand a
12
better chance of the Court finding that the executive annual
13
incentive plan is, in fact, an incentive plan that falls
14
outside the scope of 503(c)(1).
15
have for Your Honor.
16
THE COURT:
17
I want to just say thank you.
You're welcome.
Thank you.
Mr. Sassower?
18
19
And I think that's all I
MR. SASSOWER:
For the record, Edward Sassower of
20
Your Honor, Ms. Schwartz spent half of her closing
21
quoting to various language in various documents.
22
the language that she quoted to, retentions award, and
23
retention, and retain, have one thing in common, none of
24
that language is before the Court.
25
binder are the owner/operator plan which has expired.
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All of
Tab 17 and 19 in the
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not before the Court.
2
If you'll turn to the document I handed to you at
3
the end of my closing and turn to page 20, this is the SPCL
4
tip language that Ms. Schwartz was quoting to, and you can
5
see right there, squarely in the middle of that box is the
6
word "retention award."
7
Court.
8
is the language before the Court and you'll see it says
9
"supplemental incentive award".
10
But this language is not before the
If you flip the page one page earlier, page 19, this
Similarly, Ms. Schwartz spent a lot of time
11
quoting to the declaration of Ms. Kirby.
That declaration
12
was submitted in connection with the key leader program, not
13
the key leader performance program, and the key leader
14
program is for non-insiders and is a retention-based
15
program.
16
leader program and the one before the Court, because for
17
that program, that's not that you've already approved for
18
non-insiders, it's retention-based.
19
around.
20
financial metrics in order to get paid.
You don't get paid
21
a dollar if you do not hit the metrics.
So that is a -- so
22
the declaration that Ms. Kirby submitted is entirely not
23
applicable here.
But there is a huge distinction between that key
You just have to stick
For the one before the Court, you have to hit the
24
So I just -- it is a lot of documents.
25
lot of language being thrown around, and I just want to be
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clear that, you know, some of the debtors' prior programs
2
before the restructuring effort started, before they
3
commenced, before the Court -- before the debtors knew about
4
Section 503 of the Bankruptcy Code.
5
retention.
6
time based.
7
insiders have been stripped out and replaced with hard to
8
meet, incentive metrics.
9
plans that have expired that are not before the Court that
You used the word
You used the word retained.
Some of them were
All of those elements as they relate to
I don't see how the fact that
10
mention the word retention that were put in place not in
11
connection with the restructuring, you know, are relevant
12
here.
13
You heard a bunch about how Mr. Evans said that
14
the company had never before revisited metrics in the middle
15
of the year, had never before hired restructuring
16
professionals to review their compensation plans.
17
company's never been through a restructuring before.
18
would they have hired restructuring professionals for
19
restructuring to review the plans?
20
a middle year was done in contemplation of the
21
restructuring.
22
going back to when the plans were first put in place and
23
saying, well, you're halfway through the year, you know, how
24
are you doing on those metrics?
25
thing, a thing that should be applauded, not criticized.
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Well, the
Why
Reviewing the metrics in
We did not want to be criticized for people
So we did the responsible
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went through each and every metric, and we increased 18 of
2
them.
3
a good thing, that's not a bad thing.
4
to reach, more incentivizing.
The fact that we increased almost all of them, that's
5
We made them harder
The -- at the very best, if you want to be, you
6
know, the most generous you could say is that Ms. Schwartz's
7
argument is that one of the plans, a key leader performance
8
program is not ordinary course and it should meet the Dana
9
factors because tying it to the owner/operator plan, even
10
though it has the same people, and the, you know, roughly
11
the same payout amounts, you know, if the metrics are hit,
12
it's still different because that plan includes a retention
13
-- an incentive component.
14
second.
15
I'll come back to that in a
And so that one plan really shouldn't be viewed as
16
a successor to the owner/operator plan.
17
considered a new plan.
18
the test.
19
spend any of her time arguing that we haven't satisfied
20
those factors.
21
added, that little component says you don't get anything
22
unless you hit the metrics.
23
that little component is everything.
24
of it was based on incentive and half of it was based on
25
retention, and now the entire plan, the successor plan, is
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That one should be
If it's a new plan, we still pass
It's the Dana factors, and Ms. Schwartz didn't
And this little incentive component that we
So I don't -- it changed its -Before the plan, half
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based on incentive.
2
a game changer.
3
That's not a little component.
That's
On the EIAP, the third plan, Ms. Schwartz didn't
4
spend really any time talking about the language.
5
more time talking about the relevant targets.
6
to repeat all the things I said previously, just a couple of
7
notes.
8
the hedging program and I'm not a witness, but everything I
9
said was said by a witness.
10
She spent
I don't want
Ms. Schwartz said that I testified to the amounts in
All of those numbers are in
evidence, through Mr. Filsinger, through Mr. McFarlane.
11
Ms. Schwartz said that Mr. Friske did not review
12
the compensation plans of all those other companies.
13
Ms. Schwartz and her colleagues never asked that question to
14
Mr. Friske.
15
words in Mr. Friske's mouth saying -- assuming they asked
16
him and he answered no, when it's our understanding that he
17
actually did review all of those plans.
18
tower survey of those compensation plans of those companies.
19
That's testifying from the podium, just to put
That's based on a
With that, Your Honor, I think I -- I don't want
20
to repeat some of my prior comments.
21
couple in the courtroom who did want to speak in addition to
22
myself and Ms. Schwartz.
23
THE COURT:
24
MS. MORGAN:
25
very brief.
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I do think there are a
So --
Okay, briefly, Ms. Morgan.
I'll be
Pauline Morgan from Young, Conaway, Stargatt &
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Taylor.
2
TCEH first lien creditors, largest creditor constituency in
3
the case.
4
After considering and reviewing the U.S. Trustee's objection
5
and the evidence we've heard for two and a half days, we
6
still support it.
7
clearly met their burden and have demonstrated that the
8
plans are not primarily retentive, that the performance
9
metrics were well thought out, and that management is
10
I'm here today on behalf of the ad hoc committee of
We did file a statement in support of the motion.
Your Honor, we believe the debtors have
appropriately challenged to meet them.
11
Frankly, Your Honor, our view is that the debtors'
12
business judgment here, including the comprehensive process
13
undertaken to develop these plans and metrics, and then to
14
modify and refine them, is frankly exemplary.
15
the facts and circumstances of this case require that the
16
plan participants have market-based, competitive
17
compensation packages to incentivize them, to drive for
18
success, and to maximize creditor recoveries.
19
committee is in support of the debtors' management team and
20
we would like them to be properly compensated and
21
incentivized.
22
expert testimony you've heard, as well as the fact testimony
23
you've heard, that the plans and metrics here are, in fact,
24
appropriate, incentive-based compensation bonuses for this
25
company.
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Your Honor,
The ad hoc
And, Your Honor, we think that based on the
And for those reasons, Your Honor, we ask that the
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Court approve the motion.
2
THE COURT:
3
MR. BIRD:
Thank you.
John Bird
4
of Fox Rothschild on behalf the ad hoc group, the TCEH
5
unsecured noteholders.
6
for the three days of trial.
7
agreement that was reached between the unsecured group and
8
the debtors, that the Court granting the relief sought under
9
the compensation motion is without prejudice to any
I'm sorry Mr. Shore couldn't make it
He asked me to convey an
10
preference claim concerning pre-petition payments or
11
transfers.
12
entry of this order.
13
THE COURT:
With that understanding, we have no objection to
Thank you.
Anyone else?
All right,
14
I'm going to take a recess to gather my final thoughts, and
15
come out and provide a ruling that I've been working on,
16
that I've been refining throughout today and will continue
17
to refine it during the break.
18
and I'll provide my ruling at that time.
19
(Chorus of thank you)
20
(Recess)
So let's reconvene at 4:30
21
THE CLERK:
All rise.
22
THE COURT:
Please be seated.
All right.
I'm
23
ready to give my ruling.
24
it's going to become somewhat obvious, I spent a lot of time
25
thinking about the evidence and forming this ruling and it's
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I'm going to read I think because
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based on all of the evidence, including the evidence that
2
came in today and the opposing arguments.
3
on refining it, so I'll get started.
4
I've been working
Before the Court is the debtors' motion to approve
5
three compensation plans applicable to the debtor's senior
6
management, all of whom are insiders for purposes of this
7
motion.
8
as no objections were filed to that plan it's not being
9
discussed here.
10
There's a fourth plan discussed in the motion, but
The three plans before the Court are one, the
11
executive annual incentive plan or EAIP, two the key leader
12
performance plan and three, the portion of the strategic
13
planning committee long-term incentive plan for 2012 through
14
2014 also known as the LTIP.
15
The debtors' argue that all three plans were
16
adopted in the ordinary course of business and are primarily
17
incentive, as opposed to retention plans, thus meeting the
18
standard for approval articulated in this Court's opinion in
19
Nellson Nutraceutical 369 B.R. 787.
20
The Office of the United States Trustee has
21
objected.
22
incentive plans, but rather retentive and thus are subject
23
to the limitations of 503(c)(1), which governs retention
24
plans for insiders, a standard that the debtors acknowledge
25
they cannot meet.
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The trustee argues that the plans are not
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In addition the trustee argues that the plans were
2
not adopted in the ordinary course of business and assuming
3
they are incentive plans, the applicable law Section
4
503(c)(3) which requires that the plans be justified by the
5
facts and circumstances of the case, a standard that the
6
trustee argues the debtors have failed to meet.
7
The Court will grant the debtors' motion and
8
overrule the trustee's objection in its entirety.
As will
9
be discussed in some detail shortly, the Court finds that
10
the evidence overwhelmingly supports a finding that the
11
EAIP, key leader performance plan and LTIP are incentive
12
plans.
13
(Indiscernible - 4:35:29) with all such plans,
14
there is a retentive element to each.
15
incentivizing or motivational in nature, thus Section
16
503(c)(1) is not applicable.
17
were adopted in the ordinary course of business and are to
18
be governed under the deferential standard applied to such
19
actions.
20
adopted outside the ordinary course of business.
21
that plan is subject to Section 503(c)(3) of the Bankruptcy
22
Code and may only be approved if justified by the facts and
23
circumstances of the case.
24
25
They are primarily
In addition, the EAIP and LTIP
The key leader performance plan, however, was
As such,
There is some disagreement between courts as to
the correct and the manner, excuse me, as to the correct
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manner in which to apply the facts and circumstances test.
2
Some courts including in this district have stated that it
3
is nothing more than another way to implement the business
4
judgment standard applicable to transactions outside of the
5
ordinary course of business under Section 363(b).
6
in the case of in re: Dana Corporation, 358 B.R. 567, the
7
late Judge Lifland articulated six factors that courts
8
should consider in determining whether a compensation plan
9
meets the outside the ordinary course of business standard.
10
Other courts, most notably, the Northern District
11
of Texas in the case of in re: Pilgrim's Pride Corp. at 401
12
B.R. 229, have adopted a more stringent standard.
13
specifically adopting either test for the avoidance of doubt
14
in this case, the Court will apply the most stringent test
15
identified to judge such plans under Section 503(c)(3), the
16
Pilgrim's Pride test.
17
Moreover
Without
Moreover, the Court will apply that test to all
18
three plans, including the EAIP and LTIP that the Court
19
nonetheless finds were implemented in the ordinary course of
20
business.
21
After applying the most stringent test identified
22
by any court to measure insider incentive plans adopted
23
outside the ordinary course of business to the EAIP key
24
leader performance plan and the LTIP, I find that each plan
25
easily and overwhelmingly meets the standard.
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close call.
2
While Mr. Filsinger did not find the debtors' coal
3
plants to be gold plated, I find that these incentive plans
4
define the gold standard.
5
this case are not primarily incentive plans and/or did not
6
meet the justified by the facts and circumstances test, then
7
it is hard to imagine how any plan could.
8
9
The debtors' plans at issue in
To begin, based upon the exhibits in evidence and
the testimony of the witnesses, which will be discussed in
10
more detail shortly, I will describe each of the
11
compensation plans before the Court.
12
Each of the plans has the same basic structure.
13
Under each plan, the debtors' selected performance metrics
14
that were designed to measure management's job performance.
15
Those metrics were weighted to reflect the debtors' judgment
16
as to which metrics have more impact in measuring
17
management's performance.
18
The debtors' then established targets for each
19
metric designed to challenge management to perform at the
20
highest level.
21
categories in increasing difficulty as threshold, baseline
22
and superior.
23
depends upon reaching those targets on a weighted basis.
24
25
Those targets were generally placed in three
Management's entitlement to receive a bonus
If the threshold target is not reached, management
does not receive a bonus.
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If management achieves the
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baseline target, the bonus increases and the maximum bonus
2
is awarded if the superior target is reached.
3
metrics, they're weighting and the performance targets are
4
known as the scorecard.
5
These
Furthermore, each individual is assigned a
6
personal modifier that is applied to the bonus amount
7
awarded under the plan generally.
8
of the annual incentive plan that was established in or
9
about 2004.
The EAIP is the outgrowth
The AIP, as it applies to non-insiders was
10
previously approved by the Court.
11
all 26 insiders subject to the motion.
12
The EAIP is applicable to
The scorecards are divided into three categories
13
to measure the performance at TXUE Luminant and the holding
14
company.
15
metric and the weight are in the record and I won't belabor
16
this ruling by going through them one by one.
17
The details of the identity of each performance
I would note, however, there is one variation with
18
the scorecards in that Luminant -- at Luminant certain
19
management employees have a separate performance metric than
20
others and that's one linked to safety.
21
The targets for the performance metrics are set at
22
threshold, baseline and superior.
23
record and too detailed also to discuss in this ruling.
24
25
The specifics are in the
The most significant fact is that in June 2014,
the threshold targets were toughened for all of the TXUE
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performance metrics, other than average days sales
2
outstanding and the baseline for residential and end
3
customer count was also toughened.
4
At Luminant, all of the threshold performance
5
metrics were toughened as were three of the baseline and two
6
of the superior metrics.
7
Other than EFH Business Service costs, the
8
performance metrics at the business service level dropped
9
down from TXUE and Luminant, so as the TXUE and Luminant
10
targets were toughened, so were the business service
11
targets.
12
The performance targets were toughened because the
13
debtors had better than expected results for the first six
14
months of the year.
15
of the year with the bonuses, at least at the lower levels
16
assured the debtors' toughened those targets so management
17
would continue to be challenged to perform at a high level.
18
Rather than going into the second half
The potential cost of the EAIP is 5.9 million at
19
threshold, 7.9 million at baseline and 15.9 million at
20
superior.
21
The key leader performance plan is a new program
22
for 2014.
23
operator plan put in place in 2010.
24
persons, which are management subject to the motion, except
25
for the seven members of the debtors' strategic planning
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It is an outgrowth of the so-called owner
It is applicable to 19
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committee comprised of the debtors' most senior management.
2
The key leader performance plan metrics are tied
3
to overall company performance, competitive management,
4
EBITDA and competitive total spent.
5
service targets, these targets were toughened by the changes
6
at the TXUE and Luminant targets.
7
As with the business
The potential total cost of the key leader
8
performance plan is 1.7 million at threshold and 2.56
9
million at baseline.
10
The strategic planning committee, long-term
11
incentive plan or LTIP applies to the seven members of the
12
debtors' strategic planning committee, John Young, EFH CEO,
13
Jenny Burke, TXUE CEO, Stacy Duray, Executive
14
Vice-President, general counsel and co-CRO, Paul Keglevic,
15
Executive BP, CFO and co-CRO, Carrie Kirby (ph), Executive
16
Vice-President, human resources.
17
CEO and John O'Brien, Executive VicePresident, public policy
18
and external affairs.
19
Mac McFarland, Luminant's
The LTIP is a three year plan for 2012 through
20
2014.
The bonuses for 2012 and 2013 under the LTIP have
21
already been earned through the debtor performance for those
22
years.
23
The 2014 term is obviously still in progress.
The bonus payments that come due under the LTIP
24
are secured by letters of credit.
25
seeking, at this time, authorization to make bonus payment
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The debtors are not
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subject to the letters of credit and indeed may never seek
2
such authorization.
3
What is before the Court is that portion of bonus
4
payments not secured by letters of credit for two employers,
5
Ms. Duray and Ms. Kirby.
6
The performance metric for the LTIP is competitive
7
management EBITDA, the target for which was toughened by the
8
toughening of the EBITDA targets at TXUE and Luminant.
9
The total cost of the LTIP before the Court, i.e.
10
for Ms. Duray and Ms. Kirby is approximately $1.8 million.
11
The cumulative amount the debtors are seeking approval of
12
the this motion is approximately 7.6 million at threshold,
13
12.3 million at baseline and 20.3 million at superior.
14
In addition to the exhibits admitted into
15
evidence, the debtors submitted the testimony of four
16
witnesses in support of their motion.
17
TXUE, which is the debtors' retail energy company.
18
McFarland, CEO of Luminant, which is the debtors' mining and
19
power generation company, Doug Frisk, who is an expert on
20
compensation and Todd Filsinger who is an expert on the
21
energy business.
22
Jen Burke, CEO of
Mac
Mr. Burke and Mr. McFarland testified as to the
23
complicated and challenging nature of the debtors'
24
businesses, the history and current make up of the
25
compensation plans, the reasons for the selection in
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weighing of the performance metrics that serve as the
2
targets for the compensation plans, which is referred to as
3
the score card, the bottom up budgeting process in 2013 by
4
which the debtors' ultimately determined the performance
5
metrics and scorecard for 2014, the challenging nature of
6
the targets established in 2013, the debtors' better than
7
expected performance in the first half of 2014, the
8
toughening of the 2014 targets in June and the reasons
9
therefore and the continuing, if not increased, challenging
10
nature of the toughened targets for 2014.
11
They also testified at length about the evolution
12
of the debtors' business over time, the negative effect on
13
certain performance metrics as a result of the tailing off
14
of the debtors' extremely beneficial hedging transactions
15
established in 2006 and 2007 and the seasonal nature of the
16
debtors' business that makes it impossible to fairly judge
17
the debtors' 2014 performance by simply comparing the 2014
18
performance metrics to the debtors actual results for the
19
previous five years or by doubling the debtors' performance
20
for the first half of 2014.
21
Mr. Friske testified as an expert with regard to
22
the compensation plans.
23
compared them to the debtors' previous plan, which are
24
identical with a few exceptions.
25
leader performance plan is a new plan for 2014 that is a
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He described each of the plans and
One, the debtors' key
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continuation of the previous owner/operator plan.
2
unlike the owner/operator plan which was 50/50 with regard
3
to incentive and retention, the key leader performance plan
4
is based 100 percent on reaching performance targets.
5
Three, the payment period under the key leader performance
6
plan has been switched from semi-annually to quarterly, and
7
four, the 2014 targets for all three plans were toughened in
8
June 2014, which was the first time the debtors had made any
9
mid-year adjustments to its performance metrics.
10
Two,
Notwithstanding these changes, Mr. Friske opined
11
that the plans were substantially identical to their
12
previous iterations.
13
plans to those of comparable companies.
14
Mr. Friske also compared the debtors'
Mr. Friske testified that the plans were
15
substantially similar to the compensation plans of those
16
comparable companies, in particular that the use of EBITDA
17
to judge business performance as opposed to, for example,
18
net income was consistent with industry practice and those
19
of the comparable companies or peer group.
20
Mr. Filsinger testified at length as an expert as
21
to the nature of the debtors' business, the relevance of the
22
performance metrics and their challenging nature based upon
23
industry performance as well as the debtors' past
24
performance.
25
Mr. Filsinger also persuasively testified that the
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debtors' historical performance was above industry average
2
and in many instances, well above average.
3
Significantly, he cautioned that the debtors'
4
assets have a finite attainable performance level and that
5
setting performance metrics too high based upon prior
6
results can be counterproductive.
7
He further testified that exceeding industry
8
averages at the levels established in the debtors'
9
performance metrics, even if the debtors have previously met
10
similar levels.
11
Moreover he testified that it is appropriate to
12
build in some cushion for risky, finite and in some
13
instances, seemingly minor events that might have a huge
14
affect on performance.
15
these types of events, these type of events, the most
16
striking of which to the Court is the $2 million negative
17
affect to Luminant's EBITDA that results from everyday that
18
the debtors' Comanche nuclear power plant is offline.
19
He provided numerous examples of
On cross-examination, Mr. Filsinger testified at
20
length as to the historically beneficially effect of the
21
debtors' hedging program implemented in 2006 and 2007 that
22
has since run off and is not replicable as well as to the
23
debtors' current risk management hedging program, which is
24
substantial and potentially beneficial, but simply cannot
25
replicate the success and impact of the historical hedging
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program.
2
In response to the trustee's questioning regarding
3
the repetitive nature of certain risks that exist every
4
year, such as weather, which is obviously outside, to
5
control the debtors, he testified that it's not that the
6
debtors can never predict weather changes, it's how the
7
debtors' plan for these changes.
8
9
For example, it is expensive to over hedge the
purchase of power at TXUE and expensive to buy power at spot
10
market, so management must perform a balancing act in the
11
face of unpredictability.
12
The same can be said for bad debt from consumers.
13
If a customer's bill is high as a result of bad weather,
14
then the risk of non- payment increases.
15
for power does not necessarily mean a huge boon for the
16
debtors.
17
possibly customers leaving to go to another power provider
18
because the bill is higher.
19
So a larger demand
It leads to a higher level of non-payment and
It is management's successful balance between
20
hedging power purchases, buying power in the spot market and
21
customer satisfaction and payment, for example, which is
22
being measured and rewarded.
23
Each of the debtors' witnesses were entirely
24
credible and the trustee's cross-examination had, at most,
25
negligible adverse affect on the substance or credibility of
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the testimony.
2
The Court found Mr. McFarland and Mr. Filsinger to
3
be particularly competent and credible witnesses, although
4
as just stated, all four witnesses were credible and
5
persuasive.
6
The debtors and the trustee both designated
7
portions of the deposition testimony of the debtors'
8
chairman of the board Donald Evans (ph), the former United
9
States Secretary of Commerce.
10
Mr. Evans is also chairman of
the operations and compensation or O & C committee.
11
The Court reviewed the deposition testimony in
12
both video and transcript form.
13
the importance of the compensation plans, albeit, with more
14
emphasis on their retentive affects than the other
15
witnesses.
16
management team and the importance of establishing
17
challenging, but achievable targets.
18
Mr. Evans testified about
He also testified at length about the quality of
Mr. Evans testified that as chairman of the board,
19
he seeks management in a competitive market, so he must
20
create employment and compensation packages to entice good
21
management to accept employment and to remain with the
22
debtors.
23
this retentive portion with the need to maximize the value
24
of the debtors' enterprise for their creditors, which means
25
that certain financial targets must be established and met.
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He also testified that the incentive plans are
2
particularly important as his management team did not
3
receive annual salary increases in 2014.
4
Mr. Evans was a credible witness.
5
The trustee's argument that Mr. Evans -- Mr.
6
Evans' testimony established that the plan were retentive,
7
not incentive, is not borne out by the record.
8
9
The use of the term layup, for example, at various
points by Mr. Evans was not significant.
And while he
10
focused more on the retentive effects of the plans than the
11
other witnesses, he also stressed the significant importance
12
of the incentive affect of the plans.
13
in no way supports a conclusion that the plan is a primarily
14
retentive in effect.
15
Mr. Evans' testimony
Finally, in addition to the exhibits admitted into
16
evidence and the depositions designations of Mr. Evans, the
17
trustee submitted the testimony of Michael Panacio an
18
accountant and analyst with the Office of the United States
19
Trustee to provide lay witness opinion testimony under
20
Federal Rule of Evidence 701 as to a mathematical analysis
21
he performed of the debtors' performance metrics and
22
targets.
23
Mr. Panacio presented a simple mathematical
24
analysis of the debtors' plans in which he compared the 2014
25
performance metrics and targets to the debtors' average
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performance over the last five years.
2
He also compared the 2014 targets to his projected
3
2014 results, which he established by doubling the debtors'
4
actual performance through June 2014.
5
This analysis demonstrated that the debtors'
6
actual results for the last five years routinely bettered
7
the 2014 threshold targets and in certain instances, the
8
baseline or superior targets.
9
in certain instances, that the 24 -- in certain instances,
In addition, it showed that
10
that the 2014 projected results exceed the debtors' 2014
11
threshold and/or baseline targets.
12
The testimony of the debtors' fact and expert
13
witnesses as well as the cross-examination of Mr. Panacio
14
largely discredited this analysis.
15
things, the complex evolving nature of the debtors'
16
business, the loss of the historical hedging program, the
17
cancellation of hedging transactions as a result of the
18
bankruptcy filing, the refueling of the Comanche nuclear
19
power plant in the second half of 2014, the variation in
20
power prices, and the seasonal nature of the business.
21
Neither of Mr. Panacio's approaches to analyzing the
22
debtors' business is accurate or particularly helpful.
23
Given, among other
Mr. Panacio also compared the performance of the
24
debtor versus those comparable companies selected by Mr.
25
Friske for which information was available in three
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categories, operating revenue, net income and long-term
2
debt.
3
The data revealed that unlike the comparable
4
companies, with two minor exceptions, the debtors' have
5
suffered net income losses in 2011 through 2013.
6
The problem with this approach is that the net
7
income loss is a result of the debtors being greatly over
8
leveraged.
9
to perform at a high level over what it can control.
10
net income measures something outside the control of
11
management, the debtors' significant debt.
12
The point of the plan is to motivate management
Use of
The only comparable company with a similar debt
13
load is Duke Energy, which is positive net income, but
14
almost triple the debtors' revenues.
15
levels, the debtors' net income losses would have been
16
reduced if not eliminated.
17
At those revenue
Moreover, Mr. Panacio inaccurately focused on net
18
income rather than interest expense.
19
Duke Energy had a comparable level of long-term debt, his
20
interest expense was well below that of the debtors'.
21
For example, while
Indeed, all of the comparable companies would have
22
the net income loss if they had interest expense at the
23
debtors' level.
24
income is supported by the record.
25
The debtors' use of EBITDA rather than net
Based on the foregoing, the Court will apply no
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weight to Mr. Panacio's testimony.
2
At the end of the day, the debtors have presented
3
a thorough, persuasive and virtually unblemished record in
4
support of their motion.
5
Now to the law, the Court's analysis starts with
6
Section 503(c)(1) of the Bankruptcy Code.
Section 503(c)(1)
7
limits retention payments that can be made to insiders of a
8
debtor, specifically it provides subject to certain
9
exceptions not applicable in this case that "There shall
10
neither be allowed nor paid a transfer made to or an
11
obligation incurred for the benefit of an insider of the
12
debtor for the purpose of inducing such person to remain
13
with the debtors' business."
14
15
There is no dispute that if section 503(c)(1) is
applicable, the debtors' motion must be denied.
16
This Court has previously held in Nellson
17
Nutraceutical that Section 503(c)(1) only applies if
18
payments are made for the primary purpose of inducing a
19
person to remain with the debtors' business.
20
way, section 503(c)(1) is not applicable if the primary
21
purpose of the payments -- or in this case, the EAIP, key
22
leader performance plan and LTIP -- are primarily for
23
motivating or incentivizing the employees covered under the
24
plans.
25
Put another
As discussed earlier, the Court finds that the
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evidence overwhelmingly supports a finding that each of the
2
plans is primarily an incentive plan and any retentive
3
effects, while present, are incidental.
4
Let me pause here for a moment to address an
5
argument raised by the trustee.
6
fact that employees are not paid their bonuses immediately
7
upon the closing of the applicable period renders the
8
payments retentive.
9
The trustee argues that the
In this case, the delay may be between one to
10
three months.
11
effect if one earns a bonus on December 31st and is not paid
12
that bonus until March and if that employee would not be
13
entitled to payment unless he or she were still an employee
14
on the payment date.
15
in the interim period would need to consider the lost bonus
16
payment in the calculus of making that decision, but that in
17
and of itself, does not render a payment or compensation
18
plan primarily retentive.
19
There can be no question there is a retentive
Indeed, any employee who would leave
A delay between earning a payment and receiving a
20
payment is not unusual.
21
payment, delayed or otherwise, unless the incentive targets
22
are reached.
23
Moreover, there is no right to
The primary point of the plans at issue is to
24
motivate employees to meet the targets in 2014.
25
retentive affect that arises in the gap period between
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earning a payment a receiving it is incidental.
2
Also the trustee argues that the use of the words
3
retention or retain in certain of the debtors' documents
4
renders the plans retentive.
5
The Court disagrees.
First, much of the language quoted is in
6
connection with the owner operator plan that is not before
7
the Court.
8
9
Second, the language, excuse me, the retention
language is being read in isolation and out of context.
10
language and references are surrounded by language
11
referencing the purpose of incentivizing or motivating
12
employees.
13
The
Third, even when viewed with skepticism, what
14
matters is the substance, not the title.
15
the the substance supports a finding the plans are primarily
16
incentive plans.
17
As I just stated,
Third (sic), the trustee argues that the owner
18
operated plan was a retention plan and that the changes from
19
it to the key leader performance plan are insufficient to
20
make the key leader performance plan an incentive plan.
21
Although it is not before me, it appears to the
22
Court that the owner/operator plan was primarily a retention
23
plan, but the Court disagrees that the changes that resulted
24
in the key leader performance plan were insufficient to
25
remove the retentive elements.
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The key leader performance plan is 100 percent
2
based on hitting incentive targets.
3
are incidental.
4
The retentive elements
Having determined that none of the three
5
compensation plans are primarily retentive, the Court moves
6
on to determining whether the debtors' adoption of the plans
7
is inside the ordinary course of the debtors' business.
8
so, section 503(c)(3), which will be discussed in detail
9
later, is not applicable and the Court will not entertain an
If
10
objection to the transaction provided that the conduct
11
involves a business judgment made in good faith upon a
12
reasonable basis and within the scope of authority under the
13
code.
14
Put another way, the Court will not disturb a
15
transaction within the ordinary course of business if the
16
debtor can articulate reasons for its conduct as distinct
17
from a decision made arbitrarily or (indiscernible -
18
5:00:07).
19
The standard governing a determination whether or
20
not a transaction falls in the ordinary course of business
21
is well established.
22
Inc., 975 F.2nd. 949, the Third Circuit adopted a two-step
23
inquiry.
24
25
In the case of in re: Roth American
This inquiry consists of looking at the
transaction from horizontal and vertical dimensions.
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test for the horizontal dimension is whether from an
2
industry wide perspective, the transaction is of the sort
3
commonly undertaken by companies in that industry.
4
The vertical dimension, which is also known as the
5
creditors' expectation test, analyzes the transactions from
6
the vantage point of a hypothetical creditor and the inquiry
7
is whether the transaction subjects the creditor to an
8
economic risk of a nature different from those he accepted
9
when he decided to extend credit.
10
Under the vertical test, the touchstone of
11
ordinariness is the interested parties' reasonable
12
expectations of what transactions the debtor in possession
13
is likely to enter in the course of business.
14
Thus, the debtors' pre-petition business practices
15
and conduct is the primary focus of the vertical analysis.
16
The Court must also consider the changing circumstances
17
inherent in the hypothetical creditor's expectations.
18
In this case, with regard to the EAIP and LTIP
19
plans, the debtors have satisfied both the horizontal and
20
vertical dimensions and the programs were adopted in the
21
ordinary course of the debtors' business.
22
the key leader performance plan, however, while the debtors
23
have satisfied the horizontal test, they have not passed the
24
vertical test.
25
With regard to
Starting with the horizontal test, Mr. Friske's
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testimony clearly established that to paraphrase Roth
2
American, from an industry wide perspective the EAIP key
3
leader performance plan and LTIP plan are the sort of
4
transactions that are commonly undertaken by companies in
5
the industry.
6
In response, the trustee makes two primary
7
arguments.
First, she argues that the LTIP program fails
8
the horizontal test, because some of the payments, albeit,
9
not the ones directly before the Court, are secured by
10
letters of credit, a mechanism Mr. Friske testified he has
11
never seen.
12
Holding aside that the letters of credit payments
13
are not before the Court the use of them does not render the
14
program or plan outside of industry norms.
15
Friske testified that approximately 50 percent of long-term
16
incentive plans provide some security for payment, usually
17
in the form of rabbi or other types of trusts.
18
of security is secondary to its use.
19
management negotiated for the issuance of letters of credit
20
is not determinative.
Indeed, Mr.
The manner
The fact that
21
Second, the trustee argues that the proper peer
22
group for comparison should be companies in Chapter 11 or
23
otherwise undergoing financial restructuring.
24
disagreed and the Court concurs in that judgment.
25
in Roth American is the industry, not the financial
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The focus
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condition of the peer group.
2
a whole, the analysis covers the wide range of financial
3
health in that industry.
4
By looking at the industry as
Moreover, the question is what type of incentive
5
plans are necessary and appropriate to attract managers that
6
can successfully run a company of this size and nature.
7
Limiting of the peer group companies to those in
8
restructuring may make sense in the context of hiring a
9
chief restructuring officer, for example, but not in
10
designing compensation plans for operational and senior
11
management.
12
With regard to the vertical test, I would first
13
discuss the EAIP and LTIP programs.
14
there is only one difference between the pre-petition and
15
post-petition plans.
16
to better than expected results in the first half of 2014,
17
the targets were toughened in June to continue to challenge
18
management to perform at a high level.
19
time the debtors have ever adjusted their performance
20
metrics -- performance metric targets mid-year.
21
For those programs
As with all three plans, in response
That is the first
In Roth American, the Third Circuit held that the
22
vertical dimension test analyzes the transactions from the
23
vantage point of a hypothetical creditor and the inquiry is
24
whether the transaction subjects a creditor to economic risk
25
of a nature different from those he accepted when he decided
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to extend credit.
2
The question isn't whether there is a difference.
3
There is.
4
expectations.
5
performance metrics, one could easily argue the creditors
6
would be at a disadvantage.
7
credit, assuming management incentives were to reach a
8
certain target.
9
targets were achieved, it would be more likely the creditor
10
Rather, the point is to gage creditor
If the debtors had decided to lower the
They would have extended
Of course, if those performance metric
would be paid.
11
If those targets were easier to achieve, however,
12
the creditor may not have extended credit in the first
13
place.
14
assumption, the performance metrics were at a certain level
15
and then have them lowered after the extension of credit
16
would potentially hoodwink the creditor, but in this
17
instance, the creditor isn't harmed, it is benefitted.
18
Certainly, to extend credit based upon an
Management is motivated to reach certain targets
19
that make it sufficiently safe for a creditor to extend
20
credit based on that creditors' risk profile.
21
toughens the performance metrics to motivate management to
22
reach targets even more likely to result in the creditor to
23
receive payment.
24
in a loan to own scenario, would object.
25
instance as this, the vertical dimension is satisfied.
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The debtor
No reasonable creditor, except perhaps one
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The changes to the key leader performance plan
2
were more extensive.
3
is not a continuation of an existing plan.
4
adopted in 2014 on the eve of a well-publicized and almost
5
certain bankruptcy and with the input of bankruptcy savvy
6
professionals.
7
First, the key leader performance plan
It is a new plan
Second, the structure was changed from the
8
predecessor owner/operator plan from a 50/50 retention
9
incentive plan to a wholly incentive plan.
While this
10
change may have inured to the benefit of creditors, it is a
11
significantly more material change than simply toughening
12
performance metric targets.
13
Third, the payment periods were modified from
14
semiannual to quarterly.
15
that issue at some length when it found the change not to
16
render the program retentive.
17
The Court has already discussed
The confluence of these changes and most
18
particularly that this is an entirely new plan, results in
19
the key leader performance plan failing the vertical
20
dimension test, thus the debtors' adoption of the key leader
21
performance plan was outside the ordinary course of the
22
debtors' business.
23
As the EAIP and LTIP plans were adopted in the
24
ordinary course of business, the question is whether their
25
adoption involves a business judgment made in good faith
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upon a reasonable basis and within the scope of authority
2
under the Bankruptcy Code.
3
The evidence overwhelmingly establishes that the
4
debtors have met this standard.
5
would be due under the plan are the result of metrics and
6
targets established through a thorough, bottom up budgeting
7
process.
8
9
The incentive payments that
The targets present very challenging, but
achievable goals, the metrics and targets are focused on
10
what management can achieve in running the business rather
11
than the company's debt structure.
12
interest and management and economic stakeholders in this
13
case, i.e., the creditors, and they pay for themselves.
14
The plan is allowing the
If management achieves the targets, the debtors'
15
estate is better off well in excess of the cost of the
16
bonuses.
17
Now, notwithstanding that the key leader
18
performance plan and LTIP satisfied the test applicable to
19
transactions under the ordinary course of business.
20
avoidance of doubt in this case, the Court will also review
21
the EAIP and LTIP programs as if they were adopted outside
22
the ordinary course of business.
23
For the
Having determined that a transaction is outside
24
the ordinary course of business, one would generally proceed
25
to the business judgment standard governing transactions
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outside the ordinary course of business, but there is a
2
complication in relation to payments to insiders that is
3
section 503(c)(3) of the Bankruptcy Code.
4
Section 503(c)(3) limits the payments of certain
5
obligations outside the ordinary course of business
6
providing that there shall neither be allowed nor paid (3)
7
other transfers or obligations that are outside the ordinary
8
course of business and not justified by the facts and
9
circumstances of the case, including transfers made to or
10
obligations incurred for the benefit of officers, managers
11
or consultants hired after the date of the filing of the
12
petition.
13
Section 503(c)(3) applies to officers, managers or
14
consultants, a category of employees that includes all the
15
insiders covered by the plans before the Court.
16
order to satisfy section 503(c)(3), the transfers under the
17
EAIP key leader performance plan and the LTIP must be
18
justified by the facts and circumstances of the case.
19
Plus in
Courts have struggled somewhat in determining what
20
exactly congress meant by using that language.
21
have stated that it's nothing more than another way to
22
implement the business judgment standard applicable to
23
transactions outside the ordinary course of business under
24
section 363(b)(1).
25
late Judge Lifland articulated six factors the Court should
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consider in determining whether the business judgment
2
standard is met if one were to apply it under section
3
503(c).
4
The so-called Dana factors are, (1), is there a
5
reasonable relationship between the plan proposed and the
6
results to be obtained, i.e., in the case of a performance
7
incentive, is the plan calculated to achieve the desired
8
performance; (2), is the cost of the plan reasonable in the
9
context of the debtors' assets, liabilities and earning
10
potential; (3), is the scope of the plan fair and
11
reasonable, does it apply to all employees, does it
12
discriminate unfairly; (4), is the plan or proposal
13
consistent with industry standards; (5), what were the due
14
diligence efforts of the debtor in investigating the need
15
for a plan, analyzing which key employees need to be
16
incentivized, what is available, what is generally
17
applicable in a particular industry; and (6), did the debtor
18
receive independent counsel in performing due diligence and
19
in creating and authorizing the incentive compensation.
20
Other courts most notably the Northern District of
21
Texas in the case of in re: Pilgrim's Pride Corp. have
22
adopted a more stringent standard.
23
Without specifically adopting either test for the
24
avoidance of doubt in this case, the Court will apply the
25
most stringent test identified to judge such programs under
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section 503(c)(3), the Pilgrim's Pride test.
2
In Pilgrim's Pride, the Court argues with some
3
force that the test of section 503(c)(3) should not be
4
equated to the business judgment rule as applied under
5
section 363(b)(1), rather the Court holds as follows.
6
The Court concludes that section 503(c)(3) is
7
intended to give the judge a greater role, even if a good
8
business reason can be articulated for a transaction.
9
Court must still determine that the proposed transfer or
10
The
obligation is justified in the case before it.
11
The Court reads this requirement as meaning that
12
the Court must make its own determination that the
13
transaction will serve the interest of creditors and the
14
debtors' estate.
15
As a threshold matter, the Court must still find
16
that the debtors have satisfied the business judgment
17
standard under section 363(b)(1).
18
test here differs from the general corporate law business
19
judgment rule which protects corporate directors from
20
liability when they have exercised due care and were not
21
self interested in a transaction, hereby contrast the
22
bankruptcy court reviews the debtors' business judgment to
23
determine independently whether the judgment is a reasonable
24
one.
25
The business judgment
The Court should not substitute its judgment for
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the debtors however, but should determine only whether the
2
debtors' judgment was reasonable and whether a sound
3
business justification exists supporting the transaction and
4
its terms.
5
Moreover as stated earlier, in considering whether
6
an incentive compensation plan meets the outside the
7
ordinary course of business standard, courts often apply the
8
Dana factors.
9
that the plans meet the business judgment standard.
10
All six of those factors support a finding
First, the plans are the result of a bottom up
11
process where performance metrics and targets for them were
12
established that were designed to provide management with
13
challenging but achievable goals, thus the plans are
14
calculated to achieve the desired performance.
15
Two, the plans will cost no more than $20 million
16
with debtors that have over 30 billion in debt and operating
17
revenues of $6 billion annually.
18
plan is reasonable in the context of the debtors' assets,
19
liabilities and earning potential.
20
Clearly, the cost of the
Three, the plans applies to the most senior
21
members of the debtors' management and treat the various
22
members of the management on a rationale basis relating to
23
their various roles in the company, thus the scope of the
24
plan is fair and reasonable.
25
Four, Mr. Friske testimony clearly established
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that the plans are consistent with industry standards.
2
Five, the debtors' performed extensive due
3
diligence, both internally and through consulting with
4
advisors in investigating the need for the plans, analyzing
5
which key employees need to be incentivized and how what is
6
generally applicable in the industry.
7
And six, the debtors received extensive advice
8
from independent advisors, i.e. Kirkland & Ellis, Mr. Friske
9
and Mr. Filsinger in performing due diligence and creating
10
and authorizing the plans.
11
The evidence overwhelmingly establishes that the
12
debtors have met the business judgment standard applicable
13
to transactions outside the ordinary course of business both
14
generally and as articulated in the Dana factors.
15
Next, under Pilgrim's Pride in the departure from
16
the normal business judgment standard, the Court must make
17
its own determination that the plan served the interest of
18
creditors and the debtors' estate.
19
Again, the debtors have met that standard.
As I
20
just stated, the economic stakeholders in this case, i.e.,
21
the creditors, as well as the estate, will be better off if
22
management hits its targets and is awarded its incentive
23
bonuses.
24
25
At heart, the question in front of this Court is
whether it believes the incentive plans work.
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I do.
If
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properly designed, incentive plans serve like fiduciary
2
duties to align the interest of the principal and agent, in
3
this case, the debtors' estate and its creditors on the one
4
hand and management on the other.
5
It is a fundamental economic principle that an
6
employee will work harder if he or she has a tangible and
7
identifiable economic stake in the results of his or her
8
labor.
9
be beyond the reach of management.
10
It's important, however, that incentive targets not
challenging, but achievable.
11
Such targets must be
This is the case here.
The debtors have designed three incentive plans
12
that provide management with challenging but achievable
13
goals that if met will inure to the benefit of management,
14
the debtors' estate and the creditors.
15
To sum up, the EAIP key leader performance plan
16
and the LTIP are all primarily incentive as opposed to
17
retention plans and thus section 503(c)(1) is inapplicable.
18
The EAIP and the LTIP were entered in the ordinary
19
course of business, but the key leader performance plan was
20
entered outside of the ordinary course of business.
21
Nonetheless, for the avoidance of doubt, the Court reviewed
22
all three plans as if they were entered outside the ordinary
23
course of business.
24
25
Under section 503(c)(3) payments under insider
incentive plans like those before the Court can only be made
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if they are justified by the facts and circumstances of the
2
case.
3
Applying the Pilgrim's Pride iteration of the
4
facts and circumstances test, the Court finds that each of
5
the plans has easily met the standard and the motion will be
6
granted.
7
Some final notes, as mentioned earlier, the Court
8
does not believe that this is remotely a closed question.
9
The evidence in favor of the debtors' motion was thorough,
10
persuasive and virtually unchallenged by the trustee.
11
stated at the beginning, I find that these incentive plans
12
define the gold standard.
13
this case are not primarily incentive plans and/or do not
14
meet the justified by the facts and circumstances test, then
15
it's hard to imagine how any plan could.
16
As I
The debtors' plan at issue in
Also, while the Court appreciates, supports and
17
honors the mission of the Office of the United States
18
Trustee, it often looks to the position of the economic
19
stakeholders in making its decisions.
20
only party objecting to the plans is the trustee.
21
the creditor constituencies have either affirmatively
22
supported or have not objected to the debtors' motion.
23
In this case, the
All of
That is an extraordinarily, excuse me, that is an
24
extraordinary unanimity of position in the context of this
25
case.
Because the evidence so clearly supports granting the
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motion, however, the Court has made its decision without
2
consideration of the creditors' positions.
3
However, were the case -- were the issue a closer
4
one, the -- however, were the issue a closer one, the Court
5
would consider and perhaps give great weight to the position
6
of the economic stakeholders.
7
8
That concludes my ruling, which was lengthy.
Are
there any questions?
9
UNIDENTIFIED SPEAKER:
No.
No, Your Honor.
10
THE COURT:
Do you have a form of order?
11
12
THE COURT:
I can enter one.
13
All right.
The Court will enter an order -- court
Yes, we do.
I mean it's --
14
will simply enter an order granting the motion for the
15
reasons set forth on the record.
16
UNISON:
17
THE COURT:
18
19
THE COURT:
Is there anything else for today?
No, Your Honor.
Just in closing, I'd like to thank the
20
professionals for an extremely well organized and well
21
presented trial and I truly appreciate it.
22
Court's job a lot easier when parties and both parties here
23
are prepared and organized and provide such a well
24
structured trial and I truly appreciate it.
25
That's all we have for today.
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We're adjourned.
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UNISON:
(Whereupon these proceedings were concluded at 5:19 PM)
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I N D E X
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W I T N E S S E S
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WITNESS
BY
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Ms. Sarkessian
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10-K of EFCH
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First Day Presentation
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Debtors' motion to approve three
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compensation plans
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C E R T I F I C A T I O N
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I, Dawn South, Penny Skaw, Jamie Gallagher and Melissa
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Looney certify that the foregoing transcript is a true and
5
accurate record of the proceedings.
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Digitally signed by Dawn South
DN: cn=Dawn South, o=Veritext, ou,
[email protected], c=US
Date: 2014.10.16 11:50:48 -04'00'
______________________________________
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Dawn South
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AAERT Certified Electronic Transcriber CET**D-408
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Dawn South
Digitally signed by Penny Skaw
DN: cn=Penny Skaw, o=Veritext, ou,
Date: 2014.10.16 11:51:31 -04'00'
_______________________________________
Penny Skaw
Penny Skaw
Jamie Gallagher
Digitally signed by Jamie Gallagher
DN: cn=Jamie Gallagher, o=Veritext, ou,
Date: 2014.10.16 11:51:56 -04'00'
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_______________________________________
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Jamie Gallagher
Digitally signed by Melissa Looney
DN: cn=Melissa Looney, o=Veritext, ou,
Date: 2014.10.16 11:52:37 -04'00'
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Melissa Looney
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_______________________________________
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Melissa Looney
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AAERT Certified Electronic Transcriber CET**D-607
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Veritext
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Date:
October 16, 2014
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UNITED STATES BANKRUPTCY COURT
District of Delaware
In Re:
Energy Future Holdings Corp.
Energy Plaza
1601 Bryan Street
Dallas, TX 75201
EIN: 46−2488810
TXU Corp.
TXU Corp
Texas Utilities
Chapter: 11
Case No.: 14−10979−CSS
NOTICE OF FILING OF TRANSCRIPT AND OF DEADLINES RELATED TO RESTRICTION AND
REDACTION
A transcript of the proceeding held on 10/15/14 was filed on 12/1/14 . The following deadlines apply:
The parties have 7 days to file with the court a Notice of Intent to Request Redaction of this transcript. The
deadline for filing a request for redaction is 12/22/14 .
If a request for redaction is filed, the redacted transcript is due 1/2/15 .
If no such notice is filed, the transcript may be made available for remote electronic access upon expiration of the
restriction period, which is 3/2/15 unless extended by court order.
To review the transcript for redaction purposes, you may purchase a copy from the transcriber (see docket for
Transcriber's information) or you may view the document at the clerk's office public terminal.
Clerk of Court
Date: 12/1/14
(ntc)
Case 14-10979-CSS
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Notice Recipients
District/Off: 0311−1
Case: 14−10979−CSS
User: LeslieM
Form ID: ntcBK
Date Created: 12/1/2014
Total: 36
Recipients of Notice of Electronic Filing:
ust
United States Trustee
[email protected]
aty
Andrea Beth Schwartz
[email protected]
aty
Brian Schartz
[email protected]
aty
Chad J. Husnick
[email protected]
aty
Daniel J. DeFranceschi
[email protected]
aty
Edward O. Sassower
[email protected]
aty
Jason M. Madron
[email protected]
aty
Jason M. Madron
[email protected]
aty
Mark D. Collins
[email protected]
aty
Michael A. Rosenthal
[email protected]
aty
Richard L. Schepacarter
[email protected]
aty
Thomas F. Driscoll, III
[email protected]
aty
Tyler D. Semmelman
[email protected]
aty
Tyler D. Semmelman
[email protected]
aty
William A. Romanowicz
[email protected]
TOTAL: 15
Recipients submitted to the BNC (Bankruptcy Noticing Center):
db
Energy Future Holdings Corp.
Energy Plaza
1601 Bryan Street
Dallas, TX 75201
aty
Andrew McGaan
Kirkland & Ellis LLP
300 North LaSalle
Chicago, IL 60654
aty
Anthony V. Sexton
300 North LaSalle
Chicago, IL 60654
aty
Bridget K. O'Connor
655 Fifteenth Street, N.W.
Washington, DC 20005
aty
Bryan M. Stephany
655 Fifteenth Street, N.W.
Washington, DC 20005
aty
Iskender H. Catto
McDermott Will & Emery LLP
340 Madison Avenue
New York, NY 10173
aty
James H.M. Sprayregen
601 Lexington Avenue
New York, NY 10022
aty
Jeremy L. Graves
GIBSON DUNN & CRUTCHER LLP
1801 California Street
Suite
4200
Denver, CO 80202−2642
aty
Jeremy L. Retherford
Balch & Bingham LLP
1901 Sixth Avenue North
Suite
1500
Birmingham, AL 35203−4602
aty
Marc Kieselstein
300 North LaSalle
Chicago, IL 60654
aty
Mark E. McKane, Esq.
San Francisco, CA 94104
aty
Michael L. Raiff
Gibson Dunn & Crutcher LLP
2100 McKinney Avenue
Dallas, TX 75201
aty
Michael P. Esser
Kirkland & Ellis LP
San Francisco, CA 94104
aty
P. Stephen Gidiere, III
Balch & Bingham LLP
Suite
1500
Birmingham, AL 35203−4642
aty
Richard M. Cieri
New York, NY 10022−4611
aty
Stephen E. Hessler
New York, NY 10022
aty
Steven N. Serajeddini
300 North LaSalle
Chicago, IL 60654
aty
Todd F. Maynes
300 North LaSalle
Chicago, IL 60654
aty
W. Clark Watson
Balch & Bingham LLP
Suite 1500
Birmingham,
AL 35203−4642
aty
William Guerrieri
Kirkland & Ellie LLP
300 North LaSalle
Chicago, IL 60654
aty
William T. Pruitt
300 North LaSalle
Chicago, IL 60654
TOTAL: 21
TMA Annual
KEIPs, KERPs, Retentions, and
Other Compensation Packages:
A Turnaround Manager’s Tool Kit
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All Third Circuit Published Cases Addressing 11 U.S.C. § 503(c)
Below are all published Third Circuit cases interpreting 11 U.S.C. § 503(c), and the District of Delaware is the only court
with substantive decisions on the topic. The trend among courts is to construe employee bonus programs as incentivebased, rather than retention programs subject to § 503(c). Additionally, bankruptcy judges in Delaware agree that § 503(c)
(1) applies to transactions both in and out of the ordinary course of business, but that § 503(c)(3) only applies to relevant
transactions outside the ordinary course.
1. In re Airway Industries, Inc., 354 B.R. 82 (W.D. Pa. 2006)
Rule: Executive bonuses paid upon the sale of Debtor did not implicate § 503(c) because the Bonus Agreements
were executed prior to § 503(c) taking effect, and there was no evidence that Debtor purposefully timed the
Bonus Agreements to circumvent § 503(c).
Relevant Facts & Rationale: The Court acknowledged this was a unique case because the Bonus Agreements
were entered into prior to § 503(c) taking effect and were not executed with the intent to circumvent § 503(c).
The Court, however, did note that future similar arrangements must be considered closely in order to ensure that
any bonus plan was not set up to avoid § 503(c)’s restrictions.
2. In re Global Home Products, LLC, 369 B.R. 778 (Bankr. D. Del. 2007)
Rule: Management incentive plans adopted in the ordinary course of business satisfy business judgment review
of § 363 when such plans fulfill the six-part sound business judgment test set forth in In re Dana Corp., 358 B.R.
567 (S.D.N.Y. 2006).*
Relevant Facts & Rationale: The Management and Sales Plans were primarily incentive, not retentive, because
Debtors had “virtually identical plans prepetition when retention was not the motive.” Acknowledging that “all
compensation has a retention element[,]” the Court found the Plans were primarily incentive-based because
the employees relied on Debtor’s prior practice of providing similar bonuses and Debtor’s promise to seek Court
approval of the Plans.
*In re Nellson Nutraceutical, Inc. specifically disagreed with Global Home’s holding that “the Dana Corp. factors
are applicable to an incentive program adopted in the ordinary course of a debtor’s business,” as the Nellson
Court stated that the Dana Corp. sound business judgment test only applied if the incentive plan was outside the
ordinary course of business.
3. In re Nellson Nutraceutical, Inc., 369 B.R. 787 (Bankr. D. Del. 2007)
Rule: Section 503(c)(1) applies to all retention payments to insiders, regardless if such plan was established in or
out of the ordinary course of business, but § 503(c)(3) only applies if the payment is outside the ordinary course.
Relevant Facts & Rationale: Debtor retroactively changed the EBITDA trigger of its “ordinary course employee
bonus compensation program” (“OCP”) so that bonuses were paid despite not reaching the original EBITDA
trigger. The Court held that § 503(c)(1) applies whether the OCP’s modification was in or outside the ordinary
course, but § 503(c)(1) did not apply here because the payments were not for the primary purpose of retention,
Morris Nichols Business Reorganization & Restructuring Group
1
but rather for motivating employees as demonstrated by Debtor CEO’s testimony that the OCP was intended
to encourage employees to increase sales and EBITDA, and that the failure to reach the original EBITDA target
was not due to the employees’ failure. The Court also held that § 503(c)(3) did not apply to the OCP because the
OCP’s modification was in the ordinary course as Debtor retroactively modified EBITDA targets for the three
prior years and a comparable company analysis demonstrated that it was an accepted practice in the industry.
4. In re Foothills Texas, Inc., 408 B.R. 573 (Bankr. D. Del. 2009)
Rule: A person with an officer title creates a presumption that he or she is an insider, which is rebuttable by
sufficient evidence “that the person does not participate in the management of the debtor.”
Relevant Facts & Rationale: Debtor executed bonus retention agreements with the Vice President of Land and
Legal and Vice President of Engineering and argued that the vice presidents were not insiders, therefore, § 503(c)
(1) should not apply to the retention agreements. The Code’s definition of “insider” includes “officer,” and the
Court found that officer meant an individual with an officer’s title and taking part in the company’s management.
Debtor argued the vice presidents were not senior management, supervised few employees, and only received a
title to incentivize them to work for Debtor. The Court held, however, the vice presidents were officers in name
and in fact because they were responsible for such important aspects of the Debtor’s business that there would
be no business without them.
5. In re Blitz U.S.A., Inc., 475 B.R. 209 (Bankr. D. Del. 2012)
Rule: Bonus incentive plans adopted in the ordinary course of business only need to be in good faith and satisfy
§ 363’s sound business judgment requirement.
Relevant Facts & Rationale: Debtor’s employee bonus plan was an ordinary course transaction because Debtor
had a bonus plan since 1992, the bonus plan was EBITDA-based since 2008, and Debtor modeled its bonus plan
after a similar manufacturer’s plan. Relying on Nellson, the Court found that § 503(c)(3) did not apply to an
ordinary course transaction, therefore, the bonus plan only had to be in sound business judgment and good faith
under § 363. Debtor’s plan satisfied sound business judgment and good faith because the plan was designed
prepetition, “intended to provide an incentive for employees,” and it was reasonable to lower EBITDA targets
after spinning off a company.
6.
In re Energy Future Holdings, Corp., Hr’g Tr. regarding Motion of Energy Future Holdings Corp., et al., for Entry
of an Order Authorizing the Debtors to (A) Pay Certain Prepetition Amounts on Account of the Insider
Compensation Programs and (B) Continue the Insider Compensation Programs in the Ordinary Course of Business
on a Postpetition Basis, (Bankr. D. Del. Oct. 15, 2014)
Rule: Compensation plans that are primarily incentive-based are not subject to § 503(c)(1), and plans not
adopted in the ordinary course of business may still be approved if the court finds the facts and circumstances
to justify the plan.
Relevant Facts & Rationale: The U.S. Trustee argued that Debtor’s three compensation plans were retentive
subject to § 503(c)(1), but the Court found that the plans were primarily incentive and therefore, not subject
to § 503(c)(1). In particular, the U.S. Trustee argued that the one to three month delay between achieving the
bonus and payment, during which time the employee must remain employed by Debtor, demonstrated the
plan’s retentive nature. The Court, however, found that all incentive plans have an incidental retentive effect not
equating to a primary goal, and that “there is no right to payment . . . unless the incentive targets are reached.”
The Court further found that these compensation plans “defined the gold standard” as they were primarily
incentive and justified by the facts and circumstances test.
Morris Nichols Business Reorganization & Restructuring Group
2
TMA Annual
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October 6, 2015 at 11:15 a.m. to 12:15 p.m.
Second Circuit Case Law Applying Section 503(c)
The Great Atlantic & Pacific Tea Company, Inc. (A&P)
In various court pleadings, it has been revealed that, approximately 107 days prior to filing
for bankruptcy, the debtors transferred $6.9 million or more into a secular trust for the
purposes of paying bonuses to “qualifying beneficiaries.” The debtors have disclosed that
the trust paid approximately $4.6 million in bonuses prior to the petition date and that
qualified beneficiaries could be entitled to up to an additional $2.3 million in bonuses if the
debtors consummate a strategic transaction on or before April 5, 2016. To date, no motion
has been filed seeking approval of such bonuses, nor has a formal objection been raised,
although various parties have questioned the transactions.
On August 25, 2015, the debtors filed a motion seeking authorization to pay retention
bonuses totaling approximately $5 million in the aggregate to up to 495 “key” employees.
See The Great Atlantic & Pacific Tea Company, Inc., Case No. 15-23007 (RDD), Doc. No. 654
(Bankr. S.D.N.Y. Aug. 25, 2015). A number of objections were filed, and certain objectors
raised the issue of the payment of bonuses outside the bankruptcy through the trust. On
September 11, 2015, the bankruptcy court entered an order granting the debtors’ motion
and authorizing approximately $3.9 million in retention bonuses, as well as $1.096 million
in severance payments to certain union and non-union employees of the debtors who were
not participants in the KERP. See The Great Atlantic & Pacific Tea Company, Inc., Case No.
15-23007 (RDD), Doc. No. 912 (Bankr. S.D.N.Y. Sept. 11, 2015). Given the concerns that
have been raised, the issues surrounding compensation and bonuses in A&P may well be
raised again.
American Airlines
AMR Corporation and its affiliated debtors (“American”) sought bankruptcy court approval
of a merger with U.S. Airways that would create the world’s largest airline. One component
of the proposed merger was a $19.875 million severance payment (50% in cash, 50% in
stock in the newly created entity) to Thomas Horton, the CEO of American who, upon the
merger, would terminate as CEO of American and would be appointed chairman of newco.
American asserted that the severance payment was not subject to the restrictions of
Section 503(c)(2) of the Bankruptcy Code because the payment would be made by newco
999999/616-5575235.2
Page 2
and not from American’s estate. The bankruptcy court rejected this argument and denied
approval of the payment, finding that American was elevating form over substance as the
severance to Horton would be paid without any action being taken by the newco, an entity
that would be 72% comprised of the assets of the reorganized American. See In re AMR
Corp., 490 B.R. 158 (Bankr. S.D.N.Y. 2013).
American subsequently proposed a plan of reorganization that included the $19.875
million severance payment to Horton by the post-bankruptcy entity. The bankruptcy court
again rejected the severance payment, finding that American could not use the plan process
to circumvent the restrictions of Section 503(c)(2). See In re AMR Corp., 497 B.R. 690
(Bankr. S.D.N.Y. 2013).
Thereafter, the post-merger American paid Horton a severance package that included $11.9
million in cash and new American shares, among other benefits.
Residential Capital
Prior to the petition date, the debtors had negotiated sales of (1) their mortgage loan
origination and servicing business and (2) a portfolio of mortgage loans and other financial
assets. After they filed for bankruptcy, the debtors sought approval of a KEIP that provided
for bonuses of between $4.1 million and $7 million to 17 insiders if the debtors reached
certain sale milestones and financial and operational performance milestones. The
bankruptcy court denied approval of the KEIP, finding that it rewarded participants for
work that was mostly completed prepetition and that the participants only needed to
remain with the debtors’ business until the sales closed to vest their bonuses. For example,
63% of the bonuses would vest upon the occurrence of the two sale transactions that had
been negotiated prepetition. The court added that “section 503(c) requires more than
increased responsibilities [in bankruptcy] to justify increased pay to insiders” and
concluded that it would only approve a bonus plan that more directly tied payments to
“challenging financial and operational goals for the businesses.” In re Residential Capital,
LLC, 478 B.R. 154, 168, 173 (Bankr. S.D.N.Y. 2012).
The debtors subsequently proposed, and the bankruptcy court approved, a modified KEIP
under which (a) the aggregate bonus for closing the two existing asset sales was reduced
from 63% to 20%; (b) 50% of a participant’s bonus was tied to improving the purchase
price for the assets; and (c) the remaining 30% was tied to achieving the various financial
and operational metrics utilized in the original KEIP. Further, payment of 40% of any
vested bonus was deferred until the effective date of a chapter 11 plan. See In re
Residential Capital, LLC, Case No. 12-12020-mg, Doc. No. 1854 (Bankr. S.D.N.Y. Oct. 18,
2012).
Thereafter, the debtors filed a motion seeking approval of three additional bonus plans:
(1) a KERP covering 155 non-insider employees with a projected one-year cost of
approximately $4.4 million; (2) a multi-year KEIP covering six insiders with a projected
Page 3
cost of approximately $2.2 million, under which 50% of the bonus was tied to performance
against the estate budget and the remaining 50% was allocated to various recovery metrics
based upon the recoveries achieved on a portfolio of government-insured loans; and
(3) short-term bonuses of up to $400,000 and $600,000, respectively, for two insiders,
which were tied to recovery of restricted cash and certain deliverables related to mortgage
origination. The bankruptcy court approved each of the three plans. With respect to the
two KEIPs, the court found that such plans were “designed to motivate these employees to
achieve specified performance goals and enhance production, thereby increasing the value
of the estate.” In re Residential Capital, LLC, 491 B.R. 73, 87 (Bankr. S.D.N.Y. 2013).
Hawker Beechcraft
The debtors entered bankruptcy with an agreement under which 100% of prepetition debt
would be converted into equity (the “Standalone Transaction”). After the petition date, the
debtors received a $1.79 billion cash offer to acquire substantially all their assets (the
“Third-Party Transaction”). The debtors then proposed a two-prong bonus plan for eight
members of the debtors’ senior leadership team (“SLT”):
(a) if the debtors consummated the Standalone Transaction, each member of the
SLT could earn a bonus of up to 200% of his or her base salary ($5.328 million in the
aggregate), and a minimum, 50% of base salary bonus would be awarded if the
debtors closed the Standalone Transaction and met the projections in their business
plan; and
(b) if the debtors consummated the Third-Party Transaction, each member of the
SLT would receive a bonus equal to 200% of his or her base salary if (i) the
purchase price equaled at least $1.79 billion, with certain downward adjustments if
the purchase price was reduced, and (ii) the transaction closed by a date certain,
which date could be extended with the consent of the committee and certain
creditors.
If the Third-Party Transaction did not close through no fault of management, the debtors
would nevertheless award the Standalone Transaction bonus to the SLT, and the
projections needed to reach the minimum 50% bonus would be adjusted to reflect
expenses incurred by the debtors in pursuing the Third-Party Transaction.
The bankruptcy court denied approval of the bonus plan, finding that Section 503(c)(1) of
the Bankruptcy Code barred approval of the bonus plan. Of particular concern to the court
were the facts that that the SLT members could earn a 50% bonus for the Standalone
Transaction “under an indefinite deadline without meeting any financial targets,” and “they
can earn a 200% bonus under the Third-Party Transaction by consummating the
transaction under a flexible deadline at a price that [the purchaser] has already offered, or
a lesser bonus at a substantially lower price.” In re Hawker Beechcraft, Inc., 479 B.R. 308,
315 (Bankr S.D.N.Y. 2012). Thus, the court concluded that while the targets at the higher
Page 4
end of the KEIP meet the requirement were sufficiently challenging, the goals required to
receive a minimum bonus were not.
Velo Holdings
The debtors sought approval of approximately $2.875 million in incentive bonuses to be
paid to 63 insider and non-insider employees, across three business units. Under the KEIP,
payments to non-insiders were driven by the net proceeds distributed to creditors, while
the bonuses for insiders were tied to achieving specific sale milestones and providing
transition services. The bankruptcy court approved the KEIP, finding that it was primarily
incentivizing, as the plan required participants “to do more to meet the wide-scale goals
outlined in the KEIP” and “to increase their pre-bankruptcy job responsibilities to achieve
the bonus requirements and financial targets.” In re Velo Holdings, Inc., 472 B.R. 201, 210
(Bankr. S.D.N.Y. 2012).
Global Aviation
The debtors proposed a KERP for five employees of their North American operations,
which were intended to encourage the participants to remain with the debtors during the
transition of operations from New York to Georgia. The five employees were: (1) the
director of safety, (2) the vice president of operations, (3) the chief pilot, (4) the senior
director of maintenance, and (5) the chief inspector. The United States Trustee and the
Official Committee of Unsecured Creditors objected to the KERP on the ground that the
debtors had failed to prove that the KERP participants were not insiders. The bankruptcy
court concluded that, notwithstanding the fact that certain of the KERP participants had
officer- or director-sounding titles, none of the participants was an insider of the debtors.
In approving the plan, the court noted that none of the KERP participants was a member of
the board of directors, none exercised control of the debtors, all participants were at least
two levels down from senior management, none had discretionary control over substantial
budgetary amounts, and none was involved in setting corporate policy. In short, the court
concluded, “none of the KERP Employees exercises sufficient authority over the debtor as
to unqualifiedly dictate corporate policy and the disposition of corporate assets.” In re
Global Aviation Holdings, Inc., 478 B.R. 142 (Bankr. E.D.N.Y. 2012).
Dewey & LeBoeuf
The debtor was winding down its affairs through the chapter 11 with a limited staff. The
debtor sought approval of (1) a retention plan for collections and operational staff of
between three and eight weeks’ salary if employees continued in the debtor’s employ until
stated dates; and (2) an incentive plan in the aggregate amount of $250,000 for three “key”
employees tied to the amount of receivables that were collected. The bankruptcy court
approved the retention plan, finding it reasonably tailored in scope and cost in light of the
debtor’s assets and liabilities. Similarly, the court approved the incentive plan, finding that
the plan was designed to incentivize the desired performance and that the cost was
Page 5
justified by the fact that the bonus was being paid in lieu of additional commissions to a
third-party collections company. See In re Dewey & LeBoeuf LLP, 2012 Bankr. Lexis 3484,
Case No. 12-12321 (MG) (Bankr. S.D.N.Y. July 30, 2012) (unpublished opinion).
Borders
The bankruptcy court approved a KEIP under which 15 key executives could receive
bonuses of up to 55% to 75% of base salary. In order to receive the base bonuses, the
maximum amount of which was approximately $2.7 million, the debtors would have to
meet the following benchmarks:
(1) either (a) confirm a chapter 11 plan or (b) win approval of a bankruptcy sale of
the business as a going concern by August 15, 2011. If confirmation of a plan or
approval of the sale occurred between August 16, 2011 through November 15,
2011, the bonus percentages would be reduced to 55%. If neither confirmation of a
plan nor a sale occurred prior to November 16, 2011, then no incentive payments
would be made.
(2) meet specific financial benchmarks, including realizing savings in real estate
leases of at least $10 million.
In addition, KEIP participants were entitled to additional incentive bonuses if the threshold
distribution amount to general unsecured creditors was at least $73 million. The
bankruptcy court found that the KEIP satisfied Section 503(c) because it established
specific financial and bankruptcy goals to be achieved in a stated timeframe. See In re
Borders Group, Inc., 453 B.R. 459 (Bankr. S.D.N.Y. 2011).
Mesa Air
The bankruptcy court approved a KEIP that provided for bonuses of up to $287,000 in the
aggregate to seven executives for the first two quarters of 2010, followed by bonuses of up
to $110,000 in the aggregate per quarter thereafter. In approving the KEIP, the court found
that the plan was consistent with the debtors’ past practice, the bonus amounts had been
negotiated prepetition, creditors supported the plan, and the bonus payments were tied to
certain performance goals and were not retentive. In re Mesa Air Group, Inc., 2010 Bankr.
Lexis 3334, Case No. 10-10018 (MG) (Bankr. S.D.N.Y. Sept. 24, 2010) (unpublished).
Journal Register
The bankruptcy court confirmed the debtors’ plan of reorganization, which included a postemergence incentive plan. The court found that Section 503(c) of the Bankruptcy Code did
not apply to the plan as the payment of the bonuses was not being allowed as an
administrative expense of the estate, and the secured lender (which was acquiring the
debtors’ assets under the plan) would bear the financial burden of paying such bonuses.
Page 6
Additionally, the bankruptcy court found that the bonuses were incentivizing and were not
retentive. In re Journal Register Co., 407 B.R. 520 (Bankr. S.D.N.Y. 2009).
Dana Corp.
In a decision issued not long after the adoption of Section 503(c) to the Bankruptcy Code,
the bankruptcy court rejected a bonus plan that was primarily retentive in nature. The
bonus plan consisted of two parts: (1) the plan proposed retention bonuses of between
$400,000 and $560,000 for five executives, and $3.1 million for the CEO, if they remained
with the debtors through the plan effective date; and (2) the plan provided uncapped
bonuses based upon the total enterprise value of the reorganized debtors six months after
the plan effective date; for example, the CEO would earn an additional $6.2 million bonus if
the total enterprise value remained at $2.6 billion and would receive a $4.133 million
bonus if the total enterprise value declined to no more than $2 billion. The court concluded
that, by not tying the bonuses to anything other than remaining with the debtors, the bonus
was not incentivizing. As the court stated, “If it walks like a duck (KERP) and quacks like a
duck (KERP), it's a duck (KERP).” In re Dana Corp., 351 B.R. 96, 102, n.3 (Bankr. S.D.N.Y.
2006).
Subsequently, the debtors sought approval of a “substantially watered down and modified”
KEIP that was tied to certain EBITDAR minimum benchmarks that would be a “stretch” to
achieve given the debtors’ future sales projections. In re Dana Corp., 358 B.R. 567, 571,581
(Bankr. S.D.N.Y. 2006). The revised KEIP included both a long-term incentive component
and an annual incentive payment. The court approved the long-term incentive plan, finding
that it adequately incentivizing the KEIP participants to meet EBITDAR targets that were
“clearly not lay-ups.” Id. at 583. However, the court declined to approve the annual
incentive plan, finding that approval of both incentive plans could result in total
compensation to insiders that was not reasonable.

Supplemental Material - Turnaround Management Association

Transcription

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