Enron's Retention Bonuses Avoided by Texas Court as Preferential Transfers and Intentional and Constructive Fraudulent Transfers

Thanks to Tom Kirkendall for his post on his Houston's Clear Thinkers blog to a 102 page opinion (available here also) issued by Dallas' Bankruptcy Judge Robert McGuire in a case that challenged the grant (and funding) of over $100 million in retention bonuses to approximately 300 highly-coveted energy traders and related management employees on the eve of Enron's bankruptcy filing in December 2001.

Tom K. says that BAPCPA's "recent amendments to the Bankruptcy Code limit the precedential value of the decision [because] [u]nder 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." Let me add two qualifications to this comment:

First, while Tom K. is right that Bankruptcy Court approval is now needed for all proposed postpetition payments of retention bonuses (even if the bonuses were authorized prepetition), BAPCPA's amendments to new Code Section 548(a)(1)(B)(ii)(IV) do not presume that prepetition retention bonuses payments are voidable. Rather, such payments are voidable under the new Code section only to the extent that (i) the debtor "received less than a reasonably equivalent value in exchange," and (ii) the transfers were made to "an insider," "under an employment contract," and "not in the ordinary course of business." Notably, the new law does not appear to shift the burden of proof, which remains with the plaintiff/trustee as to all elements.


Second, the case has significant precedential value for a bankruptcy litigator because of the Court's analysis (often extensive) of such bread and butter issues for a bankruptcy litigator as:

  • when an "antecedent debt" arises for preference purposes (pp. 38-43);
  • whether the "new value" defense applies (pp. 43-48);
  • whether the "ordinary course" defense applies to the preference action [N.B.: discussion of what constitutes "ordinary course" for purposes of an affirmative defense to a preference action may well become the standard in future litigation under new Code section 548(a)(1)(B)(ii)(IV) regarding whether a prepetition payment under an employee contract was in the "ordinary course"] (p.48);
  • whether the debtor "was insolvent" at the time of the transfer (both from a "balance sheet" and "equitable" perspective and from a "going concern" vs. "liquidation" perspective) (pp. 48-79);
  • whether, applying the doctrine of Moore v. Bay (the case I love to hate), there existed at least one pre-existing creditor with standing to avoid the transaction (pp. 82-84);
  • whether the bonuses, being on the eve of bankruptcy, were intentional fraudulent transfers (pp. 86-88);
  • whether the bonuses were accepted for value and in good faith under Code section 548(c) (pp. 89-94);
  • whether "reasonably equivalent" value was given in exchange (pp. 94-97).

This matter was initiated by the "Official Employment-Related Issues Committee of Enron Corporation (the "Employment Committee"), an official committee formed by the US Trustee in Enron's bankruptcy case primarily to investigate these challenged payments and to commence avoidance litigation regarding them, as appropriate. Initially, over 300 defendants were sued, 40 of whom went to trial to defend their right to the bonuses (several of whom, the record suggests, apparently were unaware of the saying that "one who represents himself has a fool for a client and an idiot for a lawyer").

With extensive references to the voluminous record (which included over 1,000 documentary exhibits), Judge McGuire methodically ruled that:

(i) the payments were preferential as they were made on account of an "antecedent debt" while the debtor was "insolvent, and were not subject to valid "new value," "ordinary course," or "contemporaneous exchange" defenses;


(ii) the Enron debtors were not only insolvent, but "on their deathbeds," at the time of the grants;

(iii) Moore v. Bay remains good law, and voidable as to one means it's voidable as to all (at least in this case, unlike in the Campbell Soup case discussed here, the value of the prepetition debts exceeded the amounts sought to be recovered);

(iv) the bonuses were intentional fraudulent transfers made with intent to hinder, delay, and defraud Enron's creditors;

(v) the bonuses were constructive fraudulent transfers in that "reasonably equivalent value" was not provided in exchange given that Enron was on its deathbed at the time of the grant;

(vi) there was insufficient evidence that the transfers were taken in "good faith" under Bankruptcy Code section 548(c).

All in all, a most interesting read (particularly, at pp. 68-76, the 38 enumerated conclusions of government reports regarding the pervasiveness of the Enron debtors' financial shenanigans and the complicity of their banks and advisors in the same).

Thanks to Tom K. for being the first to share it with us all.


© Steve Jakubowski 2005

Written By:Tom Kirkendall On December 14, 2005 9:20 AM

Steve, nice analysis. However, under the new amendments, don't you think that pre-petition retention bonuses are a thing of the past? Stated another way, what debtor management team is going to risk the wrath of the Bankruptcy Court and creditors by paying retention bonuses pre-petition in the face of 548(a)(1)(B)(iv)?

By the way, I enjoy your blog very much and appreciate your efforts in providing this valuable resource.

Written By:Steve Jakubowski On December 14, 2005 11:14 AM

Tom, thanks for you comment, and very kind words of support. They are very much appreciated by us here!

To answer your question, I agree that certain pre-retention bonuses, like those in Enron that are granted on the company's "deathbed," are a thing of the past. But, let's hope the financial shenanigans witnessed in Enron (see pp. 68-76 of Enron opinion) are also a thing of the past, too! I think the two go hand-in-hand.

Still, I don't think the new provisions of Section 548 will stop retention bonuses from being granted in less egregious circumstances where the company's survival or turnaround is still feasible. Absent such bonus grants, who from the outside is going to come in and take control of a company desperate for turnaround help? And once retained, how does that person keep the people at the company needed to make the turnaround work without giving them retention bonuses too.

When one works through the practicalities, I'm not sure that the new provision really did much to change the ways things really work. Most companies paying these bonuses are insolvent or undercapitalized anyway, and all the new law in Section 548 really did was allow the trustee to avoid the prepetition payment as a fraudulent transfer without having to prove the company was insolvent or undercapitalized. The trustee already gets the benefit of that rebuttable presumption in preference cases; here, the new law merely makes that presumption conclusive when dealing with insider retention bonuses in the fraudulent transfer context. The fact is that a retention bonus granted to an insider for less than reasonably equivalent value was a fraudulent transfer before BAPCPA (as long as the company was insolvent or undercapitalized). Many cases support that point.

So, in the end, the hapless debtor is stuck between a rock and a hardplace, but that won't stop it from granting those retention bonuses because most people in these situations can be presumed to be primarily self-interested and will seek to drive the hardest bargain they can for themselves, or leave. Waiting until after the case is filed to grant such bonuses, as was often the case in the pre-Sarbox days, is not a realistic option, because the employees risk getting nothing under BAPCPA's new Section 503(c)(1). Alternatively, the debtor can give out retention bonuses prepetition, and risk being sued for the money. The old saw that "possession is 90% of the law" (or, if you prefer, "a bird in the hand is worth two in the bush") rings true here, and I expect that debtors will choose this route given the likely dead end that the postpetition alternative offers.

Look at the Enron case, 300 were sued, only 40 went to trial. That means 260 did better with the bonus than with none at all. While the case started with lots of wrath, after over two years of intense hand-to-hand litigation combat, the revenge turned into a stone-cold, plodding affair (i.e., trial), with the Court showing respectful firmness, not wrath, in carefully considering the evidence. You have to wonder, though, had Judge McGuire's opinion been a post-BAPCPA opinion, would it really have looked any different? If you excise the insolvency analysis (about 30 pages), I think Judge McGuire issues the same opinion, but does it under the new 548, instead of the old.

All the best,

Steve Jakubowski

Written By:Tyler Nurnberg On December 15, 2005 3:12 PM

very informative site; thank you. I agree that the corporate scandals are the exception not the rule and that we'll continue to see boards implement retention programs pre-petition. Curious as to whether you share the view that, under the amendments, we'll see key employees asking for letters of credit or the functional equivalent to secure bonuses due under these programs.

Written By:Steve Jakubowski On December 15, 2005 4:41 PM

Thanks Tyler, I appreciate your kind words, and your contribution even more!

As for your question, the bank lenders obviously will have much to say about it, and I expect they'd be reluctant to support reductions in their collateral base for the benefit of employees. But assuming you get over that hurdle, is the problem solved? Wouldn't the retention bonus still be subject to Code section 503(c), even if secured by an L/C? Whatever's allowed is secured, but what will be allowed? So, if the retention bonus wasn't paid in full prepetition, then isn't the right to payment subject to Section 503(c)'s retention bonus limitations. Or does Section 365 override Section 503? In Chicago's bankruptcy court, Orius just filed for chapter 11 (No. 05-63876), and it appears at first glance that there's a request to assume executive employment contracts that have "success" and "stretch" incentive provisions in them. Nothing huge or obscene, but possibly beyond the limitations of Section 503(c)(1)(C). Looks like the the debtor is looking for approval of these under 363, not 503. So here's a question back to you (if you care to answer, and no problem if you don't), should the standard for approval of such incentive programs embodied in executive executory contracts be section 365 or section 503? Does the business judgment standard even apply? Or is the burden of proving fairness on the executives, with a definition of "fair" in bankruptcy that effectively incorporates Section 503's limitations?


Written By:Tyler Nurnberg On December 19, 2005 3:25 PM

I agree that payments due post-petition under a pre-petition retention program are subject to sec 503(c). 503(c) by its terms covers both adoption of the program and payments thereunder.

Your question as I understand it is, what to do when the program isn't a pure "retention" program but is instead an incentive program? There will be line-drawing problems (are hurldles so low as to make it a disguised retention program?) but, where the program is a true "incentive" program, I tend to agree that the correct standard for assuming the program is sec 365. Although it's poorly worded, the payments themselves should also be subject to 503(c)(3), but I'm not sure that will matter since all it says is the payments need to be justified by the facts and circumstances of the case, i.e., business judgment.

Written By:Steve Jakubowski On December 19, 2005 3:45 PM

When senior executives seek authority to receive retention bonuses/incentive payments, the principal question that I think needs to be resolved is whether the standard to be applied is "business judgment" or "fundamental fairness". Obviously the answer to this question is important as it determines the levels and burdens of proof. Because many of these programs look a little self-dealt (with a modicum of trickle down), I only ask whether the entire program should be addressed under the stricter fundamental fairness standard (with the executives having the burden of proof by clear and convincing evidence) or the business judgment standard (a far lesser burden).2