In re Country Fresh Holding Co.

IN RE: COUNTRY FRESH HOLDING COMPANY INC., et al, Debtors.

CASE NO: 21-30574

UNITED STATES BANKRUPTCY COURT FOR THE SOUTHERN DISTRICT OF TEXAS HOUSTON DIVISION

July 12, 2021

Jointly Administered

CHAPTER 7

MEMORANDUM OPINION

Country Fresh Holding Company, Inc. seeks authority to implement a Key Employee Incentive Program (KEIP). Under Country Fresh's KEIP, five key Country Fresh employees will receive bonuses, but only if those employees achieve certain performance-based objectives. To implement its KEIP, Country Fresh had to demonstrate that the KEIP properly incentivizes the five employees as required by 11 U.S.C. § 503(c). Section 503(c) generally prohibits a debtor from making retentive payments to "insiders." Several parties-in-interest, including the United States Trustee and the Official Committee of Unsecured Creditors, argue that Country Fresh's proposed KEIP is a retention-based payment program prohibited by § 503(c)(1).

Although Country Fresh's proposed KEIP incentivizes the key employees, portions of the KEIP's compensation structure are not justified by the facts and circumstances of Country Fresh's bankruptcy. Country Fresh's KEIP Motion is granted in part and denied in part.

This Memorandum Opinion is issued after the close of Country Fresh's asset sale. However, the KEIP's merits must be evaluated as of the date of the KEIP's proposal, and this opinion assesses its "incentives" prospectively.

BACKGROUND

One month following its entry into chapter 11, Country Fresh proposed a "Key Employee Incentive Program." Country Fresh's proposed KEIP is aimed at five key Country Fresh employees. Under the KEIP, these five employees will be awarded bonuses if Country Fresh achieves certain objectives. The parties opposing County Fresh's proposed KEIP¹ take issue with these objectives, arguing that the objectives are too easy to achieve.

Country Fresh's Bankruptcy

Country Fresh and its affiliate debtors entered bankruptcy in February 2021.² (ECF No. 1). Like many commercial debtors over the last year, the COVID-19 pandemic thrust Country Fresh into dire financial straits. (ECF No. 18 at 3). When it entered chapter 11, Country Fresh had already determined that its best path through bankruptcy would be a sale of substantially all of its United States and Canadian assets. (ECF No. 18 at 4).

Roughly one month before filing for chapter 11 relief, Country Fresh received a letter of intent from Stellex Capital Management. (ECF No. 18 at 5-6). Stellex proposed to purchase substantially all of Country Fresh's U.S. and Canadian assets for $30 million in cash plus a secured note with a $25 million face value.³ (ECF No. 18 at 16-17). At the time it entered bankruptcy, Country Fresh "believe[d] this to be the best price attainable in the market for [its] assets." (ECF No. 18 at 17).⁴

In connection with its asset sale, Country Fresh held an auction to ensure it obtained the best possible price for its assets. (See ECF No. 164). The auction resulted in a gross bid of $68 million for substantially all of Country Fresh's assets. (Mar. 31, 2021 Hearing at 10:00:00 AM, 11:53:32 AM). After deductions, the net sale price of Country Fresh's assets was approximately $13.2 million over the Stalking Horse bid.⁵ (See Mar. 31, 2021 Hearing at 10:00:00 AM, 11:53:35 AM, 11:53:51 AM).

Country Fresh completed its asset sale process on April 29, 2021. (ECF No. 548 at 1).

Country Fresh's KEIP

Between the petition date and the sale's completion, Country Fresh moved for approval of its KEIP. (See ECF No. 275). The KEIP's focus is on five members of Country Fresh's management team: (1) William Andersen, President and CEO; (2) Art Innis, CFO; (3) Jay McMillan, Executive Vice President of Operations; (4) German Suarez, Executive Vice President of Food Safety; and (5) Debra Lawson, Executive Vice President Human Resources (collectively, the "KEIP Participants").⁶ (ECF No. 275 at 4). The KEIP Participants are "responsible for the overall strategy and direction of [Country Fresh's] business." (ECF No. 275 at 4). Country Fresh contends that, in addition to their usual job responsibilities, the KEIP Participants devoted significant time to preparing Country Fresh for chapter 11 and "laying the foundation for the sale process." (ECF No. 275 at 4-5). Country Fresh maintains that the KEIP Participants continued to shoulder these additional responsibilities postpetition. (ECF No. 275 at 5). Because the KEIP Participants are "integral" to Country Fresh's reorganization process, Country Fresh's position isthat it is imperative to incentivize the KEIP Participants to work toward a successful reorganization. (ECF No. 275 at 5, 13).

To incentivize the KEIP Participants, Country Fresh proposes to award bonuses based on two objectives: a fill-rate objective and a sale price objective. (ECF No. 275 at 5). First, the KEIP Participants will be awarded bonuses amounting to 25% of their base salaries if Country Fresh maintains a post-petition aggregate "fill rate"⁷ of 95.5% until the closing of its asset sale. (ECF No. 275 at 5). Country Fresh justifies using fill rate as a KEIP objective because it is a "challenging benchmark that will benefit [Country Fresh]" and its reorganization efforts. (ECF No. 275 at 7-8). Second, the KEIP Participants will also receive incrementally increasing bonuses based on the eventual sale price of Country Fresh's assets. (ECF No. 275 at 8). Specifically, the KEIP Participants will receive $123,550 in aggregate bonuses for every $1 million received above the "Stalking Horse Bid." (ECF No. 275 at 8). Initially, Country Fresh's KEIP imposed a cap on the sale-based bonus each KEIP Participant, except Mr. Andersen, could receive. (ECF No. 275 at 8-9).

The Objecting Parties take issue with both targets.⁸ The Objecting Parties argue that Country Fresh cannot demonstrate that the fill-rate target adequately incentivizes the KEIP Participants. (See ECF Nos. 376 at 6; 388 at 7-8). While the Objecting Parties concede that Country Fresh can use historical data to establish the difficulty of achieving the fill-rate target, they point out that sufficient data is absent from the record. (ECF Nos. 376 at 6; 388 at 8).

The Objecting Parties also argue that the sale price target fails to adequately incentivize the KEIP Participants. (ECF Nos. 376 at 7-8; 388 at 8). Driving the Objecting Parties' opposition to the sale price incentive is the fact that Country Fresh's asset sale was almost complete at the time Country Fresh proposed the KEIP. (ECF Nos. 376 at 8; 388 at 8). The Objecting Parties also contend that the KEIP Participants' efforts will have little effect on a "bidder['s] own business judgment" in valuing Country Fresh's assets. (ECF No. 376 at 7). According to the Objecting Parties, Country Fresh's Chief Restructuring Officer, not the KEIP Participants, is primarily responsible for the increased sale price. (ECF No. 376 at 7).

Based on their conclusion that the KEIP targets fail to properly incentivize the KEIP Participants, the Objecting Parties maintain that the KEIP is a disguised retention plan. (See ECF Nos. 376 at 8-9; 388 at 8).

The KEIP Hearing

Following the parties' briefing, the Court set Country Fresh's KEIP Motion for an evidentiary hearing. Country Fresh called two witnesses in support of its proposed KEIP, Michael Krakovsky, Country Fresh's investment banker, and Stephen Marotta, Country Fresh's Chief Restructuring Officer. (See ECF No. 444).

Mr. Krakovsky's testimony detailed Country Fresh's sale process and Mr. Andersen's contributions to that process. (Mar. 31, 2021 Hearing at 10:50:00-11:17:00 AM). According to Mr. Krakovsky, Mr. Andersen's efforts generated more interest in Country Fresh's assets than existed at the time the Stalking Horse Bid was made. (See Mar. 31, 2021 Hearing at 10:57:20 AM). Mr. Krakovsky also noted that Mr. Andersen's efforts led to substantially increased bids for Country Fresh's assets. (See Mar. 31, 2021 Hearing at 11:01:00 AM). The Objecting Parties donot dispute Mr. Krakovsky's characterizations of Mr. Andersen's efforts and the role Mr. Andersen played in Country Fresh's sale process.

Mr. Marotta, the KEIP's self-proclaimed designer, provided insight into the KEIP's creation, the rationale underlying its targets, and the compensation associated with the KEIP targets. (See Mar. 31, 2021 Hearing at 11:18:50 AM-12:00:00 PM). Mr. Marotta began by laying out the rationale behind using fill rates as a performance target. According to Mr. Marotta, Country Fresh's ability to maintain high fill rates directly affects its ability to operate as a going concern. (See Mar. 31, 2021 Hearing at 11:19:20 AM). Moreover, in the immediate aftermath of its bankruptcy filing, Country Fresh's fill rate fell due to skittish suppliers and carriers. (See Mar. 31, 2021 Hearing at 11:19:20-11:28:45 AM). Mr. Marotta described the work the KEIP Participants needed to perform to return Country Fresh's fill rates to their pre-petition levels, noting the post-petition responsibilities of each KEIP Participant. (See Mar. 31, 2021 Hearing at11:28:45-11:37:45 AM). Based on his judgment and past fill-rate data from Country Fresh, Mr. Marotta determined that a 95.5% fill rate would be a challenging mark to achieve. (See Mar. 31, 2021 Hearing at 11:22:00 AM, 11:24:30 AM, 11:43:10 AM).

Mr. Marotta's testimony regarding Country Fresh's sale mirrored Mr. Krakovsky's. That is, Mr. Marotta confirmed that Mr. Andersen played a vital role in generating interest in substantially all of Country Fresh's assets. (See Mar. 31, 2021 Hearing at 11:19:20 AM). Mr. Marotta also credited the increased sale price to Mr. Andersen's pre- and post-petition marketing efforts. (See Mar. 31, 2021 Hearing at 11:38:00 AM, 11:46:00 AM). Though it was Mr. Andersen's efforts that primarily led to the increased sale price, Mr. Marotta explained that the other KEIP Participants were also necessary to Country Fresh's marketing and sale process. (See Mar. 31, 2021...