Bankruptcy Code section 503(c) severely limits a debtor’s ability to pay management retention bonuses, severance, and other amounts. Holding on to valuable employees during a bankruptcy case can be a daunting task. In an Emerging Issues Analysis, the American College of Bankruptcy offers specific best practices guidelines for corporate debtors seeking to formulate compensation programs that comply with section 503(c). Following is an excerpt of the Analysis:

Among the many changes to federal bankruptcy law effectuated by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA" or the "Act") was the creation of a new Section 503(c). Section 503(c) imposes a variety of restrictions on the compensation that can be paid both to executives and other employees of companies that are in bankruptcy. Specifically, Section 503(c)(1) limits retention payments that can be made to insiders  of the debtor, imposing strict--and exceedingly difficult--requirements that must be met before such payments may be made. Section 503(c)(2) establishes strict limitations upon the payment of severance to insiders of the debtor. Finally, Section 503(c)(3) places limitations on the payment of other obligations outside of the ordinary course of business that are not covered by subsection (c)(1) or (c)(2).

Faced with these restrictions and the possibility of large-scale attrition among their most valuable employees, debtors have sought to adopt programs that are (a) designed to provide key employees with incentives to work to enhance value (and, by implication, remain in the debtors' employ) and (b) consistent with Section 503(c). Each debtor, after weighing all relevant factors, must arrive at its own solution consistent with the Bankruptcy Code's requirements. The "best practices" guidelines articulated below are, therefore, not intended to prescribe particular solutions to the executive compensation issues faced by debtors. Rather, they are intended to outline those factors that might be considered in developing and analyzing debtor compensation programs.

In determining whether to approve a debtor employee compensation program (whether structured as an initiative to motivate enhanced performance or a traditional pre-BAPCPA "pay-to-stay" retention initiative), among the factors that courts consider is the due diligence that has been undertaken in investigating the need for and propriety of such a program. A debtor should not blindly presuppose that a bankruptcy-specific compensation program is necessary or appropriate. The debtor, by way of the independent directors serving on its compensation committee  (ideally working in consultation with independent professionals), should inform itself of the relevant facts and make a determination about whether an employee compensation program is necessary and appropriate in light of those facts….

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