Despite Lawsuit, Enron Bonuses Remain Unreturned

MITCHELL PACELLE / Wall Street Journal 2nov03

In January, lawyers representing thousands of former Enron Corp. employees mailed threatening letters to 292 former executives who collected bonuses as large as $8 million on the eve of the company's bankruptcy. The message: Give back the bonuses within 30 days or we will sue.

More than nine months and several lawsuits later, former employees are still waiting. The litigation continues, and most bonus recipients haven't surrendered any of their pay-outs, which totaled roughly $73 million. In court papers, many have argued that they deserved them.

The showdown, with its David-and-Goliath overtones, is playing out in federal bankruptcy court in Houston. It represents one of the few instances during recent corporate scandals in which lower-level employees have mounted a legal assault on top executives thought to have rewarded themselves as their companies collapsed.

The outcome, however, is likely to turn more on fine points of bankruptcy law than on any analysis of whether the bonuses were deserved. At collapsing companies, retention bonuses are often regarded as necessary to keep key executives from quitting. But they are nearly always awarded after a bankruptcy filing, with court approval. Enron recipients maintain that their bonuses were not only proper but necessary for the company.

Outrage among rank-and-file workers over executive pay has been a flash-point at other ailing companies as well. In April, Donald J. Carty resigned as chairman and chief executive of AMR Corp. after failing to disclose special bonuses and pension protections for senior American Airlines executives, just days after unions agreed to large concessions ostensibly to avert a bankruptcy filing.

From time to time, bankrupt companies themselves go after such eleventh-hour payments. Kmart Corp., which emerged in May from protection, is attempting to claw back some $30 million of "retention loans" paid to executives prior to its Chapter 11 filing. A decade ago, thrift regulators sued former employees of Drexel Burnham Lambert Inc. for the return of more than $250 million of bonuses paid prior to the firm's bankruptcy. Many Drexel employees agreed to surrender a portion of the assets.

"We couldn't understand why people needed extra money to stay at Enron, since that was a far superior position to be in than out on the street in a declining energy market," explained Richard Rathvon, one of more than 4,000 employees laid off around the time of the bankruptcy filing. Mr. Rathvon, a former Enron senior director who has since found work with another energy company, is co-chairman of the employment-related-issues committee that brought the suits.

In recent weeks the employee committee also has taken aim at another target: about $53 million in deferred compensation paid to Enron executives about a month before the filing. On Oct. 1, New York law firm Kronish Lieb Weiner & Hellman sent letters to 40 former Enron executives. The letters demanded the return within 30 days of 90% of roughly $30 million they received in deferred compensation, or they would likely face lawsuits. Similar demands are planned for additional recipients.

The two initiatives, which claim the payments weren't permissible under bankruptcy law, seek to recoup as much as $125 million in payments to selected Enron officers and employees. The potential recoveries would be used to supplement severance payments already made to laid-off employees, which were capped at $13,500.

Lawyers for the committee say that some bonus recipients have chosen to settle the claims on an individual basis, although terms of those settlements remain confidential. But lawyers representing many recipients, including some of the highest-paid, say no settlements are imminent.

Bankruptcy experts say that the Enron bonuses were vulnerable to criticism because they were so large and were paid immediately before the bankruptcy filing, not after. "As a general rule, eve-of-bankruptcy bonuses are not a smart thing to do," said New York bankruptcy lawyer Brad Scheler.

"These things have gotten more controversial over the past couple of years, because of the size of the companies and the numbers involved," said Chicago bankruptcy lawyer James H.M. Sprayregen.

Yet it is far from certain whether former Enron employees will be able to recoup the payments under Chapter 11 bankruptcy law. The outcome could hinge on whether the size of the bonuses and the circumstances under which they were awarded are justifiable under bankruptcy law.

The individual bonuses range in size from $5,000 to $8 million. They were awarded to a broad range of senior employees, with an emphasis on energy traders.

Three days before Enron's bankruptcy filing, for example, former Enron President Jeffrey McMahon, then chief financial officer, was awarded a $1.5 million bonus, in exchange for a commitment to remain at the company for 90 days.

"Yes, it is a lot of money," said Woodlands, Texas, lawyer Tom Kirkendall, who represents Mr. McMahon. "But executives at companies the size of Enron receive a lot of money in compensation." Mr. McMahon's wasn't out of line, he maintains.

Enron's energy traders account for the largest pool of bonus money, with many collecting checks many times the size of their base salaries, court filings allege: John D. Arnold, an Enron vice president with a base salary of $160,000, received an $8 million bonus; John J. Lavorato, whose base salary was $360,000, received $5 million; Michael Swerzbom, a vice president with a $200,000 salary, received $2.6 million.

Lawyers for bonus recipients have mounted a variety of legal defenses to the bonus claw-back effort. Mr. Arnold, for example, moved to dismiss the complaint, arguing that the former employees hadn't proved that Enron's energy-trading unit was technically insolvent when he got his bonus.

Mr. McMahon has also argued in a motion to dismiss that he is entitled to the bonus. He was elevated to president and chief operating officer after the bankruptcy filing, but resigned in April 2002 after questions were raised about his role in a contentious Enron financing. In September, he motioned to stay the proceedings due to "ongoing criminal investigations that may involve Mr. McMahon's actions" as a former Enron officer, the motion said. He declined to comment, through his lawyer.

Federal bankruptcy law empowers bankrupt companies to recover certain payments made during the 90 days prior to a filing.

In August of 2002 the employee committee was assigned the right to attempt to recover the bonus money.

The committee argues that bankruptcy law entitles it to take back the bonus payments, for two reasons.

Some of the payments, the committee argues, are "preference payments," a bankruptcy-law term that refers to money paid out to one group of creditors at the expense of another, within 90 days of a bankruptcy filing and when a company is insolvent.

In addition, the committee contends, they constitute "fraudulent transfers," payments made with the intent to hinder or defraud other creditors.

Under bankruptcy law, if Enron didn't receive "reasonably equivalent value" for the money paid, the payments are recoverable.

Houston lawyer Mark Maney, who represents the committee, argues that the larger bonuses don't meet the value test.

More than 150 bonus recipients became employees of UBS AG when that firm took over Enron's energy-trading operations in February 2002.

Those bonus recipients have argued in court papers that Enron received "reasonably equivalent value" for the payments, because the retention of the traders allowed Enron to complete the transaction.