The U.S. Trustee for the bankruptcy court in Brooklyn objected to Cengage Learning’s proposed reorganization plan, arguing that an included management incentive plan upon emergence from Chapter 11 violates provisions of the Bankruptcy Code that limit the payment of bonuses to insiders.
As reported, a confirmation hearing on the largely consensual reorganization plan is scheduled for March 13.
According to the objection filed yesterday by U.S Trustee William Harrington, the proposed management incentive plan runs afoul of the Bankruptcy Code because it, “in effect, rewards the [company’s] executives with stock and stock options potentially worth over $10 million for remaining in their positions during the Chapter 11 case, rather than awarding bonuses prospectively if the executives meet performance targets set by the new board of directors.” According to Harrington, the company is seeking approval of the bonus payments in the context of confirmation, rather than via a motion to the Bankruptcy Court, in an effort to “circumvent the strict standards” in the Bankruptcy Code that seek to prevent excessive executive compensation during a Chapter 11 case.
Under the proposed MIP, which, under the reorganization plan, the company’s new board is required to adopt upon emergence, executives are to receive 5.6% of the reorganized equity valued at about $10 million (comprised 60% of incentive options and 40% restructured stock units). CEO Michael Hanson would receive 50% of that aggregate award amount, while eight other executives and a new CFO would split the other 50%. Under the plan, 80% of the awards, with a value of $8 million, would be distributed on the date the company emerges from Chapter 11.
In effect, Harrington argues, this scheme rewards the company’s executives for simply remaining with the firm during the bankruptcy, an incentive which the Bankruptcy Code specifically prohibits unless certain requirements are satisfied, such as paying a retention incentive only when an executive has already received a competing offer from a different firm.
Harrington further argues that the MIP would undermine the company’s new board of directors, since it would obligate the company to “distribute potentially $10 million in value to insiders prior to the formation of the new board of directors,” depriving the new board and the reorganized company of “corporate governance procedural protections” and precluding the board “from exercising its fiduciary duty.”
Separately, Harrington contends that a proposed severance payment provided for in the company’s reorganization plan for CFO Dean Durbin also violates the Bankruptcy Code prohibition against payments to insiders.
The company only first disclosed its intent to part ways with Durbin in its recently filed reorganization plan supplement, Harrington notes.
According to Durbin’s severance agreement, he is to receive his $600,000 salary for one year after separation from the company plus his pro rata distribution of any bonus he would have received had he remained in the company’s employ.
Harrington is not seeking to block confirmation of the company’s proposed reorganization plan, but he is asking the bankruptcy court to, among other things, deny approval of the MIP. – Alan Zimmerman