What factors does the court consider when approving a KERP / KEIP?
The Applicants are a group of operationally integrated companies in the pharmaceutical industry that operate in both the United States and Canada. The Canadian entities are undergoing restructuring pursuant to the Companies’ Creditors Arrangement Act, while the US entities have sought relief pursuant to Chapter 11 of the United States Bankruptcy Code. In September 2018, the Canadian and US entities entered into three stalking horse agreements, and those processes are still ongoing. The Applicants brought an application for court-approval of the group’s Key Employee Retention Plan (“KERP“) and Key Employee Incentive Plan (“KEIP“).
The KERP affects only three employees, and the contents of the program were not opposed by any stakeholder. The plan would provide these three employees with retention bonuses of between 25% and 50% of their salary, with payment to be made on the earlier of termination without cause, death or permanent disability, or the closing of a sale of the Canadian assets. The KEIP affects nine senior management employees who provide services to both the Canadian and US debtor entities. Accordingly, the KEIP was presented to both courts for approval, and the US bankruptcy court approved the program in November 2018. None of the KEIP participants are expected to have ongoing roles once the bankruptcy sales process is completed. The plan is designed to incentivize participants to assist in achieving the highest level of sales proceeds.
- restructuring businesses often have inefficiencies that need identifying and resolving, which may impact some otherwise “key” employees;
- since insolvency blunts the traditional mechanisms of shareholder oversight, the risk of management resolving conflicts in a self-interested manner is more acute; and
- economic fears and “bunker mentality” among employees during insolvency may result in a loss of key employees en masse.
- employees in newly-insecure positions are easy prey for competitors who are able to offer more stable employment;
- there is a high risk that the most employable and valuable employees would otherwise be cherry-picked, forcing the debtor company to compete for replacement employees;
- depending on the restructuring plan, employees may be asked to devote their time and skills to an endeavour that may put them out of work; and
- since many employers use a mix of base salary and profit-based incentives, employees of an insolvent business may be asked to do more – sometimes covering for colleagues who have been laid off or who have left for greener pastures – while earning only a fraction of their former income.
- Arm’s length safeguards: The parties responsible for the design, scope and implementation of the plan are independent of the beneficiaries of the program. The Monitor has an important role in assessing the need and scope to designing the targets, metrics and rewards.
- Necessity: The need for a KERP or KEIP must be examined critically. Employees in a sector that is in demand pose a greater retention risk while employees with relatively easily replaced skills in a well-supplied market pose a lesser degree of risk, and consequently necessity.
- Reasonableness of Design: The program must be effective in aligning the interests of the beneficiaries with those of the stakeholders, rather than rewarding counter-productive behaviour or incentivizing insiders to disrupt the process at inopportune times. The targets and incentives must be reasonably related to the debtor company’s goals.
Counsel: Maria Konyukhova and Kathryn Esaw of Stikeman Elliott for the Applicants, Jeffrey Levine of McMillan LLP for the Official Committee of Unsecured Creditors, David Bish of Torys LLP for Richter Advisory Group, Monitor and Danish Afroz of Bennett Jones LLP for Deerfield Management Company, L.P.
