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Full title: Objection United States Trustee's Objection to Debtors' Motion for Order Approving Employee Retention Plan Pursuant to 11 U.S.C. Sections 105(a), 363(b)(1), and 503(c)(3) and Reservation of Rights (RE: related document(s)605 Motion Miscellaneous Relief). Filed by U.S. Trustee Office of the U.S. Trustee / SF (Attachments: # 1 Certificate of Service) (Day, Jared) (Entered: 05/20/2021)

Document posted on May 19, 2021 in the bankruptcy, 10 pages and 0 tables.

Bankrupt11 Summary (Automatically Generated)

Even if the Court finds that Section 503(c)(1) does not apply to the KERP and that 13 the Motion is governed by 11 U.S.C. §§ 503(c)(3) and 363, the Debtors have failed to demonstrate 14 that the relief is necessary to preserve the value of the Debtors’ estates and “justified by the facts 15 and circumstances” of the case.the transfer or obligation is essential to retention of the person because the individual has a bona fide job offer from another 26 business at the same or greater rate of compensation; (B) the services provided by the person are essential to the survival 27 of the business; and 28 (C) either – (i) the amount of the transfer made to, or obligation 1 incurred for the benefit of, the person is not greater than an amount equal to 10 times the amount of the 2 mean transfer or obligation of a similar kind given to 3 nonmanagement employees for any purpose during the calendar year in which the transfer is made or the 4 obligation is incurred; or (ii) if no such similar transfers were made to, or 5 obligations were incurred for the benefit of, such 6 nonmanagement employees during such calendar year, the amount of the transfer or obligation is not greater 7 than an amount equal to 25 percent of the amount of any similar transfer or obligation made to or incurred 8 for the benefit of such insider for any purpose during 9 the calendar year before the year in which such transfer is made or obligation is incurred.Abuse Prevention and Consumer Protection Act (“BAPCPA”), was intended to curtail payments 19 of retention incentives to insiders, including bonuses granted to other employees without factual 20 and circumstantial justification.As discussed infra, the Motion fails to provide sufficient information 2 for the Court and parties in interest to assess whether any KERP Participants are insiders.In re Dant & Russell, Inc., 853 F.2d 700, 706 (9th Cir. 1988) (“[a]ny claim for 15 administrative expenses and costs must be the actual and necessary costs of preserving the estate 16 for the benefit of its creditors”), superseded by statute on other grounds, 11 U.S.C. § 365(d)(3); see 17 also In re Regensteiner Printing Co., 122 B.R. 323, 326 (N.D. Ill. 1990) (reversing approval of 18 severance agreements for key employees, because debtors presented no evidence that severance 19 payments were necessary to preserve bankruptcy estate);

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1 TIMOTHY S. LAFFREDI (SBN WI 1055133) Assistant United States Trustee 2 CAMERON GULDEN (SBN MN 310931) Trial Attorney 3 JARED A. DAY (SBN CA 275687) 4 Trial Attorney UNITED STATES DEPARTMENT OF JUSTICE 5 Office of the United States Trustee 450 Golden Gate Ave., Rm 5-0153 6 San Francisco, CA 94102 7 Telephone: (775) 784-5335 x109 Facsimile: (775) 784-5531 8 E-mail: jared.a.day@usdoj.gov 9 Attorneys for TRACY HOPE DAVIS United States Trustee for Region 17 10 11 UNITED STATES BANKRUPTCY COURT NORTHERN DISTRICT OF CALIFORNIA 12 SAN FRANCISCO DIVISION 13 In re: Case No. 20-30604 HLB 14 (Jointly Administered with PROFESSIONAL FINANCIAL INVESTORS, INC., Case No. 20-30579) 15 a California Corporation et al, Chapter 11 16 17 Hearing Date: May 27, 2021 Hearing Time: 10:00 a.m. 18 Debtors. Place: Telephonic or Video Conference Judge: Hon. Hannah L. Blumenstiel 19 20 UNITED STATES TRUSTEE’S OBJECTION TO DEBTORS’ MOTION FOR ORDER APPROVING EMPLOYEE RETENTION PLAN PURSUANT TO 21 11 U.S.C. §§ 105(a), 363(b)(1), AND 503(c)(3) AND RESERVATION OF RIGHTS 22 Tracy Hope Davis, United States Trustee for Region 17 (the “United States Trustee”), by 23 and through her undersigned counsel, hereby files this objection (the “Objection”) to the Debtors’ 24 Motion for Order Approving Employee Retention Plan Pursuant to 11 U.S.C. §§ 105(a), 363(b)(1), 25 and 503(c)(3) and Reservation of Rights (ECF No. 605) (the “Motion”). In support of her 26 Objection, the United States Trustee respectfully represents as follows: 27 I. INTRODUCTION 28 1. The Motion seeks approval of a Key Employee Retention Plan (the “KERP”) for 41

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1 participants (the “KERP Participants”). The individual retention bonus amounts for the KERP 2 Participants range from $2,079.90 to $19,716.66 with an aggregate proposed award of $238,536. 3 2. The Debtors did not file a list of KERP Participants with the Motion or supporting 4 declaration of the Debtors’ CRO, Andrew Hinkelman (“Hinkelman”).1 Neither the Motion nor the 5 supporting declaration disclose the employees’ identities, their specific titles, their specific job 6 responsibilities, and/or the respective bonus amounts each employee is proposed to receive under 7 the KERP. The Motion fails to provide sufficient information for the Court and parties in interest 8 to assess whether the KERP is limited to non-insiders as represented. Thus, the Debtors have not 9 demonstrated that 11 U.S.C. § 503(c)(1) is inapplicable to the KERP. Although the Motion 10 indicates that the Debtors are willing to file these disclosures under seal, they have yet to file a 11 motion satisfying their burden in this regard and requesting such authority from the Court to date. 12 3. Even if the Court finds that Section 503(c)(1) does not apply to the KERP and that 13 the Motion is governed by 11 U.S.C. §§ 503(c)(3) and 363, the Debtors have failed to demonstrate 14 that the relief is necessary to preserve the value of the Debtors’ estates and “justified by the facts 15 and circumstances” of the case. 16 II. STATEMENT OF FACTS 17 A. General Case Background 18 4. On July 16, 2020, certain creditors filed an involuntary chapter 11 petition against 19 Professional Investors Security Fund, Inc. (“PISF”). ECF No. 1, Case No. 20-30579 (Bankr. N.D. 20 Cal.). PISF consented to an order for relief, which was entered on July 27, 2020. Id. at ECF No. 21 22 10. 23 5. On July 26, 2020, Professional Financial Investors, Inc. (“PFI) filed its voluntary 24 chapter 11 petition. ECF No. 1. PFI is represented by Sheppard, Mullin, Richter & Hampton. Id. 25 26 27 1 The Debtors provided a detailed list to the United States Trustee at the United States Trustee’s request. However, as indicated, this information has not been provided in the Motion or supporting 28 declaration. The Court and parties in interest should also have an opportunity to review this

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1 6. Since that time, numerous additional involuntary chapter 11 petitions have been 2 filed by the Debtors’ various affiliates (referred to together with PISF and PFI as the “Debtors”). 3 The Court has ordered the joint administration of all cases under the above-captioned lead PFI 4 case. See ECF Docket generally. 5 7. The Debtors are currently debtors-in-possession under sections 1107 and 1108 of 6 the Bankruptcy Code. 7 8. On August 19, 2020, the United States Trustee appointed an official committee of 8 unsecured creditors to serve in the jointly administered cases. ECF No. 59. 9 9. Three separate meetings of creditors under 11 U.S.C. § 341(a) for the Debtors’ 10 various chapter 11 cases have been conducted and concluded. See ECF Docket generally. 11 10. The declarations filed in support of PFI’s chapter 11 bankruptcy filing and first day 12 motions contain a detailed discussion of the Debtors’ background, capital structure, and the events 13 leading up to the Debtors’ chapter 11 filings. Id. 14 B. The Motion 15 11. According to the Debtors, PFI is the only Debtor in the above-captioned jointly 16 administered cases with employees and has a total staff of approximately 43 full-time personnel. 17 ECF No. 605, Motion, Pg. 10. Two of those employees—the Debtors’ CRO, Hinkelman, and the 18 Debtors’ single independent director, Michael Goldberg (“Goldberg”), are insiders of the Debtors. 19 Id. at Pgs. 10 and 11. PFI serves as the property manager for the Debtors’ real properties consisting 20 of approximately seventy apartment complexes and office parks in the counties of Marin and 21 22 Sonoma, which provide leasing services to approximately 2,700 residents and 400 businesses. Id. 23 at Pgs. 11 and 12. 24 12. The Motion provides for the payment of a KERP retention bonus to the Debtors’ 41 25 purported non-insider employees upon the effective date of a successfully confirmed chapter 11 26 plan of reorganization. See Id. generally. The KERP provides for retention bonuses of one half to 27 one and three quarters times each employee’s total monthly compensation. Id. at Pg. 13. 28

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1 13. The Debtors maintain that these “rank and file” employees are essential to the 2 Debtors’ operations and implementation of a confirmed chapter 11 plan and that without the 3 payments contemplated by the KERP, these employees “may” abandon their positions leading to 4 an interruption in services for tenants and other factors impeding plan confirmation efforts. Id. 5 14. Although the Debtors contend that none of these non-insider employees hold 6 director or officer level positions (i.e., “insider” status), neither the Motion nor the supporting 7 declaration of Hinkelman provide the Court and parties in interest with a list of these employees’ 8 identities, their specific titles, their specific job responsibilities, and/or the respective bonus 9 amounts each employee is proposed to receive under the KERP. See Id. generally and Hinkelmann 10 Declaration. Rather, the Motion merely discloses general information in this regard and a range of 11 possible retention bonus amounts between $2,079.90 and $19,716.66 for an aggregate potential 12 retention bonus payout of $238,536. Id. at Pg. 13. 13 III. AUTHORITIES & DISCUSSION 14 A. The Controlling Statutory Framework 15 15. Section 503 governs the allowance of administrative expenses for “actual, necessary 16 costs and expenses of preserving” a debtor’s bankruptcy estate. 11 U.S.C. § 503(b)(1)(A). The 17 two general overriding policies of Section 503 of the Bankruptcy Code are to: (i) preserve the value 18 of the estate for the benefit of its creditors; and (ii) prevent the unjust enrichment of the insiders of 19 the estate at the expense of its creditors. See In re Journal Register Co., 407 B.R. 520, 535 (Bankr. 20 S.D.N.Y. 2009). 21 22 16. Section 503(c)(1) of the Bankruptcy Code prohibits any transfer: 23 made to, or an obligation incurred for the benefit, of an insider of the debtor for the purpose of inducing such person to remain with the debtor’s business, 24 absent a finding by the court based on evidence in the record that— 25 (A) the transfer or obligation is essential to retention of the person because the individual has a bona fide job offer from another 26 business at the same or greater rate of compensation; (B) the services provided by the person are essential to the survival 27 of the business; and 28 (C) either –

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(i) the amount of the transfer made to, or obligation 1 incurred for the benefit of, the person is not greater than an amount equal to 10 times the amount of the 2 mean transfer or obligation of a similar kind given to 3 nonmanagement employees for any purpose during the calendar year in which the transfer is made or the 4 obligation is incurred; or (ii) if no such similar transfers were made to, or 5 obligations were incurred for the benefit of, such 6 nonmanagement employees during such calendar year, the amount of the transfer or obligation is not greater 7 than an amount equal to 25 percent of the amount of any similar transfer or obligation made to or incurred 8 for the benefit of such insider for any purpose during 9 the calendar year before the year in which such transfer is made or obligation is incurred. 10 11 U.S.C. § 503(c)(1) (emphasis added). 11 17. A transfer to an insider to induce the insider to remain with the debtor’s business 12 must satisfy the requirements under subdivisions (A), (B), and (C) of Section 503(c)(1) of the 13 Bankruptcy Code to be subject to this subdivision’s exception. 4 Collier on Bankruptcy ¶ 503.17 14 (16th ed. rev. 2021); see also In re Dana Corp., 358 B.R. 567, 575 (Bankr. S.D.N.Y. 2006) (“Dana 15 II”) (summarizing the requirements under Section 503(c)(1) of the Bankruptcy Code). 16 17 18. Section 503(c) of the Bankruptcy Code, added in 2005 as part of the Bankruptcy 18 Abuse Prevention and Consumer Protection Act (“BAPCPA”), was intended to curtail payments 19 of retention incentives to insiders, including bonuses granted to other employees without factual 20 and circumstantial justification. See Journal Register; 407 B.R. at 536; see also In re Pilgrim’s 21 Pride Corp., 401 B.R. 229, 234 (Bankr. N.D. Tex. 2009) (“Section 503(c) was enacted to limit a 22 debtor’s ability to favor powerful insiders economically and at estate expense during a chapter 11 23 case”); In re Global Home Prods., LLC, 369 B.R. 778, 784 (Bankr. D. Del. 2007) (the amendments 24 were added to “eradicate the notion that executives were entitled to bonuses simply for staying 25 with the Company through the bankruptcy process”); see also In re Maust Transp., Inc., 589 B.R. 26 887, 893 (Bankr. W.D. Wash. 2018) (“[t]he 2005 amendments to § 503, which specifically prohibit 27 certain insider retention bonus administrative claims, make it clear that Congress can and has 28

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1 removed the broad discretion granted to courts in § 503 where it deems the exercise of such 2 discretion improper as to certain specific categories of administrative claims.”). 3 19. Section 503(c)(1) establishes specific evidentiary standards that must be met before 4 a bankruptcy court may authorize payments made to an insider for the purpose of inducing such 5 person to remain with a debtor’s business. See In re PG&E Corp., 2019 WL 4686765, at *1 (Bankr. 6 N.D. Cal. Aug. 30, 2019); In re Dana Corp., 351 B.R. 96, 100 (Bankr. S.D.N.Y. 2006). 7 20. The BAPCPA amendments make it abundantly clear that if a proposed transfer falls 8 within Section 503(c)(1), then the business judgment rule does not apply, irrespective of whether 9 a sound business purpose may exist. Id. at 101; see also In re Siliken Mfg. USA, Inc., 2013 WL 10 5330481, at *7 (Bankr. S.D. Cal. Sept. 19, 2013) (“[T]he Code often subjects insider dealings to 11 heightened scrutiny in recognition that even ostensibly arm’s length transactions between insiders 12 have an inherently coercive element to them.”). 13 21. The effect of Section 503(c) of the Bankruptcy Code was to put in place “a set of 14 challenging standards” and “high hurdles” for debtors to overcome before retention bonuses can 15 be paid. See In re Mesa Air Group, Inc., 2010 WL 3810899, at *2 (Bankr. S.D.N.Y. Sept. 24, 16 2010) (citing Global Home Prods., 369 B.R. at 785). 17 B. The Debtors Have Not Established that Section 503(c)(1) is Inapplicable to the 18 KERP. 19 22. To avoid the requirements of section 503(c)(1), a debtor must show that “the 20 proposed transfers are not to insiders of a debtor or, if the recipients of the proposed transfers are 21 22 insiders, that the transfers are not being made for the purpose of retaining those insiders.” See In 23 re Residential Capital, LLC, 478 B.R. 154, 169 (Bankr. S.D.N.Y. 2012) (emphasis added); see 24 also In re PG&E Corp., 2019 WL 4686765, at *1. 25 23. Here, the Debtors acknowledge that the purpose of the KERP is to retain the services 26 of the KERP Participants. See ECF No. 605, Motion generally. The Debtors contend, though, that 27 Section 503(c)(1) is inapplicable to the relief requested in the Motion, because none of the KERP 28

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1 Participants are insiders. Id. As discussed infra, the Motion fails to provide sufficient information 2 for the Court and parties in interest to assess whether any KERP Participants are insiders. 3 24. Pursuant to the Section 101(31) of the Bankruptcy Code, if a debtor is a corporation, 4 the term “insider” includes an officer of the debtor. 11 U.S.C. § 101(31)(B)(ii). A vice-president, 5 as an officer, is presumptively an insider. See In re Foothills Texas, Inc., 408 B.R. 573, 574, 579 6 (Bankr. D. Del. 2009); see also In re The Village at Lakeridge, LLC, 814 F.3d 993, 999 (9th Cir. 7 2016) (“[s]tatutory insiders, also known as ‘per se insiders,’ are persons explicitly described in 11 8 U.S.C. § 101(31)…. As a matter of law, a statutory insider has a sufficiently close relationship 9 with a debtor to warrant special treatment.”). 10 25. Moreover, regardless of title, a person with broad responsibilities over significant 11 aspects of a debtor’s business is considered an insider, even if he or she is not a member of senior 12 management. See In re Foothills Texas, Inc., 408 B.R. at 584 (finding vice presidents who were 13 not members of senior management, but who had broad responsibilities over significant aspects of 14 debtor’s business, to be insiders); see also In re The Village at Lakeridge, LLC, 814 F.3d at 1001 15 (“[h]aving - or being subject to - some degree of control is one of many indications that a creditor 16 may be a non-statutory insider, but actual control is not required to find non-statutory insider 17 status.”). 18 26. Although the Debtors contend that none of these non-insider employees hold 19 corporate director or officer level positions, neither the Motion nor the supporting declaration of 20 Hinkelman provide the Court and parties in interest with a list of these employees’ identities, their 21 22 specific titles, their specific job responsibilities, and/or the respective bonus amounts each 23 employee is proposed to receive under the KERP. See Id. generally and Hinkelmann Declaration. 24 Instead, the Motion merely discloses general information in this regard and a range of possible 25 retention bonus amounts between $2,079.90 and $19,716.66 for an aggregate potential retention 26 bonus payout of $238,536. Id. at Pg. 13. 27 28

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1 27. The Debtors should disclose this information, including the specific duties of the 2 KERP Participants, so that parties in interest can assess whether any KERP Participant’s 3 responsibilities confer “insider” status. 4 28. If the Debtors maintain that the public should not have access to this information, 5 the Debtors should appropriately meet their burden for such request under 11 U.S.C. § 107, Fed. 6 R. Bankr. P. 9018, and BLR 1001-2(a) by filing a noticed motion seeking authority to file the 7 information under seal.2 8 C. Even if the KERP is Governed by Section 503(c)(3), the Debtors Have Not 9 Established that the KERP is Justified by the Facts and Circumstances of the 10 Case. 11 29. Even if the Court were to find that Section 503(c)(1) does not apply to the KERP, 12 the Motion may be granted only if the Court finds that it is necessary to preserve the value of the 13 Debtors’ estate and is “justified by the facts and circumstances of the case.” See 11 U.S.C. § 14 503(c)(3); In re Dant & Russell, Inc., 853 F.2d 700, 706 (9th Cir. 1988) (“[a]ny claim for 15 administrative expenses and costs must be the actual and necessary costs of preserving the estate 16 for the benefit of its creditors”), superseded by statute on other grounds, 11 U.S.C. § 365(d)(3); see 17 also In re Regensteiner Printing Co., 122 B.R. 323, 326 (N.D. Ill. 1990) (reversing approval of 18 severance agreements for key employees, because debtors presented no evidence that severance 19 payments were necessary to preserve bankruptcy estate); In re Pacific Gas and Electric Co., 2001 20 WL 34133840, at *2 n.4 (Bankr. N.D. Cal. July 13, 2001) (initial declaration “‘on information and 21 22 belief’” was “insufficient” basis to grant KERP motion).3 23 24 2 The Motion indicates that Debtors will only make these specific details available to the Court for an in-camera review or file them under seal if required by the Court. ECF No. 605, Motion, Pg. 25 13. 26 3 See In re Pilgrim’s Pride Corp., 401 B.R. at 236–37 (Bankr. N.D. Tex. 2009) (“To read section 503(c)(3) as requiring nothing not already required by section 363(b)(1) would violate” the 27 principle of construction that Congress intended independent Code Sections to “have independent, differing impacts.”); see also In re GT Advanced Tech. Inc., 2015 WL 4459502, at *7 (D.N.H. July 28 21, 2015) (Section 503(c)(3) “directs courts to give more scrutiny to the business judgment of

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1 30. In Dana II, the Court listed several factors that courts consider when determining if 2 the structure of a compensation proposal and the process for its development satisfy Section 3 503(c)(3): 4 • Is there a reasonable relationship between the plan proposed and the results to 5 be obtained, i.e., will the key employee stay for as long as it takes for the debtor to reorganize or market its assets, or, in the case of a performance incentive, is 6 the plan calculated to achieve the desired performance? 7 • Is the cost of the plan reasonable in the context of the debtor’s assets, liabilities 8 and earning potential? 9 • Is the scope of the plan fair and reasonable; does it apply to all employees; does it discriminate unfairly? 10 11 • Is the plan or proposal consistent with industry standards? 12 • What were the due diligence efforts of the debtor in investigating the need for a plan; analyzing which key employees need to be incentivized; what is available; 13 what is generally applicable in a particular industry? 14 • Did the debtor receive independent counsel in performing due diligence and in 15 creating and authorizing the incentive compensation? 16 358 B.R. at 576–77. The Debtors have failed to satisfy several of these factors. 17 31. First, the Motion fails to establish a reasonable relationship between the plan 18 proposed and the results to be obtained. The KERP participants appear to have been employed by 19 the Debtors for many years before the Debtors’ chapter 11 bankruptcy cases were filed. See ECF 20 Nos. 5, 21 and 25, Debtors’ first day employee wage motion and supporting declarations. 21 Consequently, it is likely that these employees would have determined to secure other employment 22 shortly after the bankruptcy cases were filed rather than almost one-year postpetition. 23 32. Second, there is insufficient evidence of the due diligence efforts undertaken by the 24 Debtors to investigate the need for the KERP and whether all purported non-insider employees 25 need to be incentivized to remain employed through the effective date of the Debtors’ chapter 11 26 plan or reorganization. The Motion merely indicates that “PFI’s management developed a set of 27 metrics for determining what amount each employee should receive as a retention bonus upon the 28

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1 share any details regarding exactly what those “metrics” are in the Motion or supporting declaration 2 and/or how they determined that every employee should participate in the KERP. Id. 3 IV. RESERVATION OF RIGHTS 4 33. The United States Trustee specifically reserves all rights with regard to the Motion, 5 including but not limited to, any subsequent amendments thereto or additional KERP motions that 6 might be filed by the Debtors, the committees or other interested parties. 7 IV. CONCLUSION 8 WHEREFORE, for the foregoing reasons, the United States Trustee respectfully requests 9 that the Court sustain her Objection, deny the Motion, and grant such other relief as the Court 10 deems warranted under the circumstances. 11 12 Date: May 20, 2021 Respectfully Submitted, 13 TRACY HOPE DAVIS 14 UNITED STATES TRUSTEE 15 By: /s/ Jared A. Day 16 Jared A. Day Trial Attorney for the United States Trustee 17 18 19 20 21 22 23 24 25 26 27 28

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