In re Friedman's, Inc.

• Court: U.S. Bankruptcy Court — Southern District of Georgia
• Writing for the Court: Lamar W. Davis, Jr.
• Citation: In re Friedman's, Inc., 336 B.R. 891 (Bankr. S.D. Ga. 2005)
• Decision Date: 04 April 2005
• Docket Number: No. 05-40129.,05-40129.
• Parties: In the matter of FRIEDMAN'S, INC., et al., Debtors.

Page 891

336 B.R. 891

In the matter of FRIEDMAN'S, INC., et al., Debtors.

No. 05-40129.

United States Bankruptcy Court, S.D. Georgia, Savannah Division.

April 4, 2005.

Kathleen Horne, Savannah, GA, for Debtors.

MEMORANDUM AND OPINION ON DEBTORS' MOTION TO IMPLEMENT A KEY EMPLOYEE COMPENSATION PROGRAM

LAMAR W. DAVIS, JR., Bankruptcy Judge.

Debtors' cases were filed on January 14, 2005. On March 11, 2005, the Debtors filed a Motion for Order Authorizing the Debtors to Implement a Key Employee Compensation Program ("KECP") (Doc. # 358) pursuant to Sections 363(b)(1) and 105 of the Code. By implementation of the program the company hopes to stabilize its cadre of key personnel beginning with its CEO and extending through a total of 83 employees down to the store manager level. The KECP is intended to stabilize the workforce, reassure the employees that continuing to serve the company is in their economic self interest, and to provide incentive bonuses for performance if certain targets are reached.

Although it is similar in many respects to incentive programs established in other Chapter 11 cases which have been the subject of controversy and some criticism, the Debtors have structured this program to award performance and successful exit from Chapter 11 and not merely to reward employees' retention or merely remaining on the payroll. Debtors reviewed incentive programs established in other retail Chapter 11 proceedings and received substantial input from its financial advisors, legal advisors, and compensation experts. It reviewed the existing compensation structure and existing employment contracts with certain employees. Debtors believe they incorporated the most effective incentive components that they found in other employee plans in order to align the interest of key employees with the Debtors' shareholders and creditors and to strike a balance between the retention and motivation of key employees and the fiduciary obligation to maximize creditor and shareholder recoveries.

The KECP contains three elements: (1) an annual incentive plan; (2) a severance plan; and (3) an exit plan. In the incentive portion of the plan the Debtors used as a starting point their pre-petition annual incentive program, but raised the performance targets to create greater incentives on the employees' part to create value in the company. The targets for eligibility for annual bonuses depend on whether the Debtors achieve their projected EBITDAIR (Earnings Before Interest Expense Taxes Depreciation Amortization Investigation and Restructuring Expenses). Under the plan no key employee will receive an annual bonus unless the company achieves 100% of EBITDAIR and even in that event the eight most highly paid employees, including the Chief Executive Officer, Mr. Cusano, will receive no annual bonus. If Debtors achieve 170% or 200% of EBITDAIR all key employees will receive an annual bonus and to the extent the Debtors exceed 100% of EBITDAIR, but fall short of 170%, the top eight employees will receive a pro-rata portion of the 170% bonus level.

The second component, severance pay, is payable to the key employees if any of them is involuntarily terminated as a result of the corporate restructuring process that takes place within this Chapter 11 proceeding. Finally, the exit plan component provides cash and in some instances stock to key employees in varying amounts if the company emerges from Chapter 11 with a confirmed plan. The maximum in equity that can be granted at a nominal price or purchased at a price approximating fair market value is 10% of all equity in the company. The plan is detailed and far more complex than this general outline and the full terms, of course, are contained in the record. However, with respect to the issues before the Court, this general outline should suffice.

A limited objection was filed by certain shareholders of Friedman's, Regis Special Situations Fund, LLP, and the Yacktman Funds, Inc., hereinafter referred to as "R&Y." The objection stated that R&Y did not oppose, in concept, an employee benefit plan to reasonably compensate employees for the extra burden of the Chapter 11 proceeding. The objection, however, argued that insufficient information was being provided to support the Motion, and that the Debtors had failed to demonstrate a reasoned business justification for changing their existing incentive program or for the granting of cash and equity to certain key employees following confirmation of a Chapter 11 plan.

The matter was heard by the Court on March 31, 2005, and testimony was offered by Sam Cusano, President and CEO of the Debtor; Ronald Tucker, co-chair of the Creditors' Committee; Norman Deep, an independent director serving on the Board since May of 2004 and chair of the Compensation Committee; William Q. Derrough, Managing Director of Jeffries & Company, the financial advisors and investment bankers appointed to serve the Debtors; Justin Fossbender of Watson Wyatt Worldwide, an executive compensation consultant hired by the Compensation Committee of the Board of Directors; and Sal LoBiondo of Kroll Zolfo Cooper, financial advisors to the Debtors. These witnesses were subject to examination and thorough cross-examination, but no fact or expert evidence was offered by the objecting parties R&Y. Based on the testimony, I make the following Findings of Fact.

FINDINGS OF FACT

It is customary and often necessary, in order to provide for continuity of leadership and effective management of a debtor in reorganization, for a meaningful compensation program to be created. These programs are common, wide-spread and ordinarily justified and justifiable. However, they have been subject to criticism in some quarters. See, e.g., Official Comm. of Unsecured Creditors v. Henry Mayo Newhall Mem'l Hosp. (In re Henry Newhall Mem'l Hosp.), 282 B.R. 444 (B.A.P. 9th Cir. BAP 2002). The Creditors' Committee has thoroughly reviewed the terms of the KECP and believes it is a necessity in order to improve the prospects of a successful reorganization. The Committee recognizes that this is a difficult area and one in which the balancing of interests is an extraordinarily fine art. The Committee has a fiduciary obligation to its creditors and reviewed this program in furtherance of its statutory obligations. The initial program proposed during informal discussions was, in the opinion of the Committee, overly generous. Subsequent modifications to the program sought by the Committee which raised the incentive thresholds and substituted equity for some cash benefits were more acceptable to the Committee, and the Debtors' management was responsive to those suggestions. The Committee in general prefers performance-based programs and believes that this program, as presented, meets that classification. Because the thrust of the program is based on performance rather than mere retention of key employees, the Committee supports its approval. Stability and continuity in senior management are critical to the success of this company, and compared to other plans members of the Committee are familiar with, the plan is fair and reasonable, and calculated to maximize the value of the company.

In addition to the Committee's review, the Board of Directors of the company took a visible and pro-active role in the negotiation of the terms of this proposed program. Chair of the Board of Directors' Compensation...