In Jalbert v. Flanagan (In re F-Squared Investment Management), Adv. No. 17-50738-LSS (Bankr. D. Del. May 7, 2019), the trustee of a liquidating trust sought to avoid bonus payments by the debtors as fraudulent conveyances. Defendants moved to dismiss the fraudulent conveyance counts on the single ground that the trustee had failed to sufficiently plead lack of reasonably equivalent value, because the sole allegations in the complaints regarding value were that the bonuses were discretionary. The trustee argued that, as a matter of law, the payment of a discretionary bonus not tied to a previously enunciated metric was a per se fraudulent conveyance if made while the debtors were insolvent. In rejecting the trustee's argument, U.S. Bankruptcy Judge Laurie Silverstein of the District of Delaware held that whether the payment conferred value on the debtors was a factual question, and since the trustee did not intend to offer any further evidence in support of his claims, the motions to dismiss should be granted.

The debtors, F-Squared Management, and its subsidiaries, were investment management and research firms whose primary business was selling portfolio model services to investment advisers. In 2013, the SEC began an investigation into potential violations of federal securities laws related to the debtors' advertising of the model's track record. In 2014, the debtors agreed to a settlement with the SEC that required them to admit to false advertising, pay a $5 million penalty to the SEC, and disgorge $30 million in related profits. As a result, the debtors filed voluntary petitions under Chapter 11 of the U.S. Bankruptcy Code in 2015, and the plaintiff was appointed trustee of the F2 liquidating trust the following year.

Between December 2014 and March 2015, the debtors paid each defendant a bonus. The debtors' employee handbook provided for a discretionary annual cash bonus for all employees in good standing, and the opportunity to receive a bonus was also set forth in the defendants' respective offer letters.

The trustee filed complaints against each defendant seeking to avoid and recover the bonus payments as fraudulent transfers. The trustee argued that, as a result of the debtors' admitted securities law violations, they were insolvent since their inception, including when the bonus payments were made.

The defendants moved to dismiss the complaints, because the trustee failed to sufficiently allege the absence of reasonably equivalent value in connection with the bonus payments. They argued that the complaints contained no allegations with respect to the value the debtors received in exchange for the transfers, and were not sufficient to permit the court to draw a reasonable inference that the bonus payments conferred no value on the debtors. The natural inference in paying a discretionary bonus is that it brings value to the employer.

The trustee claimed that an employer receives no value for a discretionary bonus, because the employer has no obligation to pay it. Whether the defendants honestly, competently and diligently performed their jobs was irrelevant because, ultimately, the debtors could choose to make the bonus payments or not.

Silverstein noted that there were no allegations in the complaints that the bonus payments were excessive or not market-based, or that the defendants did not honestly and diligently perform their jobs. Nor were there any allegations that the defendants were involved in determining or awarding the bonus payments. There were also no allegations regarding the debtors' deliberations concerning the awarding and payment of the bonuses or what factors the debtors considered in making them. Significantly, at argument, the trustee's counsel stated that the trustee did not intend to introduce evidence on any of these topics should the matter proceed to trial. The trustee's theory was that the bonus payments, as a matter of law, conferred no value on debtors, because they were discretionary in nature and there were no pre-enunciated metrics in place prior to the work performed for the year in which the bonuses were granted.

Silverstein refused to conclude that the payment of a bonus pursuant to a discretionary bonus plan that does not contain any pre-enunciated performance or incentivizing metrics can never be for “value.” Whether value is received in a given transaction is inherently a factual question determined by reviewing the transaction at the time it occurred. However, the trustee did not plead in the complaints, and did not intend to offer at trial, any facts regarding the circumstances surrounding the awarding and payment of the bonuses. Instead, he argued that because the defendants had already received their salaries for work performed in 2014, any discretionary bonus could only be gratuitous and conferred no value on debtors.

Silverstein agreed with the defendants that, in the employment context, the common meaning of “bonus” is not “a gift or gratuity,” but rather payment in exchange for services or “consideration in addition to or in excess of the compensation that would ordinarily be given.” Normal experience and common sense suggest that the reasonable inference to be drawn from the awarding and payment of a bonus, discretionary or not, is that the employer paying the bonus believes the employee's receipt of the bonus confers value on the employer.

The trustee's analysis failed to take into consideration whether the debtors received any benefit—direct or indirect, tangible or intangible—from the payment of the bonuses. Silverstein concluded that it was easy to posit facts that would show that the payment of the bonuses conferred “value” on the debtors for purposes of Section 548. For example, it was not implausible that retention factored into the debtors' decision to pay the bonuses, since some of the payments were made a month after the debtors' laid off 30% of the work force and less than a week after debtors began cost-cutting and restructuring efforts. Rewarding your employees with a discretionary bonus (especially where the prospect of a bonus is included in both the employee handbook and the employee's offer letter) undoubtedly helps to create employee loyalty and increase morale, if nothing else. Failure to pay the bonuses, even if discretionary, could cause the company's best employees to seek employment elsewhere. The trustee's per se theory left no room for this outcome.

Value, concluded Silverstein, is an inherently factual question. It is also an element of a fraudulent conveyance action on which the trustee had the burden of proof. Silverstein could not conclude, as a matter of law, that the bonus payments conferred no value on the debtors simply because they were discretionary and without pre-enunciated performance metrics. Since the trustee eschewed offering any further evidence regarding the bonus payments, the fraudulent conveyance claims had to be dismissed.

The outcome of this case hinged on the fact that the complaints against the defendants made no allegations regarding the lack of reasonably equivalent value and the trustee chose to stand on those allegations (or absence of allegations) and not make any further offers of proof. The fact that he did so was perhaps a tacit admission that there was a bona fide reason for making the bonus payments that would translate into a finding of reasonably equivalent value. The fact that none of the defendants were involved in making the decision to pay the bonuses, and that all employees in good standing were eligible for the bonuses, even though discretionary, probably were factors that helped to tip the scales in their favor.

Barry M. Klayman is a member in the commercial litigation group and the bankruptcy, insolvency and restructuring practice group at Cozen O'Connor. He regularly appears in Chancery Court.

Mark E. Felger is co-chair of the bankruptcy, insolvency and restructuring practice group at the firm.