Pg 1 of 16 UNITED STATES BANKRUPTCY COURT Hearing Date March 27, 2013 SOUTHERN DISTRICT OF NEW YORK Hearing Time 1000 a.m. ------------------------------------------------------x In re Chapter 11 AMR CORPORATION, et al., Case No. 11-15463 (SHL) (Jointly Administered) Debtors. ------------------------------------------------------x OBJECTION OF THE UNITED STATES TRUSTEE TO THE DEBTORS OTION FOR ENTRY OF ORDER PURSUANT TO 11 U.S.C. 105(A), 363(B), AND 503(B) AUTHORIZING AND APPROVING (I) MERGER AGREEMENT AMONG AMR CORPORATION, AMR MERGER SUB, INC., AND US AIRWAYS GROUP, INC., (II) DEBTORS EXECUTION OF AND PERFORMANCE UNDER MERGER AGREEMENT, (III) CERTAIN EMPLOYEE COMPENSATION AND BENEFIT ARRANGEMENTS, (IV) TERMINATION FEES, AND (V) RELATED RELIEF TRACY HOPE DAVIS UNITED STATES TRUSTEE Of Counsel Brian S. Masumoto Michael Driscoll Trial Attorneys 33 Whitehall Street, 21 st Floor New York, New York 10004 Tel. No. (212) 510-0500 Fax No. (212) 668-2255
Pg 2 of 16 TABLE OF CONTENTS TABLE OF CONTENTS... i TABLE OF AUTHORITIES... ii I. PRELIMINARY STATEMENT...1 II. BACKGROUND...2 A. General Background...3 B. The Motion...3 C. Non-Union Employee Base Salary and Wage Changes...4 D. Employee Aggrangements...5 E. American CEO Letter Agreement...5 III. ARGUMENT...6 A. The Governing Law...6 B. The Merger Motion Fails to Establish That Section 503(c) Does Not Apply to the Employee Compensation and Benefits To Be Implemented Pursuant to the Merger...8 1. The Pre-Closing Base Salary and Wage Changes...9 2. Employee Arrangements...10 C. The Debtors Have Failed to Establish that the Severance Arrangement for Mr. Horton Complies with Section 503(c)(2)...12 IV. CONCLUSION...13 i
Pg 3 of 16 Cases TABLE OF AUTHORITIES In re Brooklyn Hospital Center, 341 B.R. 405 (Bankr. E.D.NY. 2006)...12 In re Dana Corp., 351 B.R. 96 (Bankr. S.D.N.Y. 2006)... passim In re Georgetown Steel Co., 306 B.R. 549 (Bankr. D. S.C. 2004)...12 In re Global Home Prods., LLC, 369 B.R. 778 (Bankr. D. Del. 2007)...10, 15 In re Journal Register Co., 407 B.R. 520, 535 (Bankr. S.D.N.Y. 2009)....9 Lamie v. United States, 540 U.S. 526, 534 (2004)..8 In re Mesa Air Group, Inc., Case No. 10-10018 (MG), 2010 WL 3810899 (Bankr. S.D.N.Y. Sept. 24, 2010)...10, 11, 13 In re Velo Holdings Inc., Case No. 12-11384 (MG), 2012 WL 2015870 (Bankr. S.D.N.Y. June 6, 2012)...10, 11, 16 Statutes, Rules, & Other Authorities 11 U.S.C. 503... passim 4 COLLIER ON BANKRUPTCY 503.17 (15th ed. 2007)...10 ii
Pg 4 of 16 UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK -------------------------------------------------------- x In re AMR CORPORATION, et al., Debtors. -------------------------------------------------------- x Objection Date March 15, 2013 at 400 p.m. Hearing Date March 27, 2013 at 1000 a.m. Chapter 11 Case No. 11-15463 (SHL) (Jointly Administered) OBJECTION OF THE UNITED STATES TRUSTEE TO THE DEBTORS MOTION FOR ENTRY OF ORDER PURSUANT TO 11 U.S.C. 105(A), 363(B), AND 503(B) AUTHORIZING AND APPROVING (I) MERGER AGREEMENT AMONG AMR CORPORATION, AMR MERGER SUB, INC., AND US AIRWAYS GROUP, INC., (II) DEBTORS EXECUTION OF AND PERFORMANCE UNDER MERGER AGREEMENT, (III) CERTAIN EMPLOYEE COMPENSATION AND BENEFIT ARRANGEMENTS, (IV) TERMINATION FEES, AND (V) RELATED RELIEF TO THE HONORABLE SEAN H. LANE, UNITED STATES BANKRUPTCY JUDGE Tracy Hope Davis, the United States Trustee for Region 2 (the United States Trustee ), respectfully submits this objection (the Objection ) to the [M]otion of Debtors for Entry of Order Pursuant to 11 U.S.C. 105(a), 363(b), and 503(b) Authorizing and Approving (i) Merger Agreement Among AMR Corporation, AMR Merger Sub, Inc., and US Airways Group, Inc., (ii) Debtors Execution of and Performance Under Merger Agreement, (iii) Certain Employee Compensation and Benefit Arrangements, (iv) Termination Fees, and (v) Related Relief (the Motion ). ECF Doc. No. 6800. In support of the Objection, the United States Trustee respectfully states I. PRELIMINARY STATEMENT The United States Trustee objects to the Motion because the Debtors fail to explain why the sweeping changes to their various employee compensation programs are permissible
Pg 5 of 16 under Section 503(c) of the Bankruptcy Code. In a conclusory statement, the Debtors assert that with respect to the Employee Arrangements, it is not necessary to address Section 503(c) because any payments that may be made will be made by Newco and not the Debtors. As discussed below, regardless of what entity is paying for any of the employee benefit programs, Section 503(c) restricts the allowance as well as the payment of certain transfers, severance payments and obligations. Contrary to the Debtors assertion, delaying payment does not avoid the applicability of Section 503(c). To permit a debtor to delay, for example, a severance payment of close to $20 million, defeats Congress intent in enacting Section 503(c). Similarly unavailing is the Debtors apparent attempt to characterize certain changes to its employee compensation programs that will be effective pre-merger as ordinary course changes in order to avoid meeting their burden of proof under Section 503(c). First, there is no information in the Motion from which to determine whether these specific changes are ordinary course. Second, regardless of the nomenclature, the Debtors must demonstrate that any changes to these particular compensation programs meet the Section 503(c) requirements. Until such time as the Debtors meet their burden and demonstrate that all of the changes they propose to their employee compensation programs meet the requirements of Section 503(c), the Motion cannot be granted. II. BACKGROUND A. General Background 1. On November 29, 2011 (the Petition Date ), AMR Corporation ( AMR ) and certain of its direct and indirect subsidiaries (each a Debtor and collectively, the Debtors ) each filed petitions for relief under chapter 11, title 11, United States Code (the Bankruptcy Code ). ECF Doc. No. 1. 2
Pg 6 of 16 2. On December 5, 2011, the United States Trustee appointed the Official Committee of Unsecured Creditors (the Creditors Committee ). ECF Doc. No. 128. 3. No trustee or examiner has been appointed in these cases. 4. The Debtors continue to operate their respective businesses and manage their properties as debtors in possession pursuant to section 1107(a) and 1108 of the Bankruptcy Code. B. The Motion 5. On February 22, 2013, the Debtors filed the Motion, which seeks approval of the Debtors execution of, and entry into, an Agreement and Plan of Merger ( the Merger Agreement ) among AMR, AMR Merger Sub, Inc. ( Merger Sub ), and US Airways Group, Inc. ( US Airways ). ECF No. 6800 at 1. Enclosed with the Motion were various exhibits including the Merger Agreement and a portion of a document entitled, American Disclosure Letter. 6. According to the Motion, upon the confirmation and consummation of a chapter 11 plan of reorganization (the Plan ), Merger Sub, a wholly owned subsidiary of AMR formed for the purpose of effecting the Merger, will be merged with US Airways, with US Airways continuing as the surviving entity as a direct, wholly owned subsidiary of AMR. See Motion at 1. 7. The Motion provides Immediately prior to the time at which the Merger becomes effective (the Effective Time ), AMR s certificate of incorporation shall be amended and restated as set forth on Exhibit A to the Merger Agreement and immediately after the Effective Time, AMR s name shall be changed from AMR Corporation to American Airlines Group Inc. (after the Effective Time, AMR is referred to as Newco and US Airways is referred to as Surviving Corporation ). Id. at 38. The Merger is further conditioned upon the confirmation and occurrence of 3
Pg 7 of 16 the effective date under a plan of reorganization that incorporates the Merger. The closing of the Merger (the Closing ) and the effectiveness of the plan will occur simultaneously. Id. at 31. 8. Among other relief sought, the Motion seeks approval of certain employee compensation and benefit arrangements that are contained in Section 4.10 of the Merger Agreement and Section 4.1(o) of the American Disclosure Letter. Id. at 33. The Motion collectively refers to these compensation and benefit arrangements as the Employee Arrangements. Id. 9. Other than with respect to the changes that the Motion characterizes as Ordinary Course Changes, all of the Employee Arrangements and employee matters that relate to benefits and incentives will be instituted prior to the consummation of the Merger but will be conditioned on the occurrence of the Closing. Id. 76. C. Non-Union Employee Base Salary and Wage Changes 10. According to the Motion, the Debtors will adopt and put into effect prior to the Closing certain changes in compensation and employee benefits in the ordinary course of business for their applicable employees (excluding AMR s Chief Executive Officer) relating to salaries and wages as set forth in Section 4.1(o) of the American Disclosure Letter. Id. at 86. 11. The following groups of non-union employees will receive base salary and wage increases (i) AA Agents, Reservation and Planners, AA Support Staff and Eagle Support Staff; (ii) Eagle Agents; (iii) Management Levels 9-11 (vice presidents, Senior/Executive Vice Presidents and President); and (iv) Front line management at AA and AMR Eagle. Id. 12. According to the Motion, [o]ther than with respect to the Ordinary Course Changes, all payments to be made under the Employee Arrangements are conditioned on the 4
Pg 8 of 16 Closing of the Merger and will be paid by Newco after the Debtors emergence from chapter 11. Therefore, section 503(c) of the Bankruptcy Code is not applicable. Id. at n.6. D. Employee Arrangements Id. at 87. 13. With respect to the Employee Arrangements, the Debtors state Promptly after an order granting this Motion is entered by the Court, AMR, AA, and AMR Eagle will adopt and put into effect the following compensation and employee benefits for the applicable employees (excluding AMR s Chief Executive Officer) to preserve and protect their operating businesses in contemplation of, and subject to the occurrence of the Effective Time, which shall be obligations of Newco. 14. The Employee Arrangements include Short-Term Incentive Plans, 2013 Long- Term Incentive Plans, Alignment Awards, Severance Arrangements, a Retention Program, and a Level 5/6 Long-Term Incentive Program. Id. E. American CEO Letter Agreement 15. Upon the Closing, the employment of the American Airlines Chief Executive Officer, Thomas W. Horton, will terminate. Id. at 89. 16. As part of the Motion, the Debtors seek to pay Mr. Horton severance of $19,875,000, which the Debtors will pay fifty percent in cash and fifty percent in Newco Common Stock. Id. 17. Further, upon the Closing, Mr. Horton will be appointed as the Chairman of the Board of Directors of Newco. Id. 5
Pg 9 of 16 A. The Governing Law III. ARGUMENT Section 503(c) of the Bankruptcy Code provides, in relevant part, that 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 debtors 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) (ii) 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 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; (2) a severance payment to an insider of the debtor, unless (A) the payment is part of a program that is generally applicable to all full-time employees; and 6
Pg 10 of 16 (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; or (3) other transfers or obligations that are outside the ordinary course of 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). Section 503(c), which was added in 2005 as part of the Bankruptcy Abuse Prevention and Consumer Protection Act, was intended to curtail payments of retention incentives or severance to insiders, including bonuses granted to other employees without factual and circumstantial justification. See In re Journal Register Co.; 407 B.R. 520, 535 (Bankr. S.D.N.Y. 2009). 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. In re Velo Holdings Inc., Case No. 12-11384 (MG), 2012 WL 2015870, *5 (Bankr. S.D.N.Y. June 6, 2012) (quoting 4 COLLIER ON BANKRUPTCY 503.17 (15th ed. 2007)). 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. In re Mesa Air Group, Inc., Case No. 10-10018 (MG), 2010 WL 3810899, *2 (Bankr. S.D.N.Y. Sept. 24, 2010) (citing In re Global Home Prods., LLC, 369 B.R. 778, 784-85 (Bankr. D. Del. 2007). Section 503(c) establishes specific evidentiary standards that must be met before a bankruptcy court may authorize payments made to an insider for the purpose of inducing such person to remain with a debtor s business or payments made on account of severance. In re Dana Corp., 351 B.R. 96, 100 (Bankr. S.D.N.Y. 2006) ( Dana I ); 11 U.S.C. 503(c)(1). These 7
Pg 11 of 16 amendments make it clear that if a proposed transfer falls within Section 503(c)(1) or (c)(2) (governing severance payments), then the business judgment rule does not apply, irrespective of whether a sound business purpose may actually exist. Id. B. The Merger Motion Fails to Establish That Section 503(c) Does Not Apply to the Employee Compensation and Benefits To Be Implemented Pursuant to the Merger The Debtors propose to implement what appear to be sweeping changes to the salaries, wages, bonuses, benefits and severance obligations that are paid to their employees. Although some of these proposed changes will take place prior to the Closing, the majority will be put into effect promptly after an order granting the Motion is entered so as to preserve and protect the Debtors operating business in contemplation of, and subject to the occurrence of the Effective Time, which shall be obligations of Newco. Id. at 87. Section 503(c) was enacted in order to provide limits on the payments of retention and incentive bonuses and severance to insiders and on the payments of retention bonuses granted to noninsiders without factual and circumstantial justification. See In re Journal Register Co., 407 B.R. 520, 535. In a one sentence footnote, however, the Debtors state that Section 503(c) is not applicable to the Employment Arrangements because other than with respect to the Ordinary Course Changes, all payments to be made under the Employee Arrangement are conditioned on the Closing and will be paid by Newco after the Debtors emergence from chapter 11. See Motion, at pg. 64 n. 6. As to the Pre-Closing Non-Union Employee Base Salary and Wage Changes, while not specifically addressed, it appears from this same footnote that the Debtors contend that ordinary course payments are not subject to Section 503(c). These arguments are not supported by a plain reading of Section 503(c). See Lamie v. United States, 540 U.S. 526, 534 (2004) ( [W]hen the statute s language is plain, the sole function of the courts at least where the disposition required by the text is not absurd is to enforce it according to its terms. ). 8
Pg 12 of 16 1. The Pre-Closing Base Salary and Wage Changes The Debtors appear to contend that ordinary course changes to base salaries and wages paid to employees need not meet the requirements of Section 503(c). See Motion, at pg. 64 n. 6. According to the Motion, prior to the Closing, certain changes in compensation and employee benefits relating to base salaries and wages in the ordinary course of business to certain nonunion employees of AA and AMR Eagle (the Non-Union-Employees ) will be made. Id. at 86. Although the Motion characterizes these proposed increases as ordinary course of business changes, with the exception of the proposed pay progression to AA Agents, Reservation and Planners, AA Support Staff and Eagle Support Staff, which are said to resume their customary annual pay progression, there is no information set forth in the description of the changes to be implemented which would explain why these changes can be fairly characterized as ordinary course changes. For example, there is no information provided regarding inter alia the salaries and wages received by these Non-Union Employees in the past, what merit-based pay increases were made in the past, what base pay increases could be expected by certain management level employees, and when pay levels and wages were adjusted in the Debtors past business practice. Aside from very general descriptions, the Motion fails to identify the actual beneficiaries of these programs, what dollar values are involved, and other relevant information. Although the Motion generally asserts that the Employee Arrangements are designed to bring parity between the Debtors employees and the employees of U.S. Airways, see Motion at pg. 46, n. 5, no such reason is provided for the proposed Pre-Closing Base Salary and Wage Changes. See Motion at 86. In short, the Debtors fail to substantiate their claims that these 9
Pg 13 of 16 changes are in the ordinary course. Further, even if these changes are in the ordinary course, the Debtors are nonetheless not exempt from the requirements of Section 503(c). 2. Employee Arrangements With respect to the Employee Arrangements, see Motion at 87, these payments are conditioned on the closing of the Merger and will be paid by Newco after the Debtors emergence from chapter 11. See Id., pg. 64, n 6. Because the payments will not be made by the Debtors, the Debtors argue that section 503(c) does not apply. Id. In this regard, however, the Debtors have failed to address the plain language in Section 503(c) which states that there shall neither be allowed, nor paid (1) a transfer.... See Section 503(c) (emphasis added). Therefore, the fact that the funds to make the proposed payments under the Employee Arrangements may come from Newco, and not the Debtors, is not relevant. The Debtors are in Chapter 11. By the Motion, the Court is being asked to allow the transfers and obligations that are being requested. Therefore, the Debtors must demonstrate that the requirements of Section 503(c) have been met. Additionally, the Debtors argue that the Employee Arrangements and other related employee matters should be authorized and approved by the Court as such provisions are required in order to focus employees on the task at hand and mitigate against the risk of employee attrition. See Motion at 114. Further, preventing the attrition of its highly qualified employees with in-depth knowledge of the Debtors businesses, assets and operations, is necessary in order to maximize the value of the combined enterprise. Id. at 113. Retention plans usually are intended to encourage certain crucial employees to remain with the company through a critical, transitional time period when the exact future of the company is unclear and when those employees would be most likely to search for other 10
Pg 14 of 16 employment. In re Brooklyn Hospital Center, 341 B.R. 405, 413 (Bankr. E.D.N.Y. 2006) (quoting In re Georgetown Steel co., 306 B.R. 549, 556 (Bankr. D.S.C. 2004). Based on the information provided by the Debtors, the Employee Arrangements are being proposed to encourage its employees to remain with the Debtors through their tenure in Chapter 11. The Debtors, however, have not provided any details on which employees will be the beneficiaries of the proposed Employee Arrangements. It appears likely that some of the employees may be insiders. Therefore, to the extent that the Debtors are seeking an Order from the Court allowing the Debtors to incur an obligation for the benefit of any insider for the purpose of inducing such person to remain with the Debtors business, the Debtors must meet the requirements of Section 503(c)(1). Dana I, 351 B.R. at 100; Mesa Air Group, 2010 WL 3810899, at *2 (citing Global Home Prods., 369 B.R. at 785). As to the employees who are not insiders, the Debtors must still meet the requirements of Section 503(c)(3). Finally, as discussed below, no severance payments should be made except as provided under Section 503(c)(2). In short, the Debtors are not exempt from the requirements of Section 503(c). The fact that these payments will be made post-confirmation by Newco is not relevant. The determinative factors under a Section 503(c) analysis are the time when the services are rendered by the employees here, pre-confirmation and when the obligation to make the payments occurs. Should the Motion be granted, the obligation will be incurred pre-confirmation. Thus, by its plain meaning, the Debtors must comply with Section 503(c). To permit any other interpretation would be to allow these and other debtors to avoid the requirements of Section 503(c). 11
Pg 15 of 16 C. The Debtors Have Failed to Establish that the Severance Arrangement for Mr. Horton Complies with Section 503(c)(2) While the Motion fails to identify the insiders entitled to severance payments or the amount of the severance to which they may be entitled, the Motion does specifically provide for the $19.8 million CEO Severance. See Motion, 89. If, however, Section 503(c)(2) is applicable, the Debtors must provide sufficient information to establish that the CEO Severance satisfies the two pronged test of Section 503(c)(2)(A) and (B) that (i) the payment is part of a program that is generally applicable to all full-time employees and (ii) 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. The information in the Motion suggests that the CEO Severance is not part of a program generally available to non-management employees, and the Motion provides no evidence that the mean severance payment to non-management employees is equal to $1.98 million. As discussed above, aside from a brief mention in a footnote, the Debtors have failed to meaningfully address (i) why the changes to their employee compensation programs need not meet the requirements of Section 503(c), a provision enacted by Congress specifically to curtail payments such as those proposed herein and (ii) why a severance payment of nearly $20 million to an insider is permissible under Section 503(c). This $20 million payment will occur upon termination by the Debtors, even though the insider will be appointed to the Chairman of the Board of Newco and will be receiving the same cash and equity compensation as other nonemployee directors, with lifetime flight and other travel benefits. This type of severance payment is not part of a program generally applicable to all full-time employees. Moreover, $20 million, the amount of the proposed payment, is more than ten times the amount of the mean 12
Pg 16 of 16 severance pay given to non-management employees during the calendar year in which the payment is going to be made. IV. CONCLUSION WHEREFORE, the United States Trustee respectfully submits that the Court sustain the Objection of the United States Trustee and grant such other relief as is just. Dated New York, New York March 15, 2013 Respectfully submitted, TRACY HOPE DAVIS UNITED STATES TRUSTEE By /s/ Brian S. Masumoto Brian S. Masumoto Michael T. Driscoll Trial Attorneys 33 Whitehall Street, 21st Floor New York, New York 10004 Tel. No. (212) 510-0500 Fax No. (212) 668-2255 13