Companies filing for bankruptcy use loophole to give CEOs huge bonuses

Denitsa Tsekova
·Reporter

The economic fallout from the coronavirus pandemic has left many companies no choice but to file for bankruptcy. But before they do, many dole out generous bonuses to CEOs and other executives before they run out of cash.

JCPenney, Hertz, and Chesapeake Energy are just a few of the companies that recently have given their executives prepaid retention bonuses worth $7.5 million, $16.2 million, $25 million, respectively, in the days and weeks leading up to filing for bankruptcy protection, where they plan to reorganize to eventually emerge with a sustainable business.

Despite these challenging times, some executives of struggling companies are getting generous bonuses just before their companies run out of cash. Photo: Getty Creative
Despite these challenging times, some executives of struggling companies are getting generous bonuses just before their companies run out of cash. Photo: Getty Creative

The practice is common, experts told Yahoo Money, even if the optics can look bad.

“Companies are getting anxious that they will have to file for bankruptcy, so they're lining their ducks up in a row,” John Pottow, a bankruptcy law professor at the University of Michigan, told Yahoo Money. “And the first duck that most CEOs worry about is their own salary.”

For instance, in the days before filing for Chapter 11 in May, JCPenney handed a total of $7.5 million to some of its executives, including CEO Jill Soltau who received $4.5 million, according to a regulatory finding. Shortly thereafter, the company announced a total of 148 store closures, which likely means layoffs for many store employees.

Some critics may point out that "all these executives make too much money, they’re just stripping the company of money before they declare bankruptcy to feather their own nest,” said James Hatch, an executive compensation expert and president of Hatch & Associates Corp. “And sometimes that’s true.”

But, in other cases, retaining that executive talent is important for the company’s eventual survival despite the price tag, he said.

Don't want those good executives jumping ship’

Such bonuses to executives are often considered by companies as a way to keep talent in executive roles while the company goes through its reorganization. JCPenney said decisions it made to secure the future of the company included “taking necessary steps to retain our talented management team,” it said in a statement.

“When you have to declare bankruptcy because you have financial problems, you don't want those good executives jumping ship at that point and going somewhere else,” Hatch said.

A woman walks by a JCPenney store that was temporarily closed on the day the company filed for bankruptcy protection and announced it would be closing some of its 800 stores amid the coronavirus crisis and ongoing debt problems. (Photo by Paul Hennessy/SOPA Images/LightRocket via Getty Images)
A woman walks by a JCPenney store that was temporarily closed on the day the company filed for bankruptcy protection and announced it would be closing some of its 800 stores amid the coronavirus crisis and ongoing debt problems. (Photo by Paul Hennessy/SOPA Images/LightRocket via Getty Images)

While such practices are aimed at retaining those executives or management with years of experience and knowledge of the company, oftentimes the entire executive team and other senior employees also get included in that bonus distribution, Hatch said.

“If I'm giving it to the CFO, I also have to give it to the head of engineering, the head of sales, the head of various other departments,” he said. “And maybe what will happen is two or three people will get swept up in this bonus scheme that don't deserve it.”

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For example, Hertz, which filed for bankruptcy protection in late May, dedicated $16.2 million in cash retention bonuses to 340 employees “at the director level and above” including a $700,000 bonus to their CEO Paul Stone, according to a regulatory filing. That was after the car rental company announced plans to lay off 10,000 employees.

Hertz said the payments are an incentive for key employees to remain at the company in recognition of “the financial and operational uncertainty the company and its employees face” as well as “the substantial additional efforts undertaken by the company’s key employees with a reduced workforce in response to an extremely challenging business environment,” according to its filing.

Bonuses are ‘under the radar or outside the radar’

In the last 15 years since a major bankruptcy law reform was passed, such pre-bankruptcy bonuses have gained popularity among large corporations, according to Pottow.

“What these companies are doing is trying to avoid that scrutiny and that restriction on the executive compensation by...paying their bonuses out before they go into the court system,” Pottow said. “They're basically under the radar or outside the radar.”

Those bonuses are given out before the company files for bankruptcy, so it doesn’t have to seek approval of the bonuses from a bankruptcy court. Bonuses are much more restricted once the company has filed for bankruptcy protection.

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“There’s a provision that says you can't make payments that are more than 10 times the payments you make to the average employee,” Pottow said. “If you do the math, they are basically impossible. That is to say, no executive worth his or her salt is interested in taking such a small amount of retention payment.”

For reference, the general CEO-to-typical-worker compensation ratio has increased exponentially in the last 50-plus year and was 278-to-1 — including stock options — in 2018, according to data from the Economic Policy Institute. In 1965, it was much smaller at 20-to-1.

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Payments made to executives can also be challenged by creditors in court. In some instances, bonuses can be clawed back, but prepaid bonuses are less likely to be at risk for clawbacks in court.

“If you make a retention payment in bankruptcy that's very likely to be attacked,” Pottow said. “If you make the payment before bankruptcy, you're still susceptible to legal attack but you've got the most chance of surviving.”

Who else got a bonus?

The recent bankruptcy filing of fracking pioneer Chesapeake Energy Corp. also came with a bonus to its executives. The company filed for bankruptcy at the end of June and announced a total of $25 million in bonuses to 21 executives in early May, according to a regulatory filing.

White Bear Lake, Minnesota, Hertz car rental. Hertz filed for bankruptcy protection due to the coronavirus pandemic. (Photo by: Michael Siluk/Education Images/Universal Images Group via Getty Images)
White Bear Lake, Minnesota, Hertz car rental. Hertz filed for bankruptcy protection due to the coronavirus pandemic. (Photo by: Michael Siluk/Education Images/Universal Images Group via Getty Images)

The historic compensation structure the company had “would not be effective in motivating and incentivizing the company’s workforce,” the company said in the filing, and given the current circumstances, the company has implemented a “revised compensation structure,” including the bonuses to its executives.

Whiting Petroleum Corp, an oil and gas company, paid members of its executive team around $14.6 million in cash bonuses, including a $6.4 million bonus for CEO Bradley J. Holly, according to a regulatory filing

That compensation program was intended to “ensure the stability and continuity of the company’s workforce and eliminate any potential misalignment of interests that would likely arise if existing performance metrics were retained and/or new performance metrics were established at a volatile and uncertain time.”

Denitsa is a writer for Yahoo Finance and Cashay, a new personal finance website. Follow her on Twitter @denitsa_tsekova.

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