Hostess Brands Inc. closed after a recent standoff with its striking bakers union. But relations between the Twinkie maker and workers were poisoned months ago amid disclosures that Hostess executives received pay raises not long before seeking bankruptcy protection. Although financially ailing companies such as Hostess Brands often pay bonuses and other compensation to executives and private-equity owners before filing for bankruptcy protection, Hostess's bankruptcy judge said during a hearing Thursday that the payments "will definitely be looked at" as he approved the company's request to start liquidating and lay off more than 18,000 employees. Hostess was exploring a potential bankruptcy filing in July 2011 when its board voted to boost the salary of its chief executive and others, according to creditors. Five months later, it filed for Chapter 11, its second bankruptcy filing in a decade. In April, creditors, including union representatives, cried foul: They alleged that Hostess made an end run around a federal law that restricts paying bonuses in bankruptcy cases before a judge could scrutinize them. Hostess later rolled back the salaries amid employee protests. Hostess's board approved the raises "long before" deciding on bankruptcy, rewarding executives for extra work, the company said. Federal law restricts "retention" bonuses paid to "insiders" (e.g., executives) after a bankruptcy case is filed but not before. Bonuses paid in and around bankruptcy often draw fire from creditors and employees angered by executives getting extra compensation while cutting jobs and benefits, and leaving investors with losses. To avoid running afoul of limits on bonuses that reward executives for sticking around during bankruptcy, companies craft incentive plans that compensate managers for meeting certain performance targets. But another way they can steer clear of the law's restrictions is by paying bonuses before filing for Chapter 11. Companies often say they are using their best business judgment when paying bonuses to executives who are working overtime to keep operations afloat. A firm's fate often isn't known when bonuses are paid, and companies argue they must motivate some executives to stay lest they suffer exoduses that further destabilize troubled situations. More than 1,600 insiders-executives and others controlling a company-received bonuses, salaries, fees and other compensation totaling more than $1.3 billion in the months before their companies filed for Chapter 11, according to a Wall Street Journal analysis of more than 80 bankruptcy cases over the past five years.
Blockbuster Inc. paid collective bonuses totaling roughly $775,000 to a dozen top executives and managers one week before its September 2010 bankruptcy filing, according to a banker and a consultant familiar with the plan. The timing was an effort to avoid scrutiny under the bankruptcy law limiting retention plans, they said. The plan included a $100,000 bonus for Block buster's general counsel, Rod McDonald, and payments to other managers, they said, but not the chief executive or finance chief. Blockbuster's bankruptcy planning was delayed during the summer of 2010, so the company paid the bonuses to avoid some employee departures, the consultant said. Mr. McDonald said in an e-mail that Blockbuster's board approved the "relatively small" bonuses as a "prudent step" to incentivize some executives to stay, and it would be "neither practical nor possible" to recruit replacements if they departed on the cusp of a Chapter 11 filing. Hostess in March 2011 hired outside lawyers, and the board "was formally preparing for a Chapter 11 filing on a 'parallel path' to its restructuring efforts," the company's creditors committee said in bankruptcy-court papers filed in April 2012 seeking to subpoena company documents and employees. On July 26, 2011, the board's compensation committee approved raises for then-CEO Brian Driscoll and several other top managers. A Hostess human-resources executive later testified in a deposition bankruptcy was "a possibility" at that time, creditors said. Mr. Driscoll's salary increased to $2.55 million from $750,000, and other executives' salaries increased, too, creditors said. Mr. Driscoll resigned in March and is now chief executive of Diamond Foods Inc. He declined to comment through a spokeswoman. The creditors alleged in bankruptcy-court papers that the "nature, amount and timing of these changes suggested that [Hostess] might have made these changes [before bankruptcy] to retain the executives and to sidestep the prohibitions on retention payments under" the Bankruptcy Code. Hostess received $60 million from Wall Street owners and lenders "for the express purpose of trying to help the company avoid Chapter 11," the company said, adding it wouldn't have received the money if bankruptcy was predetermined. The creditors withdrew their subpoena requests after Hostess rolled back executives' salaries.
Read this case and answer the following questions:
What happens to investors during a bankruptcy like this one?
Do you believe the executives in this case should receive bonuses? Why or why not?