On July 9, 2012, Judge Peter J. Walsh of the United States Bankruptcy Court for the District of Delaware issued a memorandum opinion (the "Opinion"), in the Blitz U.S.A. bankruptcy proceeding addressing whether an employee bonus plan is a transaction made in the ordinary course of business under 11 U.S.C. 363(c)(1). The court issued the Opinion after considering Blitz's motion seeking authorization to make payments associated with an employee bonus plan (the "Motion"). The Official Committee of Unsecured Creditors (the "Committee") objected to the Motion, arguing that the bonus plan was not an ordinary course transaction and did not meet the heightened requirements under 11 U.S.C. 503(c)(3)(prohibiting a debtor from making payments outside the ordinary course of business that are not justified by the "facts and circumstances of the case.") Opinion at *3; 11 U.S.C. 503(c)(3).
During an evidentiary hearing, Blitz presented testimony in support of its Motion from Blitz's President and CEO, along with the testimony of a representative of Blitz's restructuring firm. Blitz argued that the employee bonus plan was an ordinary course transaction and therefore falls under the business judgment standard of section 363(c)(1) of the Bankruptcy Code (authorizing a debtor to enter into transactions without notice and a hearing, provided the transaction is in the "ordinary course of business.") Opinion at *8.
The court began its analysis by noting that the Third Circuit and other courts apply a two-part test to determine whether a transaction is in the ordinary course of business. Opinion at *9, citing In re Nellson Nutraceutical, Inc., 369 B.R. 787, 797 (Bankr. D. Del. 2007), quoting In re Roth Am., Inc., 975 F.2d 949, 953 (3d Cir. 1992). Under Roth, the transaction at issue must be examined under both a "vertical" and "horizontal" dimension. Under the vertical dimension, the court looks at the transaction from the viewpoint of a hypothetical creditor. The issue is whether the transaction subjects the creditor to an economic risk that differs from what the creditor was subjected to when it decided to extend credit. Opinion at *9. Applying the vertical test, the court found that Blitz had "some form of bonus plan since 1992 and ... is sufficient to establish a course of pre-petition conduct." Id.
Under the horizontal test, the issue for the court is "whether from an industry-wide perspective, the transaction is of the sort commonly undertaken by companies in the industry." Opinion at *9, quoting Roth, 975 F.2d at 953. Here the court found that the evidence presented at the hearing demonstrated that the bonus plan was common to the industry. The employee bonus plan was overseen by Blitz's Compensation Committee. The Compensation Committee relied on a compensation scheme for the plan that was designed by another manufacturer in Blitz's industry. Given that the bonus plan satisfied both the horizontal and vertical analysis, the court found that the plan was an ordinary course transaction. Opinion at *10. As an ordinary course transaction, the plan was subject to less scrutiny, specifically, whether the bonus plan was taken in good faith with sound business judgment. Opinion at *11.
The court considered several factors in deciding whether the bonus plan was made in good faith and with sound business judgment. Towards the end of the Opinion, the court best explains why it approved the bonus plan:
[t]he bonus plan is intended to provide an incentive for employees, who are informed of the plan's targets and parameters during their yearly review, and have no control over the rise and fall of defense costs or the effects of the bankruptcy. Further, where, as here, the employees have known about the plan since October 2011, rewarding them for hard work already done and encouraging them to continue working hard to fill existing orders until operations cease at the end of July does not smack of bad faith or unsound business judgment. Opinion at *14.
The Blitz Opinion provides a clear framework for considering whether employee bonus plans, as well as other transactions, are "ordinary course" transactions. Under the "vertical" analysis, courts look at the transaction from the viewpoint of a creditor and ask whether the transaction subjects the creditor to a different kind of economic risk when compared to the risk that was in place when the creditor originally extended credit. Next, under the "horizontal" analysis, the court considers whether the transaction is common for the debtor's industry.
Jason Cornell is a bankruptcy attorney with the law firm Fox Rothschild LLP. Jason practices before the United States Bankruptcy Court for the District of Delaware. You can contact Jason at email@example.com or at 302 252 5833. For those not familiar with corporate bankruptcy proceedings, below are prior posts on issues that frequently arise in bankruptcy: