Clean Getaways

Several years ago, advisor Barry Glassman, a senior vice president with Cassaday & Company Inc., in McLean, Va., took on two new clients: a flight attendant and a pilot. What was special about them is that the airline they both worked for had recently filed Chapter 11 bankruptcy proceedings, so he had to go through contingency planning in the event that the reorganization turned into Chapter 7 liquidation or they lost their jobs. Planning for clients who work at troubled companies, he points out, is vastly different from planning for clients who work at financially healthy firms.

For one thing, if a client's employer goes into Chapter 11, it can have a significant impact on the client's wealth accumulation and retirement goals, says Larry Brown, a partner in private client services at PricewaterhouseCoopers LLP in Chicago. Furthermore, what to do for a particular client depends on whether or not that client is a senior executive or a member of the rank and file. In any case, adds Tim Speiss, a partner and practice leader at Eisner Personal Wealth Advisors in New York, when a client's employer is facing bankruptcy, an advisor needs to re-evaluate the client's financial plans and work to safeguard the employee's compensation and benefits.

There are a lot of things advisors can do to help such clients, even prior to the company's declaring bankruptcy.In fact, the best time to begin is at the beginning of the employment relationship. Most importantly, when negotiating the initial employment contract, make sure it contains provisions to protect the client should the employer file for bankruptcy. "You need to think things through when compensation is originally structured," says Speiss. This way, he adds, if the event occurs, the client is protected.

The effect of bankruptcy on severance should also be thought about when the initial employment contract is signed. If the employee's termination is a result of bankruptcy, negotiating a separate agreement would be a good strategy. An employment contract may state that stock options immediately vest upon termination. However, says Speiss, if the company files for bankruptcy, the stock options are usually worthless.

If clients sense their employer is having financial difficulties, it is also wise to advise them to put a home equity line of credit in place--before the company goes into Chapter 11, says Michael McLenigan, an advisor with Professional Financial Solutions LLC in Fairfax, Va. If the client is laid off, the line of credit can be used as emergency money. "It's a lot easier to get when they're still employed," he explains.

Once Chapter 11 is filed, however, it's time to start from the beginning of the planning process because it's likely that a portion of the client's wealth is at risk. "You have to go to square-one and see what they have, see what they can count on for the future and what's at risk," says Brown. Asset allocations need to be reviewed as well and possibly reallocated in light of the bankruptcy. For example, non-qualified deferred compensation is generally viewed as fixed income. Bankruptcy puts non-qualified deferred compensation at risk, so consider reallocating the portfolios to bring more balance and security to clients' accounts, Brown says.

It may be painful, but advisors should also counsel clients to start living as if they have already been laid off. "If there is a non-working spouse, advise them to find work, and clients must get conservative in spending until the uncertainty is gone," says McLenigan. If the company owes the client any money, encourage them to get it as quickly as possible, he adds.

Furthermore, although it sounds counterintuitive, if the client does get a lump sum payment--and if they can afford it--have them max out their 401(k) contributions, adds McLenigan. Once they are actually unemployed, he explains, they cannot make contributions to the 401(k) plan.

If at all possible, advisors should also encourage clients to renegotiate their employment contracts. Depending on their status in the company, clients may have some leverage to do this. Retaining key employees is often critical in Chapter 11 reorganizations. "Employee populations have to be preserved to come out of bankruptcy," Speiss says.

However, it does not necessarily follow that a client must be a senior executive to have negotiating leverage. If the employee is seen as someone key to the success of the reorganization, he or she is in a strong position to renegotiate a contract that will be accepted by the court and the creditors' committee. "You need to assess if someone is an important cog in the wheel needed to bring the company out of bankruptcy," says Brown.

If they are important, then it may be possible to negotiate a contract with cash-bonus potential, safeguards for deferred compensation and in some cases, equity. "You don't need to be an executive to get a retention bonus, stock options re-priced or additional benefits," says Glassman. Depending on the client's value to the company, he may be able to negotiate some non-salary benefits, he adds. To the greatest extent possible, the first goal should be getting cash compensation, says Speiss. He admits, however, that the ability to do that is somewhat circumscribed by the creditors committee.

There are other benefits to consider as well. For example, says Speiss, oftentimes in bankruptcy, health plans are cut back. It may not be something the employee can do anything about, but they can negotiate for more money to make up for the lost benefits.

Once the company files, McLenigan recommends that clients sell their company stock--even though prices have tanked-- and offset the losses against other gains. Alternatively, once the company is in Chapter 11, do not sell, but claim the stock has become worthless and take the losses. Clients should also retain records if they bought any company stock, says McLenigan. After the Chapter 11, there is always a class action lawsuit, and clients need those records to make a claim.

It's also the time to review estate documents, adds Brown. "It is a major life event, and you need to review the estate plan," he says. "It may have made beneficiary designations and funded trusts that may not make sense any more."

If clients have non-qualified deferred compensation (NQDC) plans, a number of issues arise. Non-qualified deferred compensation--even if funded by the clients themselves--is not protected by ERISA and is subject to the claims of creditors in bankruptcy, Speiss explains. Thus, risk exists that the client may lose all or part of this money.

There are, however, a number of insurers who will insure NQDC for executives, says Speiss. Several years ago, he worked with 30 executives of a Fortune 100 firm. The company had acquired a number of buildings that had asbestos problems. It was impossible to assess the asbestos risk, so the company went into bankruptcy, he explains. The bankruptcy filing put at risk close to $100 million in NQDC for the 30 executives.

Of course the executives wanted to take steps to protect their $100 million, so Speiss helped the group secure insurance protection on the NQDC. By obtaining the insurance, explains Speiss, the executives were protected even if the $100 million NQDC in the company coffers was seized to pay creditors. There is one proviso, Speiss warns. The client can buy insurance to secure their NQDC, but if the company does it, he says, it would trigger a taxable event. Thus, having the company obtain or pay for insurance on the NQDC is not advisable.

The executive group's stock options were also re-priced. Their stock options had been granted with exercise prices that did not reflect the current situation, says Speiss. For example, several had grants with a $15 exercise price. Prior to the bankruptcy, the stock price had been as high as $70, but afterwards, it hovered around $1.78. To help the executives, the company rescinded the previous options and gave them new options with a strike price of approximately $1.78.

Speiss acknowledges that rescinding and re-granting stock options is something of a delicate situation. Shareholders, he says, are not generally happy to see executives given new options at the current value. It's better to be seen as coming from the executives as part of the negotiations to retain, than coming from the company. The bottom line, he says, is it's best to advise clients to ask for the new options as part of their compensation negotiations.

It is not unusual to find that a major portion of senior executives' wealth lies in NQDC or equity-based plans. Therefore, when a company goes into Chapter 11, it often puts that portion of the executives' assets at risk. If an executive has significant amounts in a NQDC plan, it may be prudent, then, to review life insurance policies. Clients may need additional life insurance to counter-balance the risk of losing the NQDC funds, Brown says.

The risk/reward for executives is also much higher, says Glassman. "If they don't turn the company around, then it's harder for them to find a new job. But if they can turn it around, then there are higher rewards." Therefore, with executives, a lot of the planning requires getting into details of the incentive package and helping to negotiate, says Glassman.

Above all else, advisors also need to be sensitive to the fact that clients are going through traumatic times. Between 1999 and 2003, McLenigan worked in the finance department of WinStar Telecom which went into Chapter 11 in the spring of 2002. The company came out of Chapter 11 after it was purchased by another telecom company, and McLenigan never lost his job. But the stress of thinking he might was with him daily. During the period when the firm was in Chapter 11, McLenigan says he literally went into the office every day wondering if it was going to be his last day. "The uncertainty," he says, "is the hardest part."

[SIDEBAR]

Businesses, whether public or closely held, can petition under Chapter 11 of the Bankruptcy Code. After the filing, a creditors' committee is set up and can play a major role. The U.S. trustee appoints the committee, which ordinarily consists of creditors who hold the seven largest unsecured claims against the debtor. Among other things, the committee consults with the debtor in possession on administration of the case, investigates the debtor's conduct and operation of the business, and participates in formulating a plan. Essentially, says Tim Speiss of Eisner Personal Wealth Advisors in New York, the creditors' committee is set up to insure that company assets are protected and to make sure that compensation and benefits are fair to shareholders and creditors. "You want to keep creditors happy and don't want shareholders selling stock," he says.

In the event that the company fails to emerge from Chapter 11, and has to go Chapter 7, any negotiated arrangements are negated and the employee becomes an unsecured creditor--last to be paid after liquidation of assets and payments to secured creditors. --ERD

Elayne Robertson Demby, JD, has covered executive compensation, employee benefits, and financial issues for more than 10 years.