From the U.S. Government Accountability Office, www.gao.gov Transcript for: Chapter 11 Bankruptcy Bonuses Happen Despite Restrictions Description: Academics and bankruptcy attorneys have raised concerns that some companies may be working around federal restrictions preventing them from awarding bonuses after filing for Chapter 11 bankruptcy. We talk with GAO's Michael Clements to find out how often and when this might happen. Related GAO Work: GAO-21-104617, Bankruptcy: Enhanced Authority Could Strengthen Oversight of Executive Bonuses Awarded before a Bankruptcy Filing Released: September 2021 [Intro Music] [Mike Clements:] Bonuses can serve important purposes. However, they need to be made consistent with restrictions that Congress has set forth. [Holly Hobbs:] Hi, and welcome to GAO's Watchdog Report, your source for news and information from the U.S. Government Accountability Office --celebrating 100 years, a fact based nonpartisan government oversight. I'm Holly Hobbs. So a company files for Chapter 11 bankruptcy, but then its executives receive large bonuses. This is an abuse that Congress sought to protect against when it enacted new restrictions on bonuses in 2005. However, there are concerns that some companies may have found ways to work around restrictions. Today, we'll find out more from GAO's Mike Clements, an expert on banking regulations and a director in our financial markets and community investment team. Thanks for joining us. [Mike Clements:] Thanks for having me. [Holly Hobbs:] So, Mike, how often does this happen where companies award bonuses after filing for bankruptcy? [Mike Clements:] We looked at bankruptcy filings in fiscal year 2020. So of the approximately 7,300 bankruptcy filings, 70 companies or a little less than one percent paid $571 million to over 16,000 executive and non-executive employees. [Holly Hobbs:] And awarding bonuses when a company faces bankruptcy doesn't seem to make much financial sense. So why do companies do it? [Mike Clements:] These companies in bankruptcy are attempting to reorganize their business, both the operation itself plus also the debt. And there's two outcomes companies are looking for. One is to maximize value for the creditors--so the people who are owed money can get most of their money back. And also to facilitate the future viability of the business. In the context of these bankruptcy filings, there were two types of bonuses. First were retention bonuses paid to employees to stay with a company for a given period of time. The second type are incentive bonuses, which are paid to employees if the company, a business unit, or even the employee meets certain performance targets. So, to the extent that a retention bonus helps the company maintain key employees or that incentive bonuses can help encourage employees to put forth their best efforts--this, in fact, can help meet those goals of maximizing value for creditors and facilitating the viability of a business. [Holly Hobbs:] But Congress added restrictions to prevent companies from awarding bonuses. How are they still able to do it? [Mike Clements:] Well, that's right. In 2005, Congress imposed restrictions on incentive bonuses for both executive and non-executive employees and retention bonuses for executive employees. And Congress took that step in response to some potential abuses that had occurred in the past. For example, executives receiving bonuses for staying with a company when, in fact, they had been involved in some of the fraudulent activity that led to the bankruptcy itself. Bonuses are OK if they meet the criteria set forth in the statute. However, we did find instances where companies worked around some of the restrictions. For example, some companies paid retention bonuses to executives before filing bankruptcy. We found 42 instances where that occurred. These companies paid bonuses totaling $165 million, anywhere from 5 months to as little as 2 days before the company filed for bankruptcy. [Holly Hobbs:] And for our report we interviewed stakeholders about the effectiveness of U.S. bankruptcy code in preventing bankruptcy bonuses. What did stakeholders tell us? [Mike Clements:] That's right. We interviewed academics and legal experts. And in general, they noted that the code is less effective because the companies can work around restrictions, especially for those executive retention bonuses. Another thing the stakeholders noted were companies providing incentive bonuses where the performance targets were so low that essentially it was a retention bonus. Some stakeholders also noted that the code made it nearly impossible for companies to award retention bonuses during bankruptcy, even if they might have been warranted. For example, one of the conditions is that the executive needs to have other job offer at the same or greater compensation. You could imagine that if an executive had a job offer for greater compensation at a company that's not in bankruptcy, it's unlikely that that employee would stay around at the bankrupt company. That said, nearly all the stakeholders viewed these pre-bankruptcy filing bonuses as problematic, although they had mixed views on the changes to the code that would be necessary to resolve those problems. [Music:] [Holly Hobbs:] So it sounds like companies could have good reasons for awarding bonuses--like retaining good employees and awarding good performance. But Congress enacted restrictions to respond to potential abuses, which some companies have found ways to work around. Mike, what can be done to strengthen restrictions against these abuses? [Mike Clements:] In our report, we recommended that Congress consider amending the bankruptcy code to subject these bonuses that companies pay executives shortly before filing bankruptcy to bankruptcy-court oversight, and also to specify the factors that the court should consider when approving such bonuses. [Holly Hobbs:] And last question, what's the bottom line of this report? [Mike Clements:] As I noted, oversight is important to ensure that these executive bonuses paid immediately before or during bankruptcy are consistent with the code restrictions. Bonuses can serve important purposes, maximizing value for creditors, facilitating firm viability. However, they need to be made consistent with restrictions that Congress has set forth. [Holly Hobbs:] That was Mike Clements talking about GAO's review of Chapter 11 bankruptcy bonuses. Thanks for your time, Mike. [Mike Clements:] Thank you for having me. [Holly Hobbs:] And thank you for listening to the Watchdog Report. To hear more podcasts, subscribe to us on Apple Podcasts, Spotify, or wherever you listen; and make sure you leave a rating or review to let others know about the work we're doing. For more from the congressional watchdog, the U.S. Government Accountability Office, visit us at GAO.gov.