Coauthored by Charlene D. Davis

In the context of a commercial bankruptcy case, the retention of key employees is frequently crucial either to successfully reorganise the company or to maximise the value of the company’s assets in a liquidation. Historically, debtors relied on section 503 of the Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, 108 Stat. 4106 (1994) as the legal authority to seek approval of compensation packages to induce key employees to remain following a bankruptcy filing. Section 503 conferred administrative status on the actual costs and expenses necessary to preserve the debtors’ estate, including wages, salaries, or commissions for services rendered after the commencement of the case. This provision enabled debtors to offer key employees retention bonuses, severance pay and other compensation packages, known as KERPS, as incentives to remain employed by the debtors and provide invaluable services in the bankruptcy case and insured that, in all but the most unusual cases, these expenses would be paid in full.

On 20 April 2005, Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), which became effective on 17 October 2005. Inthe BAPCPA, the United States Congress amended section 503 so that the provision now includes a new subsection (c) that sets limitations on retention bonuses and severance payments to insiders (which by definition includes directors, officers, and persons in control of the debtor) and other transfers or obligations made or incurred outside the ordinary course of business. The change was a response to opinions expressed by commentators and advocates of employees and retirees that executives, officers and other persons managing the debtor too often were receiving excessive retention payments and other bonuses for post petition services, while lower level employees and creditors were forced to incur reductions in payments from the debtors.

As a result, since the effective date of the BAPCPA, corporate debtors seeking to retain key insider employees by offering retention bonuses, severance plans and other compensation packages have been faced withthese statutory limitations. Section 503(c) has been highly criticised by the legal community on a number of grounds, including that it is ambiguous and that the limitations are virtually insurmountable in the context of most bankruptcy cases. Nevertheless, it is the current state of bankruptcy law with respect to retention bonuses and severance packages. Its provisions set the following standards.

Section 503(c)(1) provides that a retention bonus to an insider shall not be allowed or paid unless the court finds that:

• the payment is essential to the retention because the individual has a bona fide job offer from another business at the same or greater rate of  compensation;


• the services provided by the insider are essential to the survival of the business; and


• either (i) the payment is not greater than an amount equal to 10 times the amount of the mean transfer or obligation of a similar kind given to non-management employees during the same calendar year, or (ii) if there are no similar transfers made during the calendar year, the amount of the transfer is not greater than an amount equal to 25 percent of the amount of any similar transfer or obligation made to or incurred for the benefit of such insider during the previous calendar year.

Section 503(c)(2) provides that a severance payment to an insider shall not be allowed or paid unless:

• the payment is part of a program that is generally applicable to all full-time employees; and


• the amount of the payment is not greater than 10 times the