Velo Holdings Inc.

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK 	FOR PUBLICATION
In re:
VELO HOLDINGS INC., et al.,
Debtors.
Case No. 12-11384 (MG)
MEMORANDUM OPINION APPROVING THE DEBTORS’
KEY EMPLOYEE INCENTIVE PLAN
A P P E A R A N C E S:
DECHERT LLP
Counsel for the Debtors
1095 Avenue of the Americas
New York, New York 10036
By: 	Michael J. Sage, Esq.
Shmuel Vasser, Esq.
Davin J. Hall, Esq.
TACY HOPE DAVIS
United States Trustee for Region 2
22 Whitehall Street, 21st Floor
New York, New York 10004
By: 	Paul Schwartzberg, Esq.
COOLEY LLP
Counsel for the Official Committee of Unsecured Creditors
1114 Avenue of the Americas
New York, New York 10036
By: 	Jeffrey L. Cohen, Esq.
WILKIE FARR & GALLAGHER LLP
Counsel for Barclays Bank PLC, as First Lien Prepetition Agent and DIP Agent
787 Seventh Avenue
New York, New York 10019
By: 	Margot B. Schonholtz, Esq.
Ana M. Alfonso, Esq.
Marina I. Zelinsky, Esq.
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MARTIN GLENN
UNITED STATES BANKRUPTCY JUDGE
The Debtors seek approval of a Key Employee Incentive Plan (the “KEIP”), which
proposes to set aside approximately $2.875 million in incentive-bonus payments for a number of
the Debtors’ employees (including insiders) if the Debtors’ businesses reach certain financial
goals. Such plans have become commonplace in large bankruptcy cases. The United States
Trustee (the “U.S. Trustee”) filed an objection to the Motion (defined below). In response to that
objection, the Debtors filed a reply and additional declarations in support of the Motion,
clarifying certain issues raised by the U.S. Trustee. After the hearing on May 29, 2012, the
Debtors further amended the KEIP in light of the U.S. Trustee’s remaining objections. All but
two of the U.S. Trustee’s objections have been resolved. For the reasons discussed below, the
Court now overrules the U.S. Trustee’s remaining two objections and grants the Motion
approving the KEIP, as amended.
I. 	BACKGROUND
On April 2, 2012 (the “Petition Date”), the Debtors filed voluntary petitions for relief
under chapter 11 of the Bankruptcy Code. In December 2011, before the bankruptcy, with the
assistance of their financial and legal advisors, the Debtors began a comprehensive marketing
process attempting to sell all or parts of their business. Ultimately, the Debtors received three
bids. After discussions with the advisors for Barclays Bank plc (the “First Lien Agent”) and the
majority of first lien lenders regarding the range of values and the terms of the bids, the Debtors
determined that a financial restructuring supported by the majority of their first lien lenders
would provide more value for the Debtors’ estates than pursuing any of the bids that had been
received. Before the Petition Date, General Electric Capital Corporation, Goldentree Asset
Management LP, Chase Lincoln Financial Corporation, and Barclays Bank plc, in their capacity
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as first lien lenders (collectively with the First Lien Agent, the “Lender Parties”), entered into a
chapter 11 case protocol (the “Agreed Protocol”) outlining the terms of a proposed restructuring
of the Debtors’ business and financial affairs and a proposed sale of the Debtors’ assets to the
Lender Parties.
On May 8, 2012, the Debtors filed the Debtors’ Motion for Entry of an Order Approving
the Debtors’ Key Employee Incentive Plan (the “Motion”) (ECF Doc. # 130) with the attached
declaration of Lorraine DiSanto (the “DiSanto Declaration”). The U.S. Trustee filed an
objection to the Motion (the “Objection”). (ECF Doc. # 145.) The Debtors filed a reply,
addressing each of the issues raised by the U.S. Trustee. (ECF Doc. # 181.) The Debtors also
filed the declarations of Robert A. Campagna Jr. (the “Campagna Declaration”) (ECF Doc.
# 182) and Vincent DiBenedetto (the “DiBenedetto Declaration”). (ECF Doc. # 214.)1
A. 	The KEIP Program
In developing the Agreed Protocol, the Debtors discussed the design of the KEIP with
their outside advisors and a majority of the Lender Parties (and their advisors). The KEIP
includes earnings performance targets (the “Targets”) based on the applicable business or sale
plan for each business unit. The term sheet for the originally proposed KEIP is attached to the
Motion as Exhibit 2.
The KEIP was subsequently amended, and a revised term sheet was filed with the Court.
(ECF Doc. # 218.) The amendments include modifications to the proposed service milestones
for George Thomas, General Counsel of the Debtors, and the compensation terms for Vincent
DiBenedetto, President of Coverdell & Company, Inc. The U.S. Trustee and the Official
Committee of Unsecured Creditors (the “Committee”) have consented to these modifications.
1 	According to the DiBenedetto Declaration, the Senior Vice President and Executive Vice President
identified by the U.S. Trustee are “not directors of the Company, nor do they fulfill the functions of Board appointed
officers with the authority to set corporate policy.” (DiBenedetto Decl. ¶ 6.)
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The KEIP is separately tailored to three of the Debtors’ businesses with specific incentive
programs for the following Debtors: (1) FYI Direct, Inc., Brand Magnet, Inc. and Adaptive
Marketing LLC, collectively with certain of their non-debtor affiliates (the “ACU Business”);2
(2) Coverdell & Company, Inc., and its non-debtor affiliates (“Coverdell”); and (3) Neverblue
Communications, Inc., and certain its non-debtor affiliates (“Neverblue”).
1. 	The Key Employees
The Debtors estimate that approximately 63 employees would receive payments under
the KEIP (the “Key Employees”), of whom five are insider directors or officers under the
Bankruptcy Code. The identities of the non-insider KEIP participants were shared with the U.S.
Trustee but are not identified in the Motion. These non-insider employee participants will be
determined by management (and in the case of the ACU Business, participants will be
determined by Alan Jacobs, the Chief Restructuring Officer (the “CRO”), in consultation with
the Chief Executive Officer and the Chief Financial Officer). The “insiders” who are proposed
KEIP recipients are: (i) Gary Johnson (the Debtors’ Chief Executive Officer and a director of the
Debtors); (ii) Lorraine DiSanto (the Debtors’ Chief Financial Officer and Chief Operating
Officer); (iii) George Thomas (the Debtors’ General Counsel and a director of certain of the
Debtors); (iv) Vincent DiBenedetto (a director and the President of Coverdell & Co.); and (v)
Hakan Lindskog (the President of nondebtor affiliate Neverblue Media Company). All other
employees who may receive payments under the plan are responsible for running the day-to-day
2 	The ACU Business is comprised of the Debtors’ credit and identity theft protection and the lifestyle and
shopping businesses. According to the Agreed Protocol, the Debtors will continue to operate the ACU Business in
the ordinary course, but will cease spending new marketing dollars to acquire new members on a go-forward basis
(the “Harvest”). The Harvest is further described in the in the Declaration of Lorraine DiSanto in Accordance with
Local Bankruptcy Rule 1007-2. (ECF Doc. # 3.)
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business operations; they are subordinate employees who report to an officer or an intermediary
who reports to an officer. 3
2. 	The Targets and Payouts
The KEIP’s base funding level for achieving the applicable Targets is $2.875 million,
consisting of $2 million allocated to the ACU Business (the “ACU Target”); $700,000 to
Coverdell (the “Coverdell Target”); and $175,000 to Neverblue (the “Neverblue Target”). (Mot.
¶ 18.) Depending on performance, Key Employees will have the ability to earn greater than
100% of the incentive pool Target.
a. 	The ACU Target
The ACU Target will be allocated to employees managing the Harvest of ACU through
two separate pools: (i) $600,000 (the “Executive Pool”) for Gary Johnson, Lorraine DiSanto, and
George Thomas (each, an “Executive Employee”) in the aggregate (i.e., $200,000 each); and (ii)
$1.4 million for all other Key Employees required to maximize the value of the Harvest (the
“Employee Pool”). The Employee Pool will be allocated by the CRO in collaboration with Gary
Johnson and Lorraine DiSanto, who will continue to consult with the CRO on adjustments while
they are employed by the Debtors. Payouts from the Executive Pool will be based on achieving
defined milestones and providing transition services essential to the success of the Harvest. At a
minimum, for Executive Employees to earn their KEIP payments, the Debtors must meet the net
operating cash flow covenant in section 7.1(a)(ii) of the Debtors’ postpetition credit agreement
over the initial thirteen weeks of the Debtors’ cases (the “DIP Budget”), and the Executive
3 	However, the Debtors disclosed that one employee in Coverdell’s finance department, Roseanne
Corigliano, is the sister of Vincent DiBenedetto and thus is a statutory insider under section 101 of the Bankruptcy
Code. 	Under the proposed KEIP, she would earn $15,000. 	According to the Debtors, Ms. Corigliano has no
corporate authority to dictate policy and is subordinate to the officers and directors of the Debtors.
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Employees must provide additional transitional services, as described in the Motion. (Mot.
¶ 25.)
Payouts for the rank and file Employee Pool will be distributed based on “Net
Proceeds” 4 to creditors as follows:
b. 	The Coverdell Target
The $700,000 Coverdell Target will be allocated to Key Employees of Coverdell;
amounts per employee will be determined at the discretion of Coverdell’s management. (Mot.
¶ 28.) Participants include approximately 27 non-insider employees of Coverdell, as well as
Coverdell’s President, Vincent DiBenedetto (who also serves as a Director). (Id.) Under the
revised KEIP, in the event that Coverdell is sold to a third-party purchaser or the Lender
Parties for more than $80 million, DiBenedetto’s compensation is calculated as a percentage of
the Coverdell Net Sale Proceeds; the percentage increases as the range of the Coverdell Net
4 	“Net Proceeds” is the unlevered free cash flow from the ACU Business after deducting all recurring and
non-recurring cash payments associated with the ACU Business and all post-petition professional fee payments
related to the entire restructuring process (excluding the investment banking fees of the proposed investment banker
for Coverdell and Neverblue), on an undiscounted basis. The Net Proceeds calculation will be measured from the
Petition Date and excludes unlevered free cash flow from Coverdell and Neverblue and the ending cash balance as
of the Petition Date.
Net Proceeds 	% of Employee
Pool
Cash Payment 	Cumulative
Cash
$50 million 	75.0% 	$1.050 million 	$1.050 million
$60 million 	87.5% 	$0.175 million 	$1.225 million
$70 million 	100% 	$0.175 million 	$1.400 million
$80 million 	112.5% 	$0.175 million 	$1.575 million
$90 million 	125.0% 	$0.175 million 	$1.750 million
$100 million 	137.5% 	$0.175 million 	$1.925 million
$110 million 	150.0% 	$0.175 million 	$2.100 million
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Sale Proceeds increases. Additionally, the U.S. Trustee negotiated an across-the-board
$100,000 reduction in Mr. DiBendetto’s compensation under the KEIP.
With respect to the rank and file employees of Coverdell, one of two tests will apply to
the allocation of the Coverdell Target. First, if the Lender Parties acquire Coverdell through
an $80 million credit bid, or if the Debtors sell Coverdell for less than $80 million, then
Coverdell would have to meet revenue and EBITDA targets for participants to receive KEIP
compensation. Alternatively, if Coverdell is sold to a third party for $80 million or more, or if
the Lender Parties acquire Coverdell under a credit bid in excess of $80 million, then a net
sale proceeds calculation applies. 5 Participants would also have the ability to earn more or
less than the Coverdell Target based upon performance relative to the revenue and EBITDA
targets or the Coverdell Net Sale Proceeds test.
c. 	The Neverblue Target
The $175,000 proposed allocation to Key Employees of Neverblue will be allocated to
approximately eight non-insider employees; the exact participants and incentive amounts will
be determined at the discretion of Neverblue’s management. Similar to the Coverdell Target,
the tests and allocation methods for Key Employees of Neverblue will depend on the facts and
circumstances of these cases. First, if the Lender Parties acquire Neverblue through a $20
million credit bid, or if the Debtors sell Neverblue for less than $20 million, then Neverblue
would have to meet certain revenue and EBITDA targets for participants to receive KEIP
compensation. Alternatively, if Neverblue is sold to a third party for $20 million or more, or
5 	“Coverdell Net Sale Proceeds” would be determined by the net cash received by the estate after payment of
all expenses in conjunction with a sale transaction of the respective business, or the face amount of a credit bid in
excess of $80 million after payment of all expenses in conjunction with the sale transaction.
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if the Lender Parties acquire Neverblue under a credit bid in excess of $20 million, then a net
sale proceeds calculation would apply.
Finally, with respect to Hakan Lindskog (the President of non-debtor affiliate
Neverblue Media Company), if the Lender Parties acquire Neverblue in connection with a $20
million credit bid, then Mr. Lindskog would receive 0.5% of the face amount of the credit bid
(or $100,000). 	If Neverblue is sold to a third-party purchaser, or is acquired by the first lien
lenders under a credit bid in excess of $20 million, then he would receive 1% of the proceeds
or the face amount of the credit bid. This amount is in addition to the $175,000 allocated for
other Key Employees of Neverblue.
According to the Debtors, the KEIP will provide “incentive-based cash awards to the Key
Employees who are most capable of maximizing the Debtors’ financial performance.” (Mot. ¶
8.) The KEIP was heavily negotiated with the Lender Parties, and, as a result, the secured
lenders fully support the KEIP. Additionally, the Committee has not filed an objection.
B. 	The U.S. Trustee’s Objection and the Debtors’ Reply
The Debtors have worked diligently with the U.S. Trustee, in consultation with the
Lender Parties and the Committee, to resolve the Objection. As a result of these discussions and
the amendments to the KEIP, only two objections by the U.S. Trustee have not been resolved:
(1) the objection as to the DIP Budget milestone applicable to the Executive Employees under
the ACU Target; and (2) the objection to the sale target for Mr. Hakan Lindskog. Specifically,
with respect to the ACU Target, the U.S. Trustee argues that the Executive Employees’ bonuses
are dependent only on the Debtors’ compliance with the DIP Budget. This, according to the U.S.
Trustee, does not set an incentive target for management to reach. With respect to the Neverblue
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Target, according to the U.S. Trustee, no information on what, if anything, Mr. Lindskog is
required to do to earn his bonus was included in the information.
After consideration of the evidence and arguments, the Court finds and concludes that
the KEIP properly incentivizes all Key Employees, the KEIP meets the requirements of section
503(c) of the Bankruptcy Code, and the KEIP is a valid exercise of the Debtors’ business
judgment. Whether incentive targets require management to “stretch” to meet performance
goals is fundamentally a factual question. On the undisputed evidence submitted in support of
the KEIP Motion, the Court expressly finds in the context of this case that the DIP Budget and
sales targets indeed require all Key Employees to stretch to achieve the required Targets.
Satisfaction for the Targets is by no means assured.
II. 	DISCUSSION
A. 	Insiders
As an initial matter, in evaluating the validity of a key employee incentive plan, the Court
must determine whether each eligible employee is an “insider” within the meaning of section
101(31).6 See generally In re Borders Grp. Inc., 453 B.R. 459 (Bankr. S.D.N.Y. 2011). Insider
status is important because it may potentially bar an employee from participating in the KEIP
(assuming the program is found to be primarily retentive). If the Court determines that an
employee is an insider, then the Debtors must meet the strict requirements of section 503(c)(1).7
6 	The Court need not address these issues in full because, as explained below, the Court finds that the KEIP
is primarily incentivizing rather than retentive, and thus, the requirements of 503(c)(1) are not applicable.
7 	Section 503(c)(1) prohibits any 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 debtor’s business, absent
a finding by the court based on evidence in the record that—
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Although the term “insider” is specifically defined by the Bankruptcy Code, see 11
U.S.C. § 101(31)(B), insider status can also be determined on a case-by-case basis from the
totality of the circumstances, including the degree of an individual’s involvement in a debtor’s
affairs. See CPY Co. v. Ameriscribe Corp. (In re Chas. P. Young Co.), 145 B.R. 131, 136
(Bankr. S.D.N.Y. 1992). In such cases, insiders must have “at least a controlling interest in the
debtor or . . . exercise sufficient authority over the debtor so as to unqualifiably dictate corporate
policy and the disposition of corporate assets.” In re Babcock Dairy Co., 70 B.R. 657, 661
(Bankr. N.D. Ohio 1986) (citations omitted); see also In re 9281 Shore Road Owners Corp., 187
B.R. 837, 853 (E.D.N.Y. 1995).
Here, the Debtors have disclosed exactly which insiders are participating in the KEIP.
Additionally, based on the information provided in the DiBenedetto Declaration, the Court is
satisfied that those individuals who originally concerned the U.S. Trustee are not insiders of the
Debtors. Thus, the issue the Court must now address is whether the KEIP is valid pursuant to
(A) 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;
(B) 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;
11 U.S.C. § 503(c)(1).
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section 503(c) of the Bankruptcy Code as it relates to both the insider employees of the Debtors
and the rank and file employees.
B. 	Pursuant to Section 503(c), the KEIP Is Incentivizing
and Not Primarily Retentive
Section 503(c) was added to the Bankruptcy Code as one of the BAPCPA amendments in
2005 to “eradicate the notion that executives were entitled to bonuses simply for staying with the
Company through the bankruptcy process.” In re Global Home Prods., LLC, 369 B.R. 778, 783-
84 (Bankr. D. Del. 2007). 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 C OLLIER ON BANKRUPTCY
¶ 503.17 (15th rev. ed. 2007). In addition to limiting payments to insiders for retention purposes,
section 503 also limits severance payments to insiders and any transaction outside the ordinary
course of business that would benefit “officers, managers, and consultants hired after the date of
the filing of the petition.” 11 U.S.C. § 503(c)(3). The effect of section 503(c) was to put in
place “a set of challenging standards” and “high hurdles” for debtors to overcome before
retention bonuses could be paid. Global Home, 369 B.R. at 784-85. To the extent that either
section 503(c)(1) or (c)(2)8 apply, the transfer cannot be justified solely on the debtor’s business
judgment. In re Dana Corp., 351 B.R. 96, 100-01 (Bankr. S.D.N.Y. 2006) (“Dana I”). Section
503(c)(3) also prohibits “other transfers or obligations that are outside the ordinary course of
8 	Section 503(c)(2) prohibits severance payments made by a debtor to insiders, unless:
(A) the payment is part of a program that is generally applicable to all full-time employees;
and
(B) the amount of the payment is not greater than 10 times the amount of the mean
severance pay given to nonmanagement employees during the calendar year in which the
payment is made
11 U.S.C. § 503(c)(2). Since the KEIP does not contemplate severance payments, this subsection is not
applicable.
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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)(3).
Section 503(c) does not “foreclose a chapter 11 debtor from reasonably compensating
employees, including ‘insiders,’ for their contribution to the debtors’ reorganization.” In re
Dana Corp., 358 B.R. 567, 575 (Bankr. S.D.N.Y. 2007) (citation ommitted) (“Dana II”). A
transfer to an insider to induce the insider to remain with the debtor’s business must satisfy the
requirements under subdivisions (A), (B), and (C) of section 503(c)(1) in order to be subject to
this subdivision’s exception. 4 COLLIER ON BANKRUPTCY ¶ 503.17; see also Dana II, 358 B.R.
at 575 (summarizing the requirements under 503(c)(1)).
Section 503(c)(1) limits payments to insiders for the purpose of retention and “applies to
those employee retention provisions that are essentially ‘pay to stay’ key employee retention
programs.” Dana II, 358 B.R. at 571. 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). See, e.g.,
Dana I, 351 B.R. at 102 (stating that if a bonus proposal “walks like a duck (KERP), and quacks
like a duck (KERP), it’s a duck (KERP).”). Although a purported KEIP may contain some
retentive effect, that “does not mean that the plan, overall, is retentive rather than incentivizing in
nature.” Id. See also Global Home, 369 B.R. at 785 (“The entire analysis changes if a bonus
plan is not primarily motivated to retain personnel or is not in the nature of severance.”)
(emphasis added); In re Nellson Nutraceutical, Inc., 369 B.R. 787, 802 (Bankr. D. Del. 2007)
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(reading section 503(c)(1) to mean “a transfer made to . . . an insider of the debtor for the
[primary] purpose of inducing such person to remain with the debtor’s business” because any
payment made to an employee, including regular wages, has at least a partial retentive effect).
As stated earlier, all of the Executive Employees subject to the KEIP are insiders. Therefore, if
the Court concludes that the KEIP is essentially a retention plan, then such payments must
comply with section 503(c)(1).
In Dana II, Judge Lifland held that “[b]y presenting an executive compensation package
that properly incentivizes [management] to produce and increase the value of the estate, the
Debtors have established that section 503(c)(1) does not apply.” 358 B.R. at 584. However,
prior to Dana II, Judge Lifland found that “without tying [a] portion of [a] bonus to anything
other than staying with the company until the Effective Date, this Court cannot categorize a
bonus of this . . . form as an incentive bonus.” Dana I, 351 B.R. at 102. In Mesa Air Group, this
Court held that the debtors’ incentive bonus program was not a retention bonus because it was
designed to “motivate the employees to achieve performance goals.” In re Mesa Air Grp., No.
10-10018, 2010 WL 3810899, at *4 (Bankr. S.D.N.Y. Sept. 24, 2010) (citation omitted). In that
case, incentive bonuses were tied to certain performance goals, such as maintenance of flight
schedules, efficient return of aircraft, securing aircraft equipment at reduced rates and
negotiating reduced rates for aircraft no longer in service. Id.
The U.S. Trustee asserts that the KEIP in this case is not primarily incentive-based
because the ACU Target is predominantly tied to the Debtors’ compliance with the DIP Budget.
However, this financial target “was developed in conjunction with the projected revenue and
EBITDA targets of Coverdell and Neverblue, and expected range of recovery of the ACU
Business,” and, thus, this target “measures the same performance targets set for the Debtors’
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businesses . . . .” (Campagna Decl. ¶¶ 35-36.) Furthermore, under the KEIP, the Executive
Employees are required to do more to meet the wide-scale goals outlined in the KEIP as they
must address concerns and issues that are unique to the bankruptcy proceeding. The KEIP
encourages the Executive Employees to increase their pre-bankruptcy job responsibilities to
achieve the bonus requirements and financial targets. Accordingly, the Court is satisfied that
through the use of the Targets, the KEIP conforms to prevailing practices in this district and
others, thereby alleviating the need for a section 503(c)(1) analysis. See In re BearingPoint, Inc.,
Case No. 09-10691 (REG) (Bankr. S.D.N.Y. July 24, 2009) (ECF Doc. # 1128) (incentives based
on (i) the sale of business units, (ii) employees working on estate transition and wind-down
activities and (iii) percentage of creditor recoveries); In re Calpine Corp., Case No. 05-60200
(BRL) (Bankr. S.D.N.Y. May 15, 2006) (ECF Doc. # 1580) (size of incentive pool tied to the
debtor’s market adjusted enterprise value and plan adjusted enterprise value); In re Nortel
Networks, Inc., Case No. 09-10138 (KG) (Bankr. D. Del. Mar. 5 and 20, 2009) (ECF Doc.
## 436, 511) (incentive plan based on the achievement of separate milestones, including a cost
reduction plan, “certain parameters . . . that will result in a leaner and more focused
organization” and plan confirmation).
Furthermore, in previous years, the Debtors utilized revenue and EBITDA targets as a
means for incentive-based pay for their employees. (Campagna Decl. ¶ 18.) Historically, these
targets have proven difficult to achieve. (Id. ¶ 19-21.) And, according to representations from
counsel for the Debtors, the Debtors have yet to meet the Targets. See Dana II, 358 B.R. at 583
(noting that the financial benchmarks set for debtor’s incentive plan are difficult targets to
achieve and are therefore incentivizing); WEBSTER’ S NINTH NEW COLLEGIATE DICTIONARY 608
(9th ed. 1984) (defining “incentive” to mean “something that incites or has a tendency to incite
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to determination or action”). Additionally, as explained in the Campagna Declaration, the Court
is satisfied that the $80 million and $20 million are fair baseline target sale amounts for
Coverdell and Neverblue, respectively, in connection with the KEIP. (Campagna Decl. ¶¶ 22,
25, 27.) Thus, the Court finds that the KEIP Targets will properly incentivize all of the Key
Employees.
The Court also finds that the Targets and payments applicable to Hakan Lindskog
primarily incentivize him to perform at the highest level. Under the KEIP, Mr. Lindskog would
be paid 0.5% of the face amount of a $20 million credit bid or 1% of sales proceeds from a third-
party purchaser for Neverblue. Mr. Lindskog must work diligently with the Debtors’ investment
banker to find a third-party purchaser and work with proposed buyers, responding to due
diligence requests and providing business and financial information. (Id. ¶ 28.) Furthermore,
pursuant to his employment agreement, Mr. Lindskog is actually entitled to receive 1% of the
proceeds of a sale or change of control transaction of Neverblue. (Id. ¶ 29.) Thus, the incentives
as applied to him under the KEIP will actually force Mr. Lindskog to perform at the highest level
for Neverblue to command a price in excess of $20 million.
The KEIP’s goals are also consistent with the policies underlying chapter 11. While an
expeditious emergence from bankruptcy via a confirmed reorganization plan is the ultimate
objective of most chapter 11 debtors, a sale of a debtor’s business as a going concern under
section 363 also achieves the chapter 11 goal of preserving businesses and maximizing
recoveries for creditors. See Bank of Am. Nat’l Trust & Sav. Ass’n. v. 203 N. LaSalle St. P’ship,
506 U.S. 434, 453 (1999) (noting that the two basic purposes of chapter 11 are to preserve going
concerns and maximize property available to satisfy the claims of creditors). Meeting these
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benchmarks is also beneficial to the estate because an expedited emergence will minimize
administrative costs, thereby helping to maximize stakeholder value.
C. 	The Debtors Have Exercised Sound Business Judgment
The alternative method for approving the KEIP is as an “ordinary course” transaction by
the Debtors pursuant to 11 U.S.C. § 363. See In re Mesa Air Grp., 2010 WL 3810899, at *3.
While the Bankruptcy Code does not provide guidance whether a particular transaction is
conducted in the “ordinary course of business,” courts have applied both “horizontal” and
“vertical” tests to consider the reasonableness of a transaction and whether it was conducted in
the ordinary course. As stated by Judge Beatty,
[t]he inquiry deemed horizontal is whether, from an industry-wide
perspective, the transaction is of the sort commonly undertaken by
companies in that industry. 	The inquiry deemed vertical analyzes
the transactions ‘from the vantage point of a hypothetical creditor
and [the inquiry is] whether the transaction subjects a creditor to
economic risk of a nature different from those he accepted when he
decided to extend credit.’
In re Crystal Apparel, Inc., 207 B.R. 406, 409 (Bankr. S.D.N.Y. 1997) (citation omitted); see
also Dana II, 358 B.R. at 580 (citing Crystal Apparel with approval). The horizontal test “is
aimed at determining whether the transaction is abnormal or unusual, in which case it is probably
not in the ordinary course of business, or whether it is a reasonably common type of transaction.”
3 COLLIER ON BANKRUPTCY ¶ 363.17. The vertical test “reviews the transaction from the
perspective of creditors, asking whether the transaction is one that creditors would reasonably
expect the debtor or trustee to enter into.” Id.
If a particular transaction passes the horizontal and vertical tests, it is then considered an
“ordinary course” transaction subject to approval under section 363. As an ordinary course
transaction, the inquiry is then whether the debtor has a valid business purpose for engaging in
the particular transaction, and whether “the conduct involves a business judgment made in good
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faith upon a reasonable basis and within the scope of authority under the Bankruptcy Code.” In
re Nellson Nutraceutical, Inc., 369 B.R. at 799.
Section 503(c)(3) limits payments made to the Debtors’ employees outside of the
ordinary course unless such payments are justified by “the facts and circumstances of the case.”
11 U.S.C. § 503(c)(3). Courts have held that the “facts and circumstances” language of section
503(c)(3) creates a standard no different than the business judgment standard under section
363(b). See Dana II, 358 B.R. at 576; Global Home, 369 B.R. at 783 (“If [the proposed plans
are] intended to incentivize management, the analysis utilizes the more liberal business judgment
review under § 363.”); Mesa Air Grp., 2010 WL 3810899 at *4; In re Nobex Corp., No. 05-
20050, 2006 WL 4063024, at *2 (Bankr. D. Del. Jan. 19, 2006). In Dana II, Judge Lifland listed
several factors that courts consider when determining if the structure of a compensation proposal
and the process for its development meet the business judgment test:
- 	Is there a reasonable relationship between the plan proposed and the
results to be obtained, i.e., will the key employee stay for as long as it
takes for the debtor to reorganize or market its assets, or, in the case of a
performance incentive, is the plan calculated to achieve the desired
performance?
- 	Is the cost of the plan reasonable in the context of the debtor’s assets,
liabilities and earning potential?
- 	Is the scope of the plan fair and reasonable; does it apply to all
employees; does it discriminate unfairly?
- 	Is the plan or proposal consistent with industry standards?
- 	What were the due diligence efforts of the debtor in investigating the
need for a plan; analyzing which key employees need to be incentivized;
what is available; what is generally applicable in a particular industry?
- 	Did the debtor receive independent counsel in performing due diligence
and in creating and authorizing the incentive compensation?
358 B.R. at 576-77 (emphasis in original). See also Global Home, 369 B.R. at 786 (evaluating
an incentive plan under the business judgment standard of section 363 by applying the factors
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listed above); but see In re Pilgrim’s Pride Corp., 401 B.R. 229, 236-37 (Bankr. N.D. Tex. 2009)
(standard for approval under section 503(c)(3) is higher than the business judgment test; if
payments to employees outside the ordinary course were only subject to the business judgment
test, then the language of section 503(c)(3) would ostensibly be rendered meaningless).
As an initial matter, the Debtors have adequately shown that the incentives and Targets
proposed under the KEIP are the same as those that have been established by the Debtors in
previous years. (Campagna Decl. ¶¶ 18-20.) Further, applying the Dana II factors, the Court
finds that the Debtors have exercised sound business judgment. A reasonable relationship exists
between the plan proposed and the results to be obtained. In this case, the KEIP is keyed to the
successful sale of the Debtors’ businesses to a third-party purchaser. The KEIP is also
reasonable in light of the Debtors’ financial situation. Assuming the Debtors meet their
performance goals, the aggregate KEIP payments are $2.875 million. (Id. ¶ 15.) Additionally,
the KEIP does not unfairly discriminate and comports with industry standards, as it is nearly
identical to the bonus plan that the Debtors had in place prepetition. (Id. ¶¶ 18-20.) Finally, the
Debtors, as evidenced by the declarations filed in support of the KEIP, have exercised proper
diligence in formulating the KEIP. Specifically, the Debtors have utilized their financial advisor,
Alvarez & Marsal North America, LLC, to assist, advise and guide the Debtors in developing a
KEIP that would incentivize the Key Employees to maximize the value of the Harvest and the
sales of Coverdell and Neverblue.
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III. 	CONCLUSION
For the reasons stated above, the Court overrules the U.S. Trustee’s remaining objections.
The Debtors have met their burden of proving that the proposed KEIP is primarily incentive-
based as it relates to all Key Employees and is a valid exercise of their sound business judgment
under section 363 and 503(c)(3). A separate order will be entered approving the Motion.
Date: 	June 6, 2012
New York, New York
_____/s/Martin Glenn_______
MARTIN GLENN
United States Bankruptcy Judge
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