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Having your company go broke isn’t always a bad thing for some executives. Case in point: Trucking company Yellow paid out more than $4.6 million in retention bonuses to 10 executives in the weeks leading up to its declaration of bankruptcy this month, according to a court filing by the firm. The bonuses were criticized by the Teamsters Union, which noted that the bonuses came in the same period when Yellow missed a $50 million payment for employee benefits.
These kinds of bonuses during a bankruptcy can be risky. Payments made by a company in the period before filing bankruptcy come under special scrutiny, Howard Magaliff, a bankruptcy attorney at R3M Law, told CFO Brew. Financial professionals involved in a bankruptcy need to justify expenses going back multiple years before they file, and pay particular attention to some of those transactions, Magaliff said.
“If you’re looking ahead to the possibility of filing a bankruptcy, you should be aware, and counsel that’s advising the company should be telling the board that certain things are going to be scrutinized,” Magaliff said. “Certain actions that, when you’re not contemplating a bankruptcy are perfectly OK and perfectly legitimate, take on a different character [amid a bankruptcy proceeding].”
Magaliff said that bankruptcy law tends to consider payments made in the build-up to bankruptcy as part of two broad categories. One category is called preference, and it refers to a payment made within 90 days of declaring bankruptcy “that allows the creditor to receive more money than it would receive under a normal distribution in bankruptcy,” Magaliff said, adding that such payments can be clawed back during the bankruptcy process “if the creditor who received it doesn’t have a valid defense.”
Then there’s fraudulent transfer, in which “they look at whether payments were made to somebody for which the debtor didn’t receive reasonably equivalent value or fair consideration in return,” Magaliff said. Such payments could be clawed back by the judge overseeing the bankruptcy, even if they were made several years earlier, depending on the state in which the company filed for bankruptcy.
That’s what the team running bankrupt cryptocurrency exchange FTX is trying to do right now, in suing founder Sam Bankman-Fried’s parents to recover millions of dollars in payments they allegedly received, which the company claims are misappropriated funds.
Retention bonuses, however, are common in bankruptcies, Magaliff said. “Debtors often ask the bankruptcy courts to approve them on the theory that if we don’t pay these retention bonuses, we’re going to lose these key people that we need in order to successfully reorganize,” he said, though he noted that the court might choose not to approve those bonuses if they’re too high.