In re Nellson Nutraceutical, Inc.

• Decision Date: 24 May 2007
• Docket Number: No. 06-10072 (CSS).,06-10072 (CSS).
• Citation: 369 B.R. 787
• Parties: In re NELLSON NUTRACEUTICAL, INC., et al., Debtors.
• Court: U.S. Bankruptcy Court — District of Delaware

369 B.R. 787

In re NELLSON NUTRACEUTICAL, INC., et al., Debtors.

No. 06-10072 (CSS).

United States Bankruptcy Court, D. Delaware.

May 24, 2007.

COPYRIGHT MATERIAL OMITTED

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Laura Davis Jones, Curtis A. Hehn, Michael Seidl, Pachulski Stang Ziehl, Young Jones & Weintraub, Wilmington, DE, Brad R. Godshall, Alan J. Kornfeld, Pachulski Stang Ziehl, Young Jones & Weintraub, Los Angeles, CA, for Debtors and Debtors in Possession.

Robert S. Brady, M. Blake Cleary, Margaret B. Whiteman, Young Conaway Stargatt & Taylor, LLP, Wilmington, DE, Fred S. Hodara, Abid Qureshi, Akin, Gump, Strauss, Hauer & Feld, New York, NY, Scott L. Alberino, Akin, Gump, Strauss, Hauer & Feld, Washington, D.C., for Informal Committee of First Lien Lenders.

Kurt F. Gwynne, Thomas J. Francella, Jr., Reed Smith, LLP, Wilmington, DE, Claudia Springer, Reed Smith, LLP, Philadelphia, PA, for Official Committee of Unsecured Creditors.

Richard W. Riley, Duane Morris, LLP, Wilmington, DE, James J. Holman, Duane Morris, LLP, Philadelphia, PA, Linda Dakin-Grim, Gregory A. Bray, Thomas R. Kreller, Jason B. Bairn, Milbank, Tweed, Hadley. & McCoy, Los Angeles, CA, for UBS AG, Stamford Branch.

William K. Harrington, Trial Attorney, Office of United States Trustee, Wilmington, DE, for Kelly Beaudin Stapleton, United States Trustee for Region 3.

OPINION¹

CHRISTOPHER S. SONTCHI, District Judge.

Introduction

Before the Court is the Debtors' Precautionary Motion For Order Approving Modification To Ordinary Course Bonus Compensation Program For Employees [Docket No. 1222]. Through the motion, the Debtors seek the Court's approval to modify the Debtors'"ordinary course employee bonus compensation program" for the calendar year 2006 (the "2006 OCP").² The Debtors' motion raises a number of issues relating to the interplay between section 363(c)(1) of the Bankruptcy Code, which provides that "the [Debtors] may enter into transactions ... and may use property of the estate in the ordinary course of business without notice and a hearing," and section 503(c) of the Bankruptcy Code, which severely limits the Debtors' ability to pay retention bonuses, severance, and other amounts. More specifically, the motion concerns the scope of the Court's inquiry in determining whether to approve the Debtors' use of property in the ordinary course of business to make payments governed by section 503(c) of the Bankruptcy Code. Is the Court's inquiry limited to whether the Debtors are making payments in the ordinary course of business and application of the standard governing such transactions or does section 503(c) of the Bankruptcy Code impose additional criteria (and, if so, what criteria) that must be satisfied before such payments can be approved by the Court?

In evaluating the motion, the Court must address the following questions: (i) is the Debtors' proposed modification to the 2006 OCP a transaction or use of property that is "in the ordinary course of business" under 363(c)(1) of the Bankruptcy Code and, if so, have the Debtors satisfied the standard governing such transactions; (ii) is section 503(c)(1) of the Bankruptcy Code, which limits retention payments to insiders, applicable to an otherwise valid transfer made in the ordinary course of business to "an insider of the debtor for the purpose of inducing such person to remain with the debtor's business;" (iii) assuming section 503(c)(1) is applicable, is the modification of the 2006 OCP a `transfer to "an insider of the debtor for the purpose of inducing such person to remain with the debtor's business;" and (iv) is section 503(c)(3) of the Bankruptcy Code, which limits "other transfers ... that are outside the ordinary course of business," including payments to officers, managers or consultants, applicable to an otherwise valid transfer made in the ordinary course of business, notwithstanding the limitation on the face of the statute to the contrary.

Applying the horizontal and vertical dimensions test articulated by the Third Circuit, the Court finds that the modification of 2006 OCP is within the ordinary course of the Debtors' business under 363(c)(1) of the Bankruptcy Code. The Court further finds that the Debtors have satisfied the standard governing transactions in the ordinary course of business.

The Court also finds that section 503(c)(1) is applicable to an otherwise valid "transfer made in the ordinary course of business to an insider of the debtor for the purpose of inducing such person to remain with the debtor's business." Nonetheless, the Court finds that the modification of the 2006 OCP is not such a transfer.

Finally, the Court finds that section 503(c)(3) is specifically limited to transactions outside of the ordinary course of business and, thus, is not applicable to the modification of the 2006 OCP.

Jurisdiction

This Court has jurisdiction over this matter pursuant to 28 U.S.C. § 1334. Venue of this proceeding is proper in this district pursuant to 28 U.S.C. §§ 1408 and 1409. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(A)(B), (M) and (0).

Statement of Facts

General Background

On January 28, 2006, Nellson Nutraceutical, Inc. and certain of its affiliates (collectively, the Debtors) filed voluntary petitions, for relief under chapter 11 of the Bankruptcy Code. The Debtors continue to operate their business as debtors in possession under sections 1107(a) and 1108 of the Bankruptcy Code.

The Debtors are contract manufacturers of nutritional bars and powders. As such, the Debtors do not manufacture or sell products under their own label. Rather, the Debtors develop and produce products for sale by their customers.

2006 Employee Incentive Programs

In January, 2006, prior to the filing of these Chapter 11 cases, the Debtors implemented a key employee retention plan (the "KERP") that provided for payment to nine management employees (all of which are "insiders" under section 101(31) of the Bankruptcy Code) in the aggregate amount of $710,000 upon the occurrence of the earlier of a termination of employment without cause or a "capital event" involving a sale of the Debtors' business or a restructuring of its capital structure.

Almost immediately after the filing of these Chapter 11 cases, in April, 2006, the Debtors implemented two separate incentive plans for certain of its employees. The first such plan was a management incentive plan ("MIP"), which replaced the KERP. Under the MIP, the Debtors established a bonus pool of approximately $1.4 million to provide incentive to the same nine management employees (and insiders) covered under the KERP to assist the Debtors in the effort to restructure the Debtors' business. Unlike the original KERP, payment of the bonuses under the MIP was to be earned by the achievement of certain EBITDA targets for 2006, which were described as "performance milestones."³ After conducting a two-day trial on the matter, the Court entered an order in July, 2006, approving the MIP. Ultimately, the Debtors paid bonuses totaling approximately $550,000 under the MIP as the Debtors did not achieve all of the performance milestones. No further payments under the KERP or the MIP are due to any of the Debtors' employees.

In April 2006, the Debtors also implemented the 2006 OCP. The 2006 OCP is an employee incentive plan covering approximately 130-140 employees divided into six categories. Under the 2006 OCP, the Debtors established a bonus pool of approximately $2.1 million to motivate employees to "keep momentum going forward... in both sales and EBITDA." Hr'g. Tr. 40, Apr. 23, 2007. But see Debtors Ex. 2 ("For 2006, the purpose is to build EBITDA."). The categories under the 2006 OCP and their respective share of the bonus pool are set forth below:

                -------------------------------------------------------------------------------
                                                                        Approximate
                Number of
                Covered Bonus Pool
                Category Description of Covered Employees Employees ('000)
                -------------------------------------------------------------------------------
                Level I         Management level officers, including the      8         $1,037
                                Chief Executive Officer, Chief Financial
                                Officer and various vice presidents of the
                                Debtors
                -------------------------------------------------------------------------------
                Level II        Operational directors4 of the Debtors,  14         $  490
                                including Director of Purchasing, Director
                                of Manufacturing and Director of Finance
                -------------------------------------------------------------------------------
                Level III       Managers, including R & D Managers,          32         $  469
                                Materials Managers and Maintenance
                                Managers
                -------------------------------------------------------------------------------
                Sales Directors Director level employees in charge of         3         $   27
                                sales to customers
                -------------------------------------------------------------------------------
                Sales Managers  Manager level employees in charge of          5         $   16
                                sales to customers
                -------------------------------------------------------------------------------
                Line Managers/  Employees responsible for managing the       71         $ 87.6
                Office Staff    day-to-day tasks of the Debtors
                -------------------------------------------------------------------------------
                Total 131 $2,126.6
                -------------------------------------------------------------------------------
                

For Level I, Level II and Level III employees, payment of the bonuses under the 2006 OCP was "totally based on achievement of the Consolidated Budgeted EBITDA level" for 2006, which was $43.2 million. Debtors Ex. 2. For the remaining employees, payment of the bonuses was based on other criteria, such as sales earnings or hours worked. Id.⁵

Under the 2006 OCP, the Level I, II and III employees...