The ongoing pandemic has negatively impacted the global market in nearly every sector and has led many companies to file for bankruptcy. For example, Hertz Global Holdings Inc. thrived as a car-rental company before the pandemic broke out but now is on the verge of bankruptcy. (Brickley, Wall Street Journal). Despite filing for Chapter 11 bankruptcy in May, Hertz intends to hand out $14.6 million in bonuses to executives after having already paid out $16.2 million in a similar fashion. Id. This type of “retention” bonus was rare before the economy recently turned downward, but a spike in these bonuses could lead to an influx of novel bankruptcy claims from creditors. Id.

In its Form 8-K filing, Hertz agreed to dispose of at least 182,521 cars to help liquidate $650 million that will go to asset-backed securities creditors. (Lee, Business Insider). This effort shows the severity of Hertz’s financial struggle, yet the company will have paid out over $30 million in executive bonuses if the second round is distributed as intended. To date, at least fourteen companies with over $50 million in liabilities have distributed bonuses in this manner - shortly before filing for bankruptcy. (Spector and DiNapoli, Reuters). Amid the rapidly increasing bankruptcy filings, lawmakers have another opportunity to address regulations in a way that provides equitable solutions to junior creditors.

In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“Act”), a law specifically aimed at preventing bankrupt companies from paying retention bonuses. (Congress, Bankruptcy Abuse Prevention and Consumer Protection Act of 2005). However, companies like Hertz continue to use loopholes that effectively allow them to pay retention bonuses. (Brickley, Wall Street Journal). Specifically, Section 503(c)(1) of the Act prohibits bankrupt companies from making payments to a company insider for the purpose of inducing the individual to remain with the debtor’s business. (Congress, Bankruptcy Abuse Prevention and Consumer Protection Act of 2005).

Section 503(c)(1) was first challenged in 2006 when Dana Corp. filed for bankruptcy and stylized its retention bonuses as “incentive” payments. (Norris, New York Times). The U.S. Department of Justice joined unions and creditors in opposing Dana Corp.’s incentive payments. Id. This challenge allowed the United States Bankruptcy Court for the Southern District of New York to interpret Section 503(c)(1). Id. Dana Corp. successfully argued that Section 503(c)(1) did not apply to its payments by “presenting an executive compensation package that properly incentivizes the CEO and Senior Executives to produce and increase the value of the estate.” (In re Dana Corp., 358 B.R. 567, 584 (Bankr. S.D.N.Y. 2006)). This ruling set the precedent of allowing companies to bypass the prohibition on retention bonuses through minor stylistic variations.

Now, companies facing bankruptcy are further ignoring Congress’ disapproval of retention bonuses by distributing large sums of money shortly before filing bankruptcy. (Eavis, New York Times). In Hertz’s case, the $16.2 million distributed three days before the bankruptcy filing did not need bankruptcy court approval, and the subsequent $14.6 million will likely rely on the Dana Corp. ruling as justification to provide another round of retention bonuses. (Gladstone, Wall Street Journal).

As stated above, the court in Dana Corp. accepted an economic justification for allowing bankrupt companies to distribute incentive bonuses. In effect, companies can incentivize key personnel to stay while the company struggles because this will provide the best chance to reshape the company, pay off creditors, and contribute to the economy. This practice has been used by more than 70 companies since 2016. (Gladstone, Wall Street Journal). Interestingly, incentive payments made within a year after bankruptcy filings have occasionally been pulled back into the bankruptcy estate, but it is unheard of for creditors to recover retention bonuses that were paid before the filing. Id. Between increased bankruptcy filings, hefty retention bonuses, and pressure from junior creditors, lawmakers and bankruptcy judges have an opportunity to revisit the aims of Section 503(c)(1).

Adam Levitin, a law professor specializing in bankruptcy at Georgetown University observed that “with double-digit unemployment, it’s a strange time to be paying out retention bonuses.” (Spector and DiNapoli, Reuters). Since the pandemic outbreak, major U.S. companies have paid hefty bonuses: Whiting Petroleum paid $14.6 million to top executives four days before filing for bankruptcy; Chesapeake Energy paid $25 million to 21 executives eight weeks before filing for bankruptcy; JCPenney paid $10 million to senior executives two days before filing for bankruptcy; Hertz paid $16.2 million to 340 employees three days before filing for bankruptcy; and Neiman Marcus paid $8 million to executives three months before filing for bankruptcy. (Cao, Observer). Each of these companies fired a significant amount of their respective employee base, and each of these companies have junior creditors who stand to take a financial hit from the bankruptcy filings. Id.

People like Professor Levitin, junior creditors, and unemployed Americans are taking notice of the spike in retention bonuses. It is indisputable that companies are legally distributing these “incentive” bonuses under the current interpretation of Section 503(c)(1). It will be interesting to see if future court decisions or legislation will address this practice and redirect the standard toward the provision’s original aim.