shl Doc 134 Filed 04/30/18 Entered 04/30/18 11:47:28 Main Document Pg 1 of 11

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1 Pg 1 of 11 UNITED STATES BANKRUPTCY COURT Hearing Date: May 2, 2018 SOUTHERN DISTRICT OF NEW YORK Hearing Time: 10:00 a.m x In re Chapter 11 FIRESTAR DIAMOND, INC., et al., Debtors x Case No (SHL) (Jointly Administered) OBJECTION OF UNITED STATES TRUSTEE TO MOTION FOR AN ORDER APPROVING KEY EMPLOYEE RETENTION PROGRAM William K. Harrington, the United States Trustee for Region 2 (the "United States Trustee"), respectfully objects to the Motion for an Order Approving Key Employee Retention Program (the KERP Motion ), ECF No In support of his objection, the United States Trustee respectfully states as follows: PRELIMINARY STATEMENT The United States Trustee objects to the above-captioned debtors request to pay approximately $230,000 in bonuses in order to retain certain key employees. The objection is twofold: First, as the Court is aware, the ultimate majority shareholder of the debtors, and the founder of Firestar Diamond Nirav Modi -- has been charged by the State of India with criminal conspiracy, fraud and cheating related to the Punjab National Bank. The impact of Mr. Modi s alleged large-scale fraud upon the three debtors here is not yet known and is the subject of an investigation by the Examiner recently appointed in these cases. At this time, an award of bonuses to employees that may have known or should have known about any fraud on the part of Modi and/or these Debtors is premature. 1

2 Pg 2 of 11 Second, the information provided in the KERP Motion is seriously deficient. The Debtors make the bare assertion, without any supporting evidence, that the KERP participants are not insiders. The Debtors fail to disclose the names, titles, roles and job descriptions of the participants so that the Court and other parties in interest can determine whether the KERP participants exercise control over significant aspects of the Debtors business or are entitled to indemnification. 1 Without this information it is not possible for the Court, the United States Trustee and other parties in interest to determine whether any of the KERP participants are insiders and whether the proposed bonus plans should be evaluated under Section 503(c)(1). In addition, proposed discretionary fund bonuses are to be paid with no enumerated criteria and Court oversight. Accordingly, the United States Trustee objects to the KERP Motion on the ground that the Debtors have failed to meet their evidentiary burden of proof to show that the proposed bonuses comply with Section 503(c) of the Bankruptcy Code. BACKGROUND A. General Background 1. On February 26, 2018 (the Petition Date ), Firestar Diamond, Inc. ( FDI ), Fantasy, Inc. ( FI ), and A. Jaffe, Inc. ( AJI ) (collectively, the Debtors ) each commenced a voluntary case under chapter 11 of the Bankruptcy Code. See Voluntary Petitions, SDNY Case Nos (SHL), (SHL), (SHL), ECF Doc. No. 1. The Debtors continue to operate their jewelry businesses and manage their properties as debtors-in-possession pursuant to sections 1107(a) and On an informal basis the Debtors have offered to provide certain information regarding the KERP participants to the United States Trustee. That information is not included in the KERP Motion and was not sufficient to demonstrate that the KERP participants are not insiders and that they do not have broad responsibilities over significant aspects of the Debtors business. 2

3 Pg 3 of 11 of the Bankruptcy Code. On March 9, 2018, the Court entered an Order directing that these cases be jointly administered. ECF Doc. No To date, no Official Committee of Unsecured Creditors has been appointed in these cases. 3. By Order dated March 29, 2018, the Court authorized the Debtors to retain Getzler Henrich & Associates LLC and to provide Mark Samson as Chief Restructuring Officer nunc pro tunc to the Petition Date. ECF Doc. No By Order dated April 13, 2018, the Court directed that the United States Trustee Appoint an examiner (the Examiner Order ). ECF Doc. No Pursuant to that Order the United States Trustee appointed John J. Carney, Esq. as Examiner (the Examiner ). By Order dated April 20, 2018, the Court approved the appointment of the Examiner. ECF Doc. No The KERP Motion 5. On April 20, 2018, the Debtors filed the KERP Motion, along with a Motion to Shorten Time with regard to the scheduling of a hearing on the KERP motion. ECF Doc. Nos. 121, 123. By Order dated April 23, 2018, the Court granted the Motion to Shorten Time and scheduled the hearing on the KERP Motion for May 2, ECF Doc. No Pursuant to the KERP Motion, the Debtors seek to provide 16 employees an aggregate of up to approximately $230, KERP Motion at 25, 35. Of this approximate amount, $52, is to be shared among four (4) AJI employees, and $176, is to be shared among twelve (12) FDI employees. 2 See Declaration of 2 There is no indication that any of the KERP participants are employees of FI. See id. 3

4 Pg 4 of 11 Mark Samson (the Samson Decl. ), and the exhibit attached thereto. ECF Doc. No The amounts earmarked for the KERP participants amount to between 10% and 20% of their annual base salaries. KERP Motion, 25. The one-time payments under the KERP would be made on the earlier of (1) 30 days after the effective date of a plan of reorganization, or (2) the closing of a going concern sale under Section 303 of the Bankruptcy Code of the assets of the Debtor that employ[s] each participant. Id. 8. Payments under the KERP are contingent on the [participant] being actively employed on the date of payment. Id. If, however, a participant is involuntarily terminated without cause prior to (i) the effective date of a plan of reorganization, or (ii) the closing of a going concern sale, any payment such participant receives is to be offset by any severance payments paid to such terminated participant. Id. 9. Although the KERP Motion lists the amounts of the bonuses to be paid and the number of KERP participants, it does not disclose either the names or titles of the participants. See id. Instead, it lists the participants by number and discloses the departments in the debtor companies in which the participants are employed. See id. OBJECTION A. Statutory Framework 1. Section 101(31) Section 101(31) of the Bankruptcy Code provides in relevant part: The term insider includes -- 4

5 Pg 5 of 11 (B) if the debtor is a corporation -- (i) (ii) (iii) (iv) (v) (vi) director of the debtor; officer of the debtor; person in control of the debtor; partnership in which the debtor is a general partner general partner of the debtor; or relative of a general partner, director, officer, or person in control of the debtor; 11 U.S.C. 101(31)(B)(i)-(iv). 2. Section 503(c) Section 503(c)(1) 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 debtor s 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 5

6 Pg 6 of 11 (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). Congress added Section 503(c) in 2005 to curtail payments of retention incentives to insiders to eradicate the notion that executives were entitled to bonuses simply for staying with the Company through the bankruptcy process. In re Residential Capital LLC, 478 B.R. 154, 169 (Bankr. S.D.N.Y. 2012) ( Rescap ) (quoting In re Global Home Prods., LLC, 369 B.R. 778, 784 (Bankr. D. Del. 2007)); accord In re Hawker Beechcraft, Inc., 479 B.R. 308, (Bankr. S.D.N.Y. 2012); In re Velo Holdings, Inc., 472 B.R. 201, 209 (Bankr. S.D.N.Y. 2012). In addition, Congress intended 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. Rescap, 478 B.R. at 169. Congress intended to put into place a set of challenging standards for debtors to overcome before retention bonuses could be paid. Global Home, 369 B.R. at 784. Where Section 503(c)(1) applies, the transfer cannot be justified solely on the debtor s business judgment. See In re Borders Group., 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 6

7 Pg 7 of 11 may actually exist. In re Dana Corp., 351 B.R. 96, 101 (Bankr. S.D.N.Y. 2006) ( Dana I ). Finally, not only must bonus 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). B. In Light of the Examiner s Ongoing Investigation, The KERP Motion Should Not Be Approved At This Time The Debtor s ultimate majority shareholder has been implicated in a major fraud prosecution in India. Largely because the Court and the parties to these chapter 11 cases do not know the extent to which these debtors are involved in or have been impacted by the alleged fraud in India, the Court signed the Examiner Order on April 13, 2018 and approved the United States Trustee s appointment of the Examiner by Order dated April 20, ECF Doc. Nos. 103, 118. Among the Examiner s tasks is to investigate whether any current officer or director of the Debtors actively and knowingly participated in fraud or dishonesty in the management of the affairs of the Debtors. See Examiner Order, page 2. As the KERP Motion was filed on April 20, 2018, the very day that the Court approved the United States Trustee s appointment of the Examiner, ECF Doc. Nos. 118, 121, the Debtors are asking the Court to approve the KERP just as the Examiner is beginning his investigation. It is far too early to tell whether any of the KERP participants may be targets of the Examiner s investigation, let alone whether any of the participants may have engaged in improper conduct. As noted above, the Debtors have not identified the KERP participants, their job titles, or their job functions. As a result, neither the Court, the United States Trustee, nor the other parties-in-interest in these cases is able to evaluate 7

8 Pg 8 of 11 whether any of the KERP participants had any connection to the matters that the Examiner is investigating. Because of this uncertainty, the KERP Motion should not be granted at this time. C. The Debtors Have Failed To Establish That KERP Participants Are Not Insiders and Are Therefore Not Subject to Section 503(c)(1) Without identifying the individuals, the Debtors disclose that the KERP participants include admitted officers and directors of the Debtors. KERP Motion at Pursuant to the Section 101(31) of the Bankruptcy Code, if a debtor is a corporation, the term insider includes an officer and director of the debtor. 11 U.S.C. 101(31)(B)(ii). A vice president as an officer is presumptively an insider. In re Foothills Texas, Inc., 408 B.R. 573, 579 (Bankr. D. Del. 2009). The same is true for a director. Moreover, regardless of title, a person with broad responsibilities over significant aspects of a debtor s business is considered an insider, even if they are not members of senior management. Id. at 584 (finding vice presidents who were not members of senior management, but who had broad responsibilities over significant aspects of debtor s business, to be insiders); see also In re Borders Group, 453 B.R. 459, 469 (Bankr. S.D.N.Y. 2011) ( [i]nsider status can also be determined on a case by-case basis based on the totality of the circumstances, including the degree of an individual's involvement in a debtor's affairs ); Office of the United States Trustee v. Fieldstone Mortgage Co., No. CCB , 2008 WL , at *5 (D. Md. Nov. 5, 2008) ( [C]ontrol... is an independent additional ground for finding a person an insider, not a feature that officers or directors are required to possess in order to be deemed insiders ); In re Krehl, 86 F.3d 737, 741 (7th Cir. 1996) (definition of insider is illustrative rather than exhaustive); compare In re Kunz, 489 F.3d 1072 (10th Cir. 2007) (it is not simply the title director 8

9 Pg 9 of 11 or officer that renders an individual an insider; rather it is the set of legal rights that a typical corporate director or officer holds). Accordingly, without disclosing the identities and/or titles of the KERP participants, as well as their job descriptions, 3 some or all of the participants may well be insiders. Foothills Texas, Inc., 408 B.R. at 584 (employees with broad responsibilities over significant aspect of debtor s business can be insiders). Insiders are subject to the requirements of Section 503(c)(1) and the Debtors have not met their burden of proof under Section 503(c)(1), and the United States Trustee can only assume that the bonuses recipients include insiders as that term is defined under the Code. Foothills Texas, Inc., 408 B.R. at 584. Accordingly, the KERP should not be approved. D. Even If the KERP Was Governed by Section 503(c)(3) and Section 363, the KERP Does Not Satisfy These Statutory Provisions 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) 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. 503(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); see also 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). 4 3 Although the CRO states that he thorough[ly] review[ed] each participant s job function, Samson Decl., 15, neither the KERP Motion nor the Declaration discloses any of the participants job functions. 4 Although some courts in this district have determined that the standard under Section 503(c)(3) is not different from the business judgment test under Section 363(b), see In re Residential Capital, LLC, 491 B.R. 73, 84 (Bankr. S.D.N.Y. 2013) (additional citations omitted), these courts and others continue to apply 9

10 Pg 10 of 11 The Debtors have not established that the KERP is justified by the facts and circumstances of this case. As discussed above, some or all of the KERP participants may include insiders. The KERP Motion does not provide any information regarding any of the participants titles or job descriptions. Without this information, as well as more detailed disclosure regarding the amounts of the individual bonuses to be awarded, it is unclear why these individuals are critical to the Debtors business and that the KERP is justified in this case. The Debtor s failure to include basic information about the KERP participants makes it impossible for the Court and parties-in-interest to evaluate whether the amounts of the proposed payments are justified under the circumstances of the case. Although the amounts of the proposed KERP payments vary from participant to participant, the motion papers provide no information whatsoever so as to enable the parties to match the participants with the amounts they are to receive under the KERP. See Samson Decl. and the Exhibit attached thereto. For example, one of the participants is to receive $44, under the KERP. Why is that key employee receiving more than any of the other participants? The only information provided by the Debtor is that the person Key Employee 15 is employed in the sales department of FDI. See id. Due to the lack of information about Key Employee 15 and the other participants, the parties have no way to evaluate whether the amount of each of the payments is appropriate. 5 the factors listed by Judge Lifland in In re Dana Corp., 358 B.R. 567, 576 (Bankr. S.D.N.Y. 2007) ( Dana II ), when determining if the structure of a compensation proposal and the process for its development meet with the standard under Section 503(c)(3). 5 The KERP Motion is also deficient with respect to its description of when involuntarily terminated employees are eligible to receive a payment under the KERP. See KERP Motion, 25. In the first half of paragraph 25 of the KERP Motion, the Debtors define the term Award Determination Event as the earlier of the effective date of a plan of reorganization or the closing of a going concern sale off the assets of the 10

11 Pg 11 of 11 CONCLUSION WHEREFORE, the United States Trustee respectfully requests that the Court deny approval of the KERP Motion and grant such other and further relief as it may deem just and proper. Dated: New York, New York April 30, 2018 Respectfully submitted, WILLIAM K. HARRINGTON UNITED STATES TRUSTEE, Region 2 By: /s/ Richard C. Morrissey Richard C. Morrissey Trial Attorney 201 Varick Street, Room 1006 New York, New York Tel. (212) Debtor that employ the participant. See id. However, paragraph 25 goes on to state that involuntarily terminated participants shall receive a KERP award (offset by any severance payments) if such termination occurs prior to the effective date of a plan of reorganization or the sale closing, but after the Award Determination Event. See id. Given the definition of this term, paragraph 25 appears to be selfcontradictory. 11