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1 Main Document Page 1 of 14 UNITED STATES BANKRUPTCY COURT Hearing Date: October 29, 2015 NORTHERN DISTRICT OF NEW YORK Hearing Time: 11:00 a.m Hearing Location: Syracuse, New York In re: Case No Chapter 11 COYNE INTERNATIONAL ENTERPRISES CORP., Debtor UNITED STATES TRUSTEE S OBJECTION TO DEBTORS MOTION FOR ORDER APPROVING KEY EMPLOYEE INCENTIVE PLAN William K. Harrington, the United States Trustee for Region 2 (the "United States Trustee"), respectfully objects to the Debtor s Motion For Order Approving Key Employee Incentive Plan ( KEIP Motion ). In support of his objection, the United States Trustee states as follows: PRELIMINARY STATEMENT The Debtor seeks authority to, among other things, award bonuses to three senior officers, who already are the highest paid employees of the Debtor, up to an aggregate amount of $500,000 under a Key Employee Incentive Plan ( KEIP ). It is undisputed that these employees, by virtue of their status as officers, are insiders, pursuant to Section 101(31) of the Bankruptcy Code. Specifically, the proposed KEIP provides for payment to Chief Executive Officer, Mark Samson ( Samson ), (ii) Vice President and General Counsel, Alexander Pobedinsky ( Pobedinsky ), and (iii) Chief Financial Officer, Jennifer Collins-Clemons ( Clemons ), (collectively, the KEIP Participants ), based on arbitrary targets that have no link to the KEIP Participants efforts. Instead, these targets are simply an attempt to disguise the true 1

2 Main Document Page 2 of 14 retentive nature of the bonuses and to compensate the officers for work that was already completed, or should have been completed, at the time the KEIP Motion was filed. The payment of bonuses to the KEIP Participants is contingent upon the purchase of the Debtor s assets by entities other than the Debtor s senior secured lender. However, even in the event the senior secured lender is the successful bidder, the KEIP Participants are alternatively rewarded because they are guaranteed continued employment and equity interests as officers in the acquiring company. This double insider status underscores the gratuitous nature of the proposed KEIP between the Debtor, NXT and the KEIP Participants. Given the fast track bankruptcy sale process, the Debtor has not sufficiently demonstrated that the KEIP Participants contribution to the sale process justifies such a significant windfall. In May 2015 and while the Debtor was committed to filing a chapter 11 bankruptcy, two of the KEIP Participants received 65% raises in their salaries, the purpose of which was to guarantee their continued employment with the Debtor. Accordingly, for the reasons set forth below, the United States Trustee submits that the KEIP Motion should be denied. BACKGROUND 1. On July 31, 2015 ( Petition Date ), Coyne International Enterprises, Corp. filed a voluntary chapter 11 petition for relief under Title 11 of the United States Code (the Bankruptcy Code ). 2. The Debtor continues to operate as a debtor in possession under Sections 1107(a) and 1108 of the Bankruptcy Code. 2

3 Main Document Page 3 of On August 12, 2015, the United States Trustee appointed a committee of unsecured creditors ( Committee ). Counsel for the Committee is Womble Carlyle Sandridge & Rice LLP. 4. A First Meeting of Creditors, pursuant to 341 of the Bankruptcy Code ( 341 Meeting ), was held on August 31, Samson testified on behalf of the Debtor. 5. On September 24, 2015, the Debtor filed the KEIP Motion. The KEIP Motion seeks authority to carry out a performance based incentive plan for the benefit of the above named KEIP Participants. 6. According to the Debtor, payments under the KEIP will be paid based upon the Debtor s ability to attain certain sales targets and assets sales proceeds. The amount of payment increases according to the rise in AWR Targets and Sale Proceeds (collectively Targets ), with a maximum aggregate payment of $500, Under the Court s Order, entered September 11, 2015, authorizing bidding procedures related to the Debtor s motion to sell substantially all of its assets, certain bidding procedures and protections were approved in connection with a proposed stalking horse sale ( NXT Transaction ) of a large portion of the Debtor s assets to NXT Capital LLC ( NXT ). 8. Payment under the KEIP is contingent upon the acceptance of a higher and better offer by a bidder other than NXT. If NXT is the accepted bid, the KEIP Participants do not receive the incentive payment. But in the alternative, the KEIP Participants receive an equity position in CTS Acquisition, an entity formed for the purchase of assets from NXT, and owned by the Debtor s senior management team. The Debtor s senior management team is comprised of the very same individuals who are beneficiaries of the proposed KEIP. 3

4 Main Document Page 4 of 14 Relevant Authority ARGUMENT 9. Section 503(c) of the Bankruptcy Code provides in relevant part: Notwithstanding subsection (b), there shall neither be allowed, nor paid (1) a transfer made to, or an obligation incurred for the benefit of, an insider of the debtor for the purpose of inducing such person to remain with the debtors business, absent a finding by the court based on evidence in the record that (A) (B) the transfer or obligation is essential to retention of the person because the individual has a bona fide job offer from another business at the same or greater rate of compensation; the services provided by the person are essential to the survival of the business; and (C) either (i) the amount of the transfer made to, or obligation incurred for the benefit of, the person is not greater than an amount equal to 10 times the amount of the mean transfer or obligation of a similar kind given to nonmanagement employees for any purpose during the calendar year in which the transfer is made or the obligation is incurred; or (ii) if no such similar transfers were made to, or obligations were incurred for the benefit of, such nonmanagement employees during such calendar year, the amount of the transfer or obligation is not greater than an amount equal to 25 percent of the amount of any similar transfer or obligation made to or incurred for the benefit of such insider for any purpose during the calendar year before the year in which such transfer is made or obligation is incurred;... (3) other transfers or obligations that are outside the ordinary course of business and not justified by the facts and circumstances of the case, including transfers made to, or obligations incurred for the benefit of, officers, managers, or consultants hired after the date of the filing of the petition. 11 U.S.C. 503(c). 4

5 Main Document Page 5 of Congress added Section 503(c) in 2005 as one of the BAPCPA amendments in 2005, to curtail payments of retention incentives to insiders. In re Journal Register Co., 407 B.R. 520, 535 (Bankr. S.D.N.Y. 2009). In particular, Congress imposed significant limits on the payments of retention and incentive bonuses and severance to insiders and on the payments of retention bonuses granted to non-insiders without factual and circumstantial justification. Id. The intent of Section 503(c) is to limit the scope of key employee retention plans and other programs providing incentives to management of the debtor as a means of inducing management to remain employed by the debtor. 4 Alan N. Resnick & Henry J. Sommer (eds.), Collier on Bankruptcy (15th ed. rev. 2007); In re AMR Corp., 497 B.R. 690, 696 (Bankr. S.D.N.Y. 2013) (the language of Section 503(c) is prohibitive; if payments to insiders do not comply with the applicable 503(c) provisions, they shall neither be allowed, nor paid ); accord In re Residential Capital LLC, 478 B.R. 154 (Bankr. S.D.N.Y. 2012) ( Rescap. ). 11. Section 503(c) establishes specific evidentiary standards that must be met before a bankruptcy court may authorize payments to an insider for the purpose of inducing such person to remain with a debtor s business or payments made on account of severance. In re Dana Corp., 351 B.R. 96, 102 (Bankr. S.D.N.Y. 2006) ( Dana I ); 11 U.S.C. 503(c)(1). By enacting the BAPCPA, Congress put into place a set of challenging standards and high hurdles for debtors to overcome before retention bonuses could be paid. In re Mesa Air Grp., Inc., Case No (MG), 2010 WL , *2 (Bankr. S.D.N.Y. Sept. 24, 2010) (citations omitted). The proponent of a KEIP plan has the burden of showing that the plan is not a retention plan governed by Section 503(c)(1). In re Hawker Beechcraft, Inc., 479 B.R. 308, 313 (Bankr. S.D.N.Y. 2012). 5

6 Main Document Page 6 of Where Section 503(c)(1) applies, the transfer cannot be justified solely on the debtor s business judgment. See In re Borders Grp., Inc., 453 B.R. 459, (Bankr. S.D.N.Y. 2011). If a proposed transfer falls within Section 503(c)(1), then the business judgment rule does not apply, regardless of whether a sound business purpose may actually exist. Dana I, 351 B.R. at 100; 11 U.S.C. 503(c)(1). 13. Further, a debtor s label of a plan as incentivizing to avoid the strictures of Section 503(c)(1) must be viewed with skepticism; rather, the circumstances under which the proposal is made and the structure of the compensation package control. In re Velo Holdings Inc., 472 B.R. 201, (Bankr. S.D.N.Y. 2012) ( Attempts to characterize what are essentially prohibited retention programs as incentive programs in order to bypass the requirements of section 503(c)(1) are looked upon with disfavor, as the courts consider the circumstances under which particular proposals are made, along with the structure of the compensation packages, when determining whether the compensation programs are subject to section 503(c)(1). ) (internal quotation marks and citations omitted); see also Rescap., 478 B.R. at 161 (An incentive plan should incentivize employees for their post-petition efforts, not compensate them for the work they did before the bankruptcy filing. ). 14. Finally, not only must KEIP plans comply with Section 503(c) but, as administrative expenses, they must also be actual, necessary costs and expenses of preserving the estate, as required by Section 503(b). 6

7 Main Document Page 7 of 14 OBJECTION A. The KEIP is a Disguised Insider Retention Program 15. The law is clear that the burden is on the Debtor to either show that the KEIP complies with the requirements of section 503(c)(1) or that it is not a disguised retention plan. See Dana I, 351 B.R. at 100; Mesa Air Group, 2010 WL , at *2 (citing Global Home Prods., 369 B.R. at 785). 16. Here, it is undisputed that the proposed KEIP Participants are the Debtor s three most senior officers, and therefore, insiders. See KEIP Motion at 10. (If a debtor is a corporation, the term insider includes an officer of the debtor. 11 U.S.C. 101(31)(B)(ii)). 17. Section 503(c) strictly limits awards to insiders as a means to simply remain employed by the debtor. The Debtor s general characterization of the proposed KEIP as a performance-based incentive program does not relieve the Debtor from overcoming the required high hurdle of 503(c)(1). 18. The Debtor filed the KEIP Motion well beyond any time period in which the senior officers required incentivizing. With the KEIP Motion and the Sale Motion scheduled to be heard on the same hearing date, the case is nearly at its conclusion and there is no longer any need for a performance based incentive. At this point, the KEIP Participants can do to substantially influence the outcome. 19. Moreover, the KEIP Motion provides no baseline numbers by which to measure the effort involved in reaching the Targets, which are no more than an attempt by the Debtors to circumvent the provisions of Section 503(c). This is because the so called Targets are arbitrary and lack any substantive tie to the Debtor s actual sales numbers. 7

8 Main Document Page 8 of Retention plans usually are intended to encourage certain crucial employees to remain with the company through a critical, transitional time period when the exact future of the company is unclear and when those employees would be most likely to search for other employment. Brooklyn Hosp., 341 B.R. 405, 413 (Bankr. E.D.N.Y. 2006). Although the Debtor styles the performance as an incentive plan, see KEIP Motion at 11, they fail to satisfy the stringent criteria that it is not merely retentive. It is the substance of how and why the proposed payments are made, not the label put on the plan that is determinative. Mesa Air Group, Inc., 2010 WL , at *4 (incentive plans are designed to motivate employees to achieve performance goals). 21. The Debtor fails to specifically identify the services each participant will need to contribute to achieve the Targets. See Hawker Beechcraft, 479 B.R. at 313 (debtors failed to sustain burden of proof under 503(c)(1) where they did not identify the roles of each member of the SLT or why, individually or as part of a team, they will contribute services that are necessary to achieve the targets. ). 22. Here, given the KEIP Participants respective roles as officers to the Debtor, it is more than likely that the Debtor will reach its Targets as a result of an occurrence completely out of the Key Participants control (the sale). Yet, each participant would receive a bonus even though none may have provided any services beyond what is regularly expected of them. 23. Furthermore, the Key Participants contributions have already been compensated by the substantial increases in their salaries. In reality, there is little now for the Participants to do in order to maximize the value of the Debtor s assets. 22. Indeed, Samson testified at the 341Meeting that he authorized an increase in both Pobedinsky s and Clemons salaries in an effort to prevent them from leaving the company, and 8

9 Main Document Page 9 of 14 to further compensate them for work to be completed in contemplation of the Debtor s bankruptcy and sale. Samson stated, that in his opinion, Pobendinsky and Collins were underpaid, and therefore, in May, 2014 (just two months prior to the bankruptcy filing), increased their salaries by more than 65%. Pobendinsky s salary increased from approximately $155,000 to $240,000; and Collins s salary increased from $135,000 to $200, Particularly staggering is Samson s compensation. Prior to his position as Debtor s President and CEO, Samson, while employed with turnaround management firm Getzler Henrich Associates LLC ( GHA ), acted as Interim CEO to the Debtor. During his tenure as Interim CEO, GHA billed the Debtor $18,500 per week, according to Samson s 341 Meeting testimony. 24. On April 1, 2015, Samson resigned from GHA following concerns raised by the United States Trustee that Samson s position violated the Jay Alix Protocol 1, and became the Debtor s full-time CEO with a salary of $7, (plus expenses) per week. See Debtor s Statement of Financial Affairs (Dkt ). This salary is equal to the salary that Samson was receiving at GHA. As part of Samson s appointment as CEO, his former partner, William Henrich, who is now serving as the sole director and chairman of the Debtor receives $62,500 per month in compensation. Apparently, according to Samson, this was done to make the postpetition compensation to Samson and Henrich equivalent to the $18,500 per week that GHA billed the Debtor prior to Samson s ascension to CEO of the Debtor. 1 The Jay Alix Protocol emerged from a settlement reached between the United States Trustee and a turnaround management firm, Jay Alix & Associates, relative to the disinterestedness requirements of Bankruptcy Code Sections 327 and 101(14) in retention of a CRO, requiring the CRO to fulfill certain conditions of retention and compensation (CRO must only wear one hat, disclose individuals acting as executives, and provide detailed time records, etc.). 9

10 Main Document Page 10 of It is obvious that Samson s employment as CEO was never meant to be permanent, given GHA s initial retention as turnaround specialists. Upon information and belief, Samson has indicated to all parties that he has no intention on remaining with the Debtor or its successor as CEO. 26. Finally, the Debtor fails to establish that, among other things, any of the insiders have a bona fide job offer with other companies at the same or greater rates or that either (a) the new proposed payments are less than ten times the mean of similar payments made to nonmanagement employees during the calendar year, or (b) the proposed payments are less than 25 percent of the amount of any similar payments made to the Senior Managers in the prior year. 11 U.S.C. 503(c)(1). 27. Accordingly, the Court should conclude that the Debtor has failed to satisfy its burden under section 503(c)(1) and the incentive awards should not be approved at this time. B. To the Extent Section 503(c)(3) and Section 363(b) Applies, the Court Must Find that the Debtors Have Met the Applicable Standards 28. If the Court finds that section 503(c)(1) does not apply, the Court may also consider whether the payments are permissible under section 503(c)(3). In re Dana Corp., 358 B.R. 567, 576 (Bankr. S.D.N.Y. 2006)( Dana II ). Section 503(c)(3) authorizes judicial discretion with respect to KEIP plans motivated primarily by reasons other than retention. Id. Should the Court find that Section 503(c)(1) does not apply, to grant the KEIP Motion the Court must find that it passes the test of Section 503(c)(3) that it is necessary to preserve the value of the Debtor s estate, and is justified by the facts and circumstances of the case. 11 U.S.C. 10

11 Main Document Page 11 of (c)(3); In re Unidigital, Inc., 262 B.R. 283, 288 (Bankr. D.Del. 2001) (administrative expenses may not be allowed unless they are actual and necessary to preserve the estate). 29. In analyzing whether an executive KEIP plan is justified by the facts and circumstances under Section 503(c)(3), the Court should consider the following factors set forth in Dana II: Whether a reasonable relationship exists between the KEIP program and the results to be obtained; i.e., will the key employees stay for as long as the debtor needs to reorganize or market its assets, or in the case of a performance incentive, whether the plan is calculated to achieve the desired performance; Whether the cost of the plan is reasonable in the context of the debtor s assets, liabilities and earning potential; Whether the scope of the plan is fair and reasonable, applies to all employees, and/or discriminates unfairly; Whether the proposed compensation is consistent with industry standards; Whether the debtors diligently investigated the need for a KEIP compensation plan, including whether they analyzed which key employees needed to be incentivized, what resources are available, and what types of incentive programs are generally applicable in the relevant industry; and Whether the debtor received independent counsel in performing due diligence and in creating and authorizing the incentive compensation. Id., 358 B.R. at As discussed below, the Debtor fails to meet its burden of demonstrating compliance with certain of the foregoing factors. See In re Regensteiner Printing Co., 122 B.R. 323 (N.D. Ill. 1990) (reversing approval of severance agreements for key employees, because debtors presented no evidence that severance payments were necessary to preserve bankruptcy estate). 11

12 Main Document Page 12 of 14 No Relationship Between Effort and Outcome 31. The proposed KEIP is not calculated to achieve a substantive target or metric. As discussed above, the KEIP incentive of maximizing the proceeds from a sale of assets already in place, virtually guarantees that KEIP bonuses will be paid to the KEIP Participants. In addition, the outcome of these cases for creditors holding general unsecured claims remains uncertain and speculative. 32. Even under the less rigorous standards of Sections 503(c) and 363, the benchmarks for the payment of bonuses must be difficult to reach. Dana II, 358 B.R. at 583. The Targets proposed under the KEIP are in line with the goals of every liquidating chapter 11, and one which the KEIP Participants would need to accomplish as part of their fiduciary duties even in the absence of a KEIP. No Business Justification 33. The Debtors have presented no evidence that the cost of the KEIP is reasonable in the context of their assets and liabilities. Given that the Debtor has no ability to use cash collateral beyond the sale, a payout of up to $500,000 in the aggregate to three insiders on top of generous base salaries is not fair or reasonable. Indeed, the KEIP Participants pre-petition involvement in overseeing the Debtor s pre-bankruptcy decline does not justify an extraordinary reward to such individuals at the expense of the Debtor s estate. 34. To the contrary, the Debtor s records show that such an expense is imprudent. According to the Debtor s August, 2015 Monthly Operating Report, the Debtor incurred a net operating loss of $1.04 million. The United States Trustee estimates that the Debtor had negative cash flow of as much as $485,000 in August alone, and will most likely continue to 12

13 Main Document Page 13 of 14 suffer losses. The United States Trustee submits that the Debtor s dire financial position illustrates that the approval and implementation of the KEIP is simply not warranted. No Evidence that KEIP is Consistent with Industry Standards 35. The Debtor fails to present any facts to establish that the proposed KEIP is consistent with any KEIP plan proposed in context with an expedited sale/liquidation scenario in a chapter 11 case of a similarly sized company. No Demonstration of Need For KEIP 36. Although the KEIP Motion states that the Debtor, in conjunction with its sole director and financial advisors, determined that the KEIP was appropriate to compensate the KEIP Participants for additional responsibilities that will require intensive labors throughout the Chapter 11, the Debtor makes mere conclusory statements regarding the KEIP s necessity. 37. Based on the foregoing, the Debtor fails to make a sufficient showing that the KEIP is justified by the facts and circumstances of the chapter 11 case or that it is an exercise of sound business judgment. 38. Finally, not only has the Debtor failed to establish that the KEIP plan complies with Section 503(c) but, the Debtor has not shown that the KEIP is an actual, necessary costs and expenses of preserving the estate, as required by Section 503(b). With no provision for a carve-out to unsecured creditors, and without funding of the estate beyond the sale date, there is no benefit to the estate. 13

14 Main Document Page 14 of 14 CONCLUSION WHEREFORE, the United States Trustee respectfully requests that the Court deny the KEIP Motion and grant such other and further relief as it may deem just and proper. Dated: New York, New York October 22, 2015 Respectfully submitted, WILLIAM K. HARRINGTON UNITED STATES TRUSTEE, Region 2 By: /s/ Guy A. Van Baalen Guy A. Van Baalen, Esq. Assistant United States Trustee Erin P. Champion, Esq. Trial Attorney 105 U.S. Courthouse & Federal Building Utica, New York (315)

shl Doc 57 Filed 12/12/14 Entered 12/12/14 16:33:42 Main Document Pg 1 of 10

shl Doc 57 Filed 12/12/14 Entered 12/12/14 16:33:42 Main Document Pg 1 of 10 Pg 1 of 10 UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK ----------------------------------------------------------------------------X : In re: : Chapter 11 : Case No. 14-13200 (SHL) AEREO,