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Economics Beats The Law Even In Bankruptcy

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It’s an oft tried tactic, to pass some law or other to make the world a better place. Well, obviously enough, that’s rather the purpose of having the law and passing new ones. However, there are times when the new laws fly in the face of economic rationality. At which point, which wins? The law or the economic reality? No, not should win – for of course the intentions of those who passed the law must be obeyed, obviously – but which does win?

It ain’t the law:

Nearly a third of more than 40 large companies seeking U.S. bankruptcy protection during the coronavirus pandemic awarded bonuses to executives within a month of filing their cases, according to a Reuters analysis of securities filings and court records.

The point being that according to the law this shouldn’t be happening. For back in 2005 a law was passed saying that the executives of bankrupt companies shouldn’t be awarded bonuses.

Under a 2005 bankruptcy law, companies are banned, with few exceptions, from paying executives retention bonuses while in bankruptcy. But the firms seized on a loophole by granting payouts before filing.

For example, here’s Neiman Marcus which went bust a couple of months back. They want to pay such bonuses:

Neiman Marcus is asking a federal bankruptcy court in Texas to allow almost $10 million in pay raises for CEO Geoffroy van Raemdonck and seven other executives as the company goes through debt restructuring.

The proposed compensation plan covers staff who are “critical to day-to-day operations” and Neiman Marcus’ financial success during the bankruptcy process, according to a court filing.

They didn’t pre-organise it so are now having to ask the court. And it’s not certain that they’ll get it either. As to why they’re asking:

“In light of these pressures and the additional challenges of the Chapter 11 filing, it is critical that the debtors implement the KEIP (compensation plan) immediately to ensure that key employees remain with the debtors,” the filing said.

The jobs require more intense negotiations with customers, vendors and employees to convey a “business as usual” message needed for its restructuring, the company said. The COVID-19 pandemic has “further exacerbated” their jobs and made it more difficult to operate a company in bankruptcy.

Basically, it’s difficult to run a company in bankruptcy so those who are doing it would like some more money please. And if they don’t get it they’ll be off elsewhere to the detriment of the money recovery for the creditors.

It’s the same argument for having to pay people high wages in the first place. If you don’t you don’t get the people with the talents you need. For there really is a market out there for labour and you’ve got to pay the rate needed to attract it.

So, what happens when you’re not allowed to cough up more money to keep the management when you’re in bankruptcy proceedings?

Neiman Marcus’ pay raise plan goes against the typical timeline major companies follow during bankruptcy plans. Usually a company will give executive retention bonuses then file for restructuring.

Just organise it a little in advance.

Now, of course, that’s not breaking the law. Which is clearly why it’s being done that way. But it’s breaking the spirit of the law which is that execs don’t get beaucoups of cash in bankruptcy. And yet it’s an economic necessity that they do for otherwise they’ll sidle off to where they can get those beaucoups.

So, who has won here, the law or economic reality? Well, as so often happens, reality, of course it has. The lesson here being don’t try to pass laws which go against that grain of the universe out there. Because it’s going to happen anyway and all you’ve done is make it a little more expensive to the detriment of all involved.

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