Among the more interesting civil cases that arose out of the Enron Corp. bankruptcy case are the various lawsuits that were filed to recover retention bonuses paid to former key Enron executives.
Retention bonuses are payments made to a company’s key executives immediately before the filing of the company’s bankruptcy for the purpose of retaining those key executives during the company’s bankruptcy case, particularly during the early stages of the case when risk of liquidation is high. The theory behind retention bonuses is that ensuring that key executives continue to work for a debtor-company is a reasonable hedge against the risk of liquidation, which generally results in greater loss of jobs and lesser dividends on creditors’ claims than if the debtor-company is reorganized.
Retention bonuses have always been controversial, primarily because they are made immediately prior to the company going into bankruptcy and, thus, are not subject to Bankruptcy Court approval as they would be if proposed after the company enters bankruptcy. Nevertheless, creditors have traditionally used the avoidance powers in bankruptcy cases — i.e., the power of the Bankruptcy Court to order the return to the debtor’s bankruptcy estate of certain pre-petition payments that prefer certain creditors over others or that constitute fraudulent transfers to third parties — to go after retention bonuses paid to a debtor-company’s former executives. In most cases, the core issue in such lawsuits is whether the debtor-company’s payment to the key executive was a reasonable price to pay for the executive’s services in helping the debtor-company reorganize.

Enron’s bankruptcy involved a particularly interesting case in regard to retention bonuses. Once one of the most valuable public companies in the U.S., Enron went through a dizzing spiral downward during the last several months of 2001 amid revelations of an accounting scandal and CFO Andrew Fastow’s use of special purpose entities to enrich himself and several of his close associates. Inasmuch as Enron was the market maker in its online trading business, that business (called “Enron Online”) was hugely profitable and potentially one of Enron’s most valuable assets as it entered bankruptcy. However, due to competitive pressures, Enron Online was losing its key traders during Enron’s descent into bankruptcy, particularly after it became clear that the company’s trading desk was going to have to go dark for a time after bankruptcy while Enron attempted to find a buyer for trading operation.
Consequently, during the company’s chaotic days leading up to bankruptcy, Enron’s management and board of directors approved the payment of retention bonuses in the total amount of over $100 million to approximately 300 key traders and executives in an effort to retain that personnel during the early stages of Enron’s bankruptcy case. The number and amount of those payments (one payment to a particularly successful trader was over $8 million) infuriated Enron’s creditors and former employees who lost their jobs as a result of bankruptcy, so a former employee’s committee was formed in Enron’s chapter 11 case and that committee pursued the lawsuits on behalf of Enron’s estate to recover the retention bonuses. Most of the cases settled, but approximately 40 former Enron key employees declined to settle and decided to defend their bonuses at trial, which took place earlier this fall.
In this 102 page decision (pdf), Bankruptcy Judge Robert McGuire of Dallas (sitting by designation in Houston’s bankruptcy court) concluded that the retention bonuses were either voidable preferences or constructive fraudulent transfers (i.e., payments made for inadequate consideration in return) and ordered that the former Enron executives pay damages to the Enron estate equal to the amount of their retention bonuses. Here is the Mary Flood/Chronicle article on Judge McGuire’s decision.
The decision makes for interesting reading in an area of the law that does not have much precedent, but the recent amendments to the Bankruptcy Code limit the precedential value of the decision. Under those amendments, pre-petition retention bonuses to key employees are now presumed to be voidable transfers and are expressly subject to Bankruptcy Court approval even if made prior to the commencement of a bankruptcy case. Thus, the new Bankruptcy Code amendments make it more difficult for troubled companies to retain their key employees as they tumble toward reorganization in bankruptcy, which — at least on the margin — increases the risk that those companies will liquidate rather than reorganize in bankruptcy. Increased liquidations generally result in greater job loss for communities and smaller dividends (if any) on creditors’ claims, which are two consequences that I don’t think Congress had in mind when it passed this particular amendment.