In Re: LSC Communications, Inc.

Background

LSC Communications, Inc. filed for Chapter 11 bankruptcy after facing liquidity problems. As part of the bankruptcy, LSC asked the Bankruptcy Court for the Southern District of New York to approve a Key Employee Retention Plan, or KERP, for 190 employees. The plan provided up to $8 million in bonuses based solely on continued employment. Six employees in the plan had been appointed as LSC officers by its Board.

The United States Trustee objected because Section 503(c) of the Bankruptcy Code generally bars retention payments to a debtor’s corporate insiders. The Code’s definition of an insider includes an officer. LSC argued that the six employees were not insiders because they lacked broad decision-making authority, control over company policies or assets, and substantial budgetary authority.

The Bankruptcy Court approved the plan. It used a functional approach that focused on the employees’ actual authority and responsibilities, and concluded that the six were officers in title only. The Trustee appealed.

Equitable Mootness

LSC argued that the appeal should be dismissed as equitably moot because the Trustee had not sought a stay and LSC had already made most, if not all, of the payments. Equitable mootness is a bankruptcy doctrine that can prevent an appellate court from granting relief when later events make reversal inequitable.

The district court declined to dismiss the appeal on that ground. It concluded that clawing back payments from the six current or recent employees could still provide effective relief. The court also found that the case involved bonuses for six high-level employees, not regular paychecks for hundreds of employees or a large-scale reorganization transaction. Although the Trustee’s failure to seek a stay was regrettable, the court reasoned that requiring repayment would not be inequitable if the payments were unlawful. The court noted that LSC did not challenge two of the five relevant factors and concluded that the overall analysis weighed against equitable mootness.

Whether the Employees Were Insiders

Section 503(c) prohibits certain transfers to an insider intended to induce the person to remain with the debtor’s business, unless statutory conditions are met. The Bankruptcy Code lists an officer as a corporate insider but does not define “officer.”

The Trustee argued that Delaware law should control because LSC was incorporated in Delaware, and that the six employees were officers under that law. LSC argued that state law was largely irrelevant and that the Bankruptcy Court correctly examined the employees’ actual functions.

The district court held that board appointment is a significant legal fact. It explained that a mere job title may be insufficient when an employee has not been appointed or elected as an officer. But the six employees had been appointed by LSC’s Board, and the parties did not dispute that they would be treated as officers under Delaware law. The court held that board-appointed employees are officers under the Bankruptcy Code unless there is a particularly strong showing that they perform no significant management role.

The court found that LSC had not made that showing. LSC provided mostly negative descriptions of the employees’ authority, such as statements that they lacked discretionary budget control, did not dictate company policy, and could not determine the disposition of corporate assets. The court explained that those powers were more characteristic of a board of directors and that officers may instead run a corporation’s day-to-day operations or perform duties delegated by the board. LSC did not provide enough detail about the employees’ affirmative duties to overcome the presumption arising from their board appointments.

Disposition

The district court held that the six employees were statutory officers and therefore corporate insiders who were ineligible to receive the KERP payments. It reversed the Bankruptcy Court’s order approving the KERP as to those six employees and directed the Clerk of Court to close the case.