Contributed by Conray C. Tseng
In In re Blitz U.S.A. Inc., the Honorable Judge Walsh for the United States Bankruptcy Court for the District of Delaware found, over the objections of the Creditors’ Committee and the U.S. Trustee, that the continuation of a prepetition EBITDA-based employee bonus plan – with significant payments to insiders and senior management – was an ordinary course transaction and approved the plan. In an era where employee bonus plans in chapter 11 cases come under increased scrutiny, Blitz suggests that debtors can continue to implement plans consistent with past practice despite payments to senior management and insiders.
Blitz manufactures portable gas containers distributed through various retailers. Prior to commencing its chapter 11 case, Blitz defended numerous product liability cases relating to alleged injuries caused by the use of Blitz gas cans. Litigation and rising defense costs caused Blitz to seek bankruptcy protection in November 2011. Immediately prior to the bankruptcy, Blitz spun off its non-gas-can business, F3 Brands LLC. F3 accounted for one-third of Blitz’s sales.
Since 1992, Blitz has offered all of its employees, including senior management, participation in a bonus plan as part of their overall compensation package. Originally based on Blitz’s net income, the plan became based on EBITDA in 2007 similar to other plans found within the industry. Under the EBITDA-based plan, the original 2012 bonus targets were EBITDA targets of $6 million, $9 million, and $12 million. After the F3 spinoff, Blitz lowered the original initial bonus target to an EBITDA of $5 million.
In May 2012, Blitz filed a motion with the court for authority to pay bonuses related to the first two EBITDA targets under the 2012 bonus plan. As of the filing of the motion, Blitz had only hit the first EBITDA target (i.e., the $5 million EBITDA target). Under the 2012 bonus plan, all employees would receive bonuses, with the most junior employees receiving approximately 4% of their base pay and senior management receiving 67% of their base pay, for a total payout of approximately $427,000.
Blitz asserted that the 2012 bonus plan was an ordinary course transaction subject to the business judgment standard under section 363(c) of the Bankruptcy Code. Section 363(c) of the Bankruptcy Code permits the debtor to enter into transactions in the ordinary course of business without notice, hearing, or approval of the bankruptcy court. Blitz stated that it sought bankruptcy court approval to the pay bonuses out of an abundance of caution.
The unsecured creditors’ committee objected to Blitz’s motion and argued that the 2012 bonus plan was subject to section 503(c)(3) of the Bankruptcy Code, which requires such plans to be “justified by the facts and circumstances of the case.” The creditors’ committee alleged that the 2012 bonus plan was not so justified based upon, among other things, the lowering of the initial bonus target due to the F3 spinoff, higher average payments per employee under the 2012 bonus plan, and the fact that Blitz no longer shouldered significant litigation defense costs because of the automatic stay.
Applying the Third Circuit’s horizontal and vertical tests, Judge Walsh found the 2012 bonus plan to be an ordinary course transaction. The vertical test requires the court to determine whether the transaction is consistent with the debtor’s prepetition practice. The horizontal test requires the court to examine whether the transaction is consistent with industry practice. Judge Walsh found the 2012 bonus plan satisfied both tests.
As to the creditors’ committee’s specific objections, Judge Walsh noted that a reduced EBITDA target was expected with the spinoff of a business that represented one-third of the company’s sales. Judge Walsh also noted it was not unexpected that the average payment per employee was higher because a number of lower level employees left the company. Further, although the company could have raised EBITDA targets to address decreased litigation costs, the 2012 bonus plan was not invalid because the company did not. In particular, Judge Walsh noted that Blitz did not lower its EBITDA targets when litigation costs increased in previous years. Further, the court observed that although the bankruptcy filing imposed the automatic stay, the filing could have an offsetting negative impact on EBITDA in light of the stigma associated with bankruptcy and related restructuring expenses.
Accordingly, Judge Walsh concluded that the 2012 bonus plan was an ordinary course transaction. Because the plan was designed to encourage employee performance, Judge Walsh found the plan within the purview of Blitz’s business judgment and held that the 2012 bonus plan satisfied the applicable standard set forth in section 363 of the Bankruptcy Code. Although bonus plans such as the one proposed in Blitz will continue to be the subject of scrutiny in chapter 11 cases, plans that are likely to have the highest chances of success of being approved are those that are found to be incentive based and consistent with company-wide and industry-wide practice.