• Post category:Court Cases

Aralez Pharmaceuticals Inc. (Re), 2018 ONSC 6980

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.

The Court was tasked with determining whether to approve the KERP and KEIP as proposed by the Applicants. The Court acknowledged the various challenges in respect of employees that converge in the early stages of an insolvency filing: 
  • 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.
The benefits of an appropriately-calibrated incentive or retention plan are obvious: 
  • 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.
A court’s role in assessing a request to approve a KERP or KEIP is to assess the totality of circumstances to determine whether the process has provided a reasonable means for objective business judgment to be brought to bear, and whether the end result is objectively reasonable. Where business judgment is applied in a process that has taken appropriate account of as many of the competing interests as possible, the result will adhere more closely to the standard of objective reasonableness.
The Court articulated three criteria that provide a framework for considering the degree to which appropriately objective business judgment underlies a KERP or KEIP: 
  1. 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.
  2. 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.
  3. 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.
Given the above framework, the Court approved both the KERP and KEIP. There was substantial evidence that the process of negotiating and designing both plans involved arm’s length and objective oversight in the negotiation, design and implementation phases. The Applicants’ financial advisor worked with the board of directors—none of whom are beneficiaries of either program—when formulating the plans. The Monitor was consulted extensively and a number of alterations were made based on the Monitor’s recommendations. The Monitor concluded that the plans protect the interests of the Canadian stakeholders.
Further, the design of the two plans demonstrated an appropriate regard for the criterion of necessity. The designers of the plans assessed each prospective beneficiary in terms of the ease with which they might be replaced, how critical they are to daily operations of the debtor companies or completion of the sales process, and the perceived retention risk. The inclusion of the three employees in the KERP program was a condition of the purchaser under the stalking-horse bid. The loss of these employees would endanger the stalking horse bid process at worst and, at best, disrupt the business being sold by  requiring the debtor companies to deal with recruiting new employees at an inopportune juncture. The nine employees covered by the KEIP were also deemed essential to ensuring the business remains stable and performs well during the restructuring process. Notably, most of them are also working under the near certainty that the more efficient and successful they are in their efforts, the sooner they will be out of a job. As such, tailored financial incentives are appropriate.
Finally,  the Court concluded that the targets are realistic and appropriate, and the incentive amounts are reasonable in all of the circumstances. It approved both the KERP and KEIP.

CounselMaria 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.