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Two US Trustee's Objections: to SCO's October Incentive Bonuses & to Confidentiality
Saturday, March 15 2008 @ 12:42 AM EDT

Hello! The US Trustee's Office has filed not one but two objections, an objection to the October incentive bonuses and a limited objection to the SCO request for a closed hearing about it:
398 - Filed & Entered: 03/14/2008
Objection
Docket Text: Objection to Debtors' Motion for a Determination that Incentive Bonuses for Quarter Ending October 31, 2007 were Paid in the Ordinary Course of Debtors' Business and for Continuing Authority to Pay Ordinary Course of Business Incentive Bonuses (related document(s)[344] ) Filed by United States Trustee (Attachments: # (1) Exhibit A -- Wage Motion # (2) Exhibit B -- Wage Order # (3) Exhibit C -- Excerpt of 9/18/07 Transcript # (4) Certificate of Service) (McMahon Jr., Joseph)

399 - Filed & Entered: 03/14/2008
Objection
Docket Text: Limited Objection to Debtors' Motion to Present Evidence and Testimony Related to the Debtors' 2007 Incentive Program Under Seal (related document(s)[345] ) Filed by United States Trustee (Attachments: # (1) Certificate of Service) (McMahon Jr., Joseph)

"11 U.S.C. Section 107 codifies the strong, compelling presumption of open access to judicial records and proceedings in civil matters," the US Trustee tells the court. There are some exceptions to that in a bankruptcy, but SCO doesn't fit into them, because SCO is a public company, and the SEC requires a public company to reveal the names of any insiders' compensation, so "the Debtors' argument lacks merit." So, you don't want to miss the hearing on this, for sure.

Update: We seem to have another case of redaction that isn't altogether effective, so I've pulled the first PDF, #398, but we have the redacted document as text now, and frankly you can figure out the redaction from what's left. I'll put it back up if it turns out to be OK to do so. If someone could do a PDF with proper redaction, that'd be great.

Update 2: The low-tech way to fix it if one had the original would be to scan and file as an image. But there are other ways. Judge David Nuffer in Utah's blog includes unofficial info for attorneys on how to do it. Here's a page he references on how to redact in Adobe 8, and there is a free trial offered here. And Adobe has a technical paper [PDF] that explains the why of it, why redaction sometimes fails in Word documents to PDF. In the past, we've cut out the redacted parts or covered them with paper fitting the redacted parts and then scanned and reconstructed the PDF. It's harder if you try to do it after the fact, of course.

As for the objection to the bonuses as being paid in the ordinary course, I think you'll notice that the US Trustee's Office has been reading what SCO has been filing, and the Office's representative assigned to this bankruptcy, Joe McMahon, has been paying attention and noticing what isn't matching up. I discern some real indignation in the tone. SCO, he states, didn't indicate this was an ongoing money trough. Rather, the Incentive Plan's payments were understood to be prepetition, not postpetition. Here's my favorite part, from page 4 of the PDF:

Third the Debtors expressly indicate that payments under the Incentive Plan were conditioned upon achievement of the Performance Metrics. Finally, the Debtors specifically identify one of the metrics as being a "net income" objective.

I believe my sense of humor comes from the understatement you find in the law. Do not those simple words tell you everything? And for us longtime onlookers, doesn't it make you smile? The sheer lunacy of giving the executives bonuses after they ran the company into bankruptcy is not lost on Mr. McMahon. According to the plan, bonuses are supposed to be contingent on meeting a "net income" goal. Did they?

Probably our favorite parts would the parts blacked out on page 5, if we could read them, that begin, "The Office of the United States Trustee learned that ...."[REDACTED]. But I note, and if I were SCO, I'd find this my least favorite part, that section ends, "At no time between the U.S. Trustee's aforementioned contact of the Debtors and the filing of the Motion did the Debtors communicate to the Office of the U.S. Trustee their belief that the fourth quarter bonus payments were authorized under the Wage Order." I think we may now presume that the US Trustee's Office has come to understand with whom they are dealing. Note paragraph 15:

15. The Debtors take the untenable position that this Court approved post-petition implementation of the Incentive Plan and the fourth quarter bonus payments. The Debtors never sought authority to implement the Incentive Plan post-petition, and this Court neither considered nor granted such authority; as described previously, the Debtors failed to include in the text of the Wage Motion a request for going-forward authority to implement the Incentive Plan. There is absolutely no support in the Wage Motion, the Wage Order, and/or the transcript of the "first day" hearing for the Debtors' thirteenth-hour attempt to find cover for their unauthorized, out-of-the-ordinary-course, post-petition bonus payments.

I'll translate from the understated legalese. I believe the man is saying that SCO is trying to pull a fast one. Good. Maybe the judge will now begin to realize also with whom he is dealing. If you recall, at the last hearing, he said SCO seemed to be making a good faith effort. Now what will he think? He'll be reading in the next paragraph where the document speaks of the "tangled web they have created for themselves." Do tell! Testify! The next page is blacked out almost completely. What comes through is the tone. He has SCO's number, at last, I see.

Remember when Judge Gross at the last hearing said he relied greatly on the US Trustee's Office? I hope he means it, because McMahon tells the Court that SCO incorrectly claimed that the Court approved post-petition implementation of the Incentive Plan, and that they have "placed themselves in violation of the Wage Order." They should have asked the court's permission to make the bonus payments, and since they didn't, the payments "are unauthorized post-petition transfers" and SCO's motion should be denied. Further, no post-petition Incentive Plan payments should be authorized going forward.

There are lots more filings since we last looked, but nothing one tenth as interesting as this, and I didn't want you to have to wait for the rest to be ready. Enjoy.

**************************

UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE

In re

THE SCO GROUP, INC., et al.,

Debtors

Chapter 11

Case Number 07-11337 (KG)
(Jointly Administered)
Hearing Date: April 2, 2008 at 2:00 P.M.

OBJECTION OF THE UNITED STATES TRUSTEE TO THE DEBTORS' MOTION
FOR A DETERMINATION THAT INCENTIVE BONUSES FOR QUARTER ENDING
OCTOBER 31, 2007 WERE PAID IN THE ORDINARY COURSE OF DEBTORS'
BUSINESS AND FOR CONTINUING AUTHORITY TO PAY ORDINARY COURSE OF
BUSINESS INCENTIVE BONUSES
(DOCKET ENTRY # 344)

In support of her objection to the Debtors' motion for a determination that incentive bonuses for the quarter ending October 31, 2007 were paid in the ordinary course of the Debtors' business and for continuing authority to pay ordinary course of business incentive bonuses (the "Motion"), Kelly Beaudin Stapleton, United States Trustee for Region 3 ("U.S. Trustee"), by and through her counsel, avers:

INTRODUCTION

1. Under (i) (an) applicable order(s) of the United States District Court for the District of Delaware issued pursuant to 28 U.S.C. 157(a) and (ii) 28 U.S.C. 157(b)(2)(A), this Court has jurisdiction to hear and determine the Motion.

2. Under 28 U.S.C. 586, the U.S. Trustee has an overarching responsibility to enforce the laws as written by Congress and interpreted by the courts. See United States Trustee v. Columbia Gas Sys., Inc. (In re Columbia Gas Sys., Inc.), 33 F.3d 294, 295-96 (3d Cir. 1994) (noting

1

that U.S. Trustee has "public interest standing" under 11 U.S.C. 307 which goes beyond mere pecuniary interest); Morgenstern v. Revco D.S., Inc. (In re Revco D.S., Inc.), 898 F.2d 498, 500 (6th Cir. 1990) (describing the U.S. Trustee as a "watchdog").

3. Under 11 U.S.C. 307, the U.S. Trustee has standing to be heard on the Motion and the issues raised in this objection.

GROUNDS/BASES FOR RELIEF

A. BACKGROUND

4. On August 6, 2007, the Debtors filed a motion titled "Debtors' Motion for an Order (I) Authorizing the Debtors to (A) Pay Prepetition Wages, Salaries, Commissions, Employee Benefits and Other Compensation; (B) Remit Withholding Obligations; (C) Maintain Employee Benefits Programs and Pay Related Administrative Obligations; and (II) Authorizing Applicable Banks and Other Financial Institutions to Receive, Process, Honor and Pay Certain Checks Presented for Payment and to Honor Certain Fund Transfer Requests" (Docket Entry # 8) (the "Wage Motion"). A copy of the Wage Motion is attached as Exhibit A.

5. In paragraph 12 of the Wage Motion, the Debtors described the relief requested:

To minimize the personal hardship the Employees may suffer if prepetition employee-related obligations are not paid when due or honored as expected, and to maintain the morale of Employees during this critical time, the Debtors seek authority, in their discretion, to pay and/or honor, as the case may be: (i) certain prepetition claims for, among other items, wages, salaries, commissions, incentive bonus programs, and other compensation (collectively, the "Employee Wages"), as well as (ii) vacation, paid time off, fixed holidays, medical benefits, contributions to employee benefit plans and all other employee benefits (collectively, "Employee Benefits") that the Debtors historically have paid in the ordinary course of their business; (ii) to reimburse certain reimbursable unpaid employee Reimbursement Obligations (defined below), and (iv) [sic] all costs incident to the foregoing (collectively, and as more fully described

2

below, the "Employee Wages and Benefits"). The Employee Wages and Benefits for which this relief is sought are set forth in detail below.

To summarize, in paragraph 12 of the Wage Motion, the Debtors divided the relief requested into two categories wages and benefits with prepetition claims for incentive plans falling into the "wages" category.

6. In paragraph 13 of the Motion, the Debtors addressed their request to pay prepetition incentive plan payments:

The Debtors' salaried U.S. Employees have been paid their salaries current through September 13, 2007. However, neither the U.S. nor Foreign Employees have been paid pre-petition quarterly bonuses totaling $30,000 under an incentive plan for eligible officers, vice presidents, corporate employees, and senior and key managers for the period of November 1, 2006 through October 31, 2007 (the "Incentive Plan"). The Incentive Plan provided eligible Employees with bonuses to the extent that certain revenue and net operating income as well as personal performance objectives were met (the "Performance Metrics"). An eligible Employee was eligible to receive a certain percentage of his or her salary as an incentive bonus ranging from 4% up to 70% (4% employee, 8% manager, 12% director, 20% VP, 40% SVP and 70% CEO) with the revenue objective accounting for 40%, the net income objective accounting for 40% and the personal objective for 20% of the eligible incentive bonus) if the Employee achieved or exceeded the Performance Metrics established under the Plan (the "Incentive Bonus"). The potential Incentive Bonus is typically paid 45 days after the end each [sic] quarter (if achieving the Performance Metrics). During the quarter ending July 31, 2007 the Debtors' [sic] achieved the required Performance Metrics established pursuant to the Incentive Plan.

The Debtors make several noteworthy statements in paragraph 13. First, the Debtors' references to the Incentive Plan are made with use of a verb in the past tense. Second, unlike the part of the Wage Motion discussing the Debtors' request to pay severance benefits, the Debtors do not specifically indicate in paragraph 13 that they are seeking court authority to continue the Incentive

3

Plan: post-petition. Mot. paragraph 28 ("The Debtors seek authority to continue the Severance Plan postpetition and to pay any outstanding prepetition severance claims of former employees."). Third, the Debtors expressly indicate that payments under the Incentive Plan were conditioned upon achievement of the Performance Metrics. Finally, the Debtors specifically identify one of the metrics as being a "net income" objective.

7. In paragraph 35(b) of the Wage Motion, the Debtors sought authority to "continue, in its [sic] sole discretion, on a postpetition basis," the following:

  • the Medical and Insurance Benefits and the Workers' Compensation Policy described herein as such programs were in effect immediately prior to the Petition Date;
  • the 401(k) Plan;
  • the PTO policy, except that the Debtors do not seek authority to pay any pre or postpetition PTO claims; and
  • the Debtors [sic] other benefit programs as described in this Motion. (Emphasis added).

8. In the "Authority" section of the Wage Motion ( 36 - 44), the Debtors do not discuss the Incentive Plan or the Incentive Bonuses.

9. Prior to the "first day" hearing in the above-captioned cases, undersigned counsel communicated with counsel to the Debtors and obtained three concessions with regard to the Wage Motion: first, all wage and benefit payments would be capped at the $10,950 figure referenced in 11 U.S.C. 507(a)(4, 5); second, the Debtors' request to pay $30,000 in pre-petition Incentive Bonuses was put out on notice; and third, the Debtors confirmed on the record at the hearing that no retention or severance authority was being approved under the Wage Motion. Accordingly, during or shortly after the "first day" hearing on September 18, 2007, this Court entered an order approving the Wage Motion (Docket Entry # 27) (the "Wage Order"). A copy of the Wage Order

4

is attached as Exhibit B. A copy of the relevant portion of the September 18, 2007 hearing is attached as Exhibit C; the full transcript is available at Docket Entry # 59.

10. The Wage Order does not authorize the Debtors to implement the Incentive Plan post-petition.

11. On October 18, 2007, the Office of the U.S. Trustee conducted the meeting of creditors under 11 U.S.C. 341(a). At the meeting of creditors, undersigned counsel requested that, going forward, the Debtors provide notice of any bonus payments which the Debtors asserted were made in the ordinary course of business so that the Office of the U.S. Trustee could determine whether it agreed with the Debtors' position.

12. On December 28, 2007, undersigned counsel received an electronic mail communication from Debtors' counsel (James O'Neill, Esquire) attaching data which detailed the post-petition allocation of ordinary course quarterly bonus payments for the fourth quarter of fiscal year 2007. Undersigned counsel subsequently asked Debtors' counsel to forward the performance metrics for the fourth quarter bonuses so that his office could review same.

13. By electronic mail communication dated January 17, 2008, Debtors' counsel (Grace Robson, Esquire) forwarded information describing the performance metrics. The Office of the United States Trustee learned that [REDACTED]

5

[REDACTED].

14. In response to this discovery, the Office of the United States Trustee contacted Debtors' counsel and gave the Debtors a choice: they could file their own motion seeking retroactive approval of the fourth quarter bonus payments (with the Office of the U.S. Trustee's rights to object to the requested relief being fully reserved) or they could respond to a filing by the U.S. Trustee addressing the subject. The Debtors chose the former option and filed the Motion. At no time between the U.S. Trustee's aforementioned contact of the Debtors and the filing of the Motion did the Debtors communicate to the Office of the U.S. Trustee their belief that the fourth quarter bonus payments were authorized under the Wage Order.

B. ANALYSIS

15. The Debtors take the untenable position that this Court approved post-petition implementation of the Incentive Plan and the fourth quarter bonus payments. The Debtors never sought authority to implement the Incentive Plan post-petition, and this Court neither considered nor granted such authority; as described previously, the Debtors failed to include in the text of the Wage Motion a request for going-forward authority to implement the Incentive Plan. There is absolutely no support in the Wage Motion, the Wage Order, and/or the transcript of the "first day" hearing for the Debtors' thirteenth-hour attempt to find cover for their unauthorized, out-of-the-ordinary-course, post-petition bonus payments.

16. Ironically, the Debtors' contention that this Court authorized the Incentive Plan under the Wage Order extends the tangled web they have created for themselves. The Debtors did not attach a copy of the Incentive Plan to the Wage Motion. Further, the Debtors did not seek

6

[REDACTED] Finally, the Debtors described part of the Performance Metrics as being [REDACTED]. Accordingly, although the Debtors are incorrect in asserting that the Court approved post-petition implementation of the Incentive Plan via the Wage Order, even if they were correct, this Court did not [REDACTED]. In short, the Debtors have placed themselves in violation of the Wage Order.

17. The Debtors' [REDACTED] rendered the fourth quarter bonus payments transfers outside of the ordinary course of their business. While the Debtors correctly cite to In re Roth American, Inc., 975 F.2d 949 (3d Cir. 1992) for the appropriate standard to determine whether a particular transaction is an "ordinary course" transaction, the Debtors have not satisfied the standard. First, with respect to the "horizontal dimension" test (whether the transaction is of the sort commonly undertaken in the Debtors' business), the Debtors do not demonstrate [REDACTED]. Additionally, with respect to the "vertical dimension" test (whether the transaction subjects a creditor to an economic risk of a nature which he accepted when he decided to extend credit), there is nothing in the Motion which suggests that, in implementing their incentive plans, the Debtors ever [REDACTED]

7

[REDACTED]

18. Given that the bonus payments were made outside of the ordinary course of the Debtors' business, under the Bankruptcy Code the Debtors were obligated to seek approval of this Court before making those payments. See 11 U.S.C. 363(b)(1).1 The Debtors failed to obtain such approval. Accordingly, the bonus payments are unauthorized post-petition transfers, and the Motion should be denied. Further, given the Debtors' failure to obtain this Court's approval prior to making the fourth quarter 2007 bonus payments, this Court should not authorize the Debtors to make Incentive Plan payments for subsequent periods.

[Continued on next page -- space intentionally left blank]

8

CONCLUSION

WHEREFORE the U.S. Trustee requests that this Court issue an order denying the Motion.

Respectfully submitted,

KELLY BEAUDIN STAPLETON
UNITED STATES TRUSTEE

BY: /s/ Joseph J. McMahon, Jr.
Joseph J. McMahon, Jr., Esquire (# 4819)
Trial Attorney
United States Department of Justice
Office of the United States Trustee
[address, phone, fax]

9

1 If the Debtors had sought prior approval to make the bonus payments, such approval would have been denied by this Court. [REDACTED] Additionally, for the reasons stated in this objection, the payments were not justified under the facts and circumstances of these cases and, accordingly, the Debtors were prohibited from making the payments under 11 U.S.C. 503(c)(3).


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