Using Chapter 11 to Shed Extravagant Benefit Packages

Federal regulation of 'defined benefit' pension plans is largely accomplished under the twin purview of the Employee Retirement and Income Security Act (ERISA) and the Internal Revenue Code. ERISA mandates that companies establish an organized funding program to cover future liabilities. The Pension Benefit Guaranty Corporation (PBGC) was established under ERISA to backstop underfunded pension schemes. Currently, the PBGC estimates that underfunding of U.S. pension plans exceeds $600 billion. With the PBGC already operating at a $23.3 billion deficit, United's default will undoubtedly lead to increased calls for pension reform.

In addition, many pension and other retiree benefit plans of large corporations are negotiated with union representatives under collective bargaining agreements (CBAs), which are governed by the National Labor Relations Act (NLRA). The NLRA prohibits modification or termination of CBAs without first satisfying certain requirements. ERISA also prohibits termination of a defined benefit pension plan if termination will violate an existing CBA. Failure to comply with the NLRA requirements constitutes an unfair labor practice under the NLRA.

In light of the considerable burdens imposed by ERISA and the NLRA, distressed companies are looking toward bankruptcy as a backdoor to eliminate legacy costs. In NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984), the Supreme Court affirmed the Chapter 11 debtor's right to reject its CBA, and thereby eliminate negotiated pension benefits. The resulting outcry from unions prompted Congress to add Section 1113 to the Bankruptcy Code (the Code), allowing for negotiated modification of CBAs while providing a process by which the debtor can unilaterally terminate or modify a CBA under certain circumstances.

In 1988, the addition of Section 1114 to the Code expressly extended similar protections to debtor programs that pay direct and indirect health and death benefits for retired workers and their spouses and dependents. Its requirements are substantively and procedurally similar to section 1113 requirements.

Current Requirements

Under sections 1113 and 1114, the debtor must adhere to the terms of CBAs until either modifications are agreed with an appointed labor or retiree representative or the court orders relief following the debtor's failure to negotiate a consensual modification plan with the representative. Absent a consensus the Court may allow the debtor to unilaterally modify benefits if:

' the debtor negotiated with the representative in 'good faith';

' the representative refused to accept the proposal without 'good cause'; and

' the debtor's proposed modifications are 'necessary' to permit reorganization, treat all affected parties 'fairly and equitably', and are clearly favored by the balance of the equities.

Good Faith

The debtor must base its proposal on the most complete and reliable information then available. The debtor has negotiated in 'good faith' when it has earnestly tried to negotiate reasonable modifications in the existing agreements, but no consensus is reached. See, eg, In re Kentucky Truck Sales Inc., 52 B.R. 797 (Bankr. W.D. Ky. 1985). A debtor's 'take it or leave it' approach might be evidence of bad faith. See, eg, In re S.A. Mech., Inc., 51 B.R. 130 (Bankr. D. Ariz. 1985).

Good Cause

The labor or retiree representative may have 'good cause' to reject the proposal if it lacks sufficient financial information or fails to treat all parties fairly and equitably. The representative may not, however, reject the debtor's proposal by persisting with demands that the debtor cannot meet and failing to offer reasonable alternatives. See, eg, In re Maxwell Newspapers, Inc., 981 F.2d 85 (B.A.P. 2d Cir. 1992).

Necessity of Modification

The applicable standard in determining whether modifications are 'necessary' is not crystal clear. One approach is that modifications must be essential to the short-term goal of preventing liquidation, not merely related to 'general long-term viability.' See, eg, Wheeling-Pittsburg Steel Corp. v. United Steelworkers, 791 F.2d 1074, 1084-91 (3d Cir. 1986). More recently, however, courts have developed a more flexible approach, holding that modifications need not be restricted to those that are absolutely essential, but should be necessary to the feasibility of reorganization. See, eg, Truck Drivers Local 807 v. Carey Transp., Inc., 816 F.2d 82, 89 (2d Cir. 1987). Still, the proposed modifications must be more than potentially helpful; they must be directly related to the debtor's financial condition and bring significant savings to the debtor.

Fairly and Equitably

The debtor's proposal must treat all parties 'fairly and equitably' by spreading the pain of the cost-cutting measures among all parties. See, e.g, In re Century Brass Prods., Inc., 795 F.2d 265, 273 (2d Cir. 1986). The court may look at whether concessions have been made by other affected constituencies. See, eg, In re K&B Mounting, 50 B.R. 460, 464, 468 (Bankr. N.D. Ind. 1985) and Carey, 816 F.2d at 90-91. Finally, the court may consider potential consequences of its decision, including: 1) the likelihood of liquidation; 2) likely reduction in the value of creditors' claims; 3) likelihood of a strike; and 4) possibility of employee claims for breach of contract; and other aspects such as cost-spreading abilities of the various parties and good or bad faith of the parties in dealing with debtor's financial dilemma. See, eg, Carey, 816 F.2d at 93.

The standards for rejecting collective bargaining agreements or modifying other retiree benefit plans enable a bankruptcy court to consider the interests of both the employees (current and retired) and the debtor. A bankruptcy court is thus able to level the playing field for the employees by ensuring that debtors cannot easily use Chapter 11 to avoid their obligations and brush off NLRA and ERISA type requirements.

Other Considerations

There are other aspects for a debtor to consider before going into a bankruptcy court with the intent of dropping labor and retiree obligations. Withdrawal from or termination of a pension plan triggers PBGC claims in the debtor's and the debtor's affiliates' estates. In addition, organized labor is unlikely to be happy with unilateral modifications to agreements, even if a court finds such modifications necessary. Threat of strike is not uncommon where CBAs are at risk. Even where the issue is retiree benefits, current workers might be induced to strike over what they perceive as a threat to their own futures, or in support of familial relationships between retirees and current workers.

A debtor's success in withdrawing from or terminating its pension plan nevertheless triggers a claim for any unfunded liabilities and/or delinquent contributions by the PBGC against the debtor's estate. The PBGC's claim can be as much as 30% of the collective net worth of the debtor and affiliates defined to be within its 'controlled group.' The PBGC, the debtors and their experts rarely agree on the appropriate amount of the PBGC's claim, usually resulting in litigation to determine the allowed amount of the claim. Plan participants and beneficiaries may also submit claims in the debtor's estate. The PBGC's claim will generally be an unsecured claim, while individual claims will be priority claims of up to $4925 (or $10,000 under the new bankruptcy provisions effective Oct. 17, 2005), less amounts already received as priority claims for wages, salaries and commissions. The claims for deficiency that the PBGC asserts against the debtor may also be asserted, to the extent not satisfied by the debtor's estate, against debtor and non-debtor affiliates. While the PBGC has taken the position that all affiliated entities can be held liable to the PBGC in connection with a failed pension plan, the issue has not yet been resolved whether the PBGC can (or will) pursue non-debtor affiliates outside of the U.S.

Where a debtor uses the bankruptcy court to shed pension benefits governed by ERISA, the PBGC will continue to play an important role in resolving the overall case. For example, if the PBGC assumes the debtor's pension liabilities and union employees later strike, the debtor may not be able to use pensions as a negotiating tool. In PBGC v. LTV Corp., 496 U.S. 633 (1990), the PBGC had assumed the debtor's pension plans. In settling later litigation with union workers, LTV negotiated new pension benefits that the PBGC considered a follow-on plan, which is a new benefit arrangement that wraps around the PBGC insurance benefits so as to provide substantially the same benefits as if no termination occurred. The PBGC objected to the follow-on plan, and restored the pension plans to LTV under the PBGC's ' 4047 powers, in part because LTV's subsequent negotiation of pension benefits indicated that LTV was in fact willing to continue its pension plans.

Recently, the PBGC has been taking a more active role in large, complex bankruptcy cases, gaining a wealth of experience that may be useful in its negotiations with corporations. This might explain how the PBGC negotiated a relatively beneficial settlement with United Airlines on its pension plan terminations. It should be expected that, in the future, the PBGC will be a proactive participant in large bankruptcy cases.

Pending Legislation

The large number of corporations with significantly underfunded plans, along with the declining financial status of the PBGC, has received a great deal of coverage in the press and has become a concern for the U.S. government. In addition, some corporations have taken the position that, without some assistance from the government, they may have no choice but to file for bankruptcy.

Legislation is pending in Congress (H.R. 2830, 109th Cong. (2005)) which, if enacted, would increase premiums payable to the PBGC (which hopefully will address, in part, PBGC liquidity concerns), and would require companies sponsoring defined benefit pension plans to contribute to their plans at faster rates than currently required. Among other things, such legislation would require companies to pay off any current liability funding shortfalls over 7 years (under current law, employers may have up to 30 years to fund such liability funding shortfalls), or 5 years in the case of plans that are less than 60% funded. The legislation would also focus more on the assumptions used by the PBGC to calculate termination basis liabilities (ie, the standard used by the PBGC when calculating the amount due in a standard or distress termination) rather than those assumptions used by plan actuaries to estimate liabilities on an ongoing funding basis (which latter assumptions project long-term health, mortality risk, turnover and other factors into the equation). The termination and ongoing funding approaches can produce wildly different results on the funded status of a particular plan.

The legislation also aims to limit the general practice of using historical investment return over the preceding five years as the basis for the assumed rate of return on plan assets. That look-back period would be shortened to a period within a range of three months to four years, depending upon which legislative proposal(s) might ultimately be carried forward. In addition, the legislative proposals would curtail the current practice of allowing companies having financial difficulties to use 'credit' balances in order to take a 'pension holiday' and not make contributions at a time when a plan appears to be significantly underfunded.

Lastly, plan sponsors would be permitted to contribute more to their pension plans on a tax-deductible basis than permitted currently. Under the legislation, the maximum tax-deductible contribution would be set at 150% of a plan's current liability. While there is no certainty that any of the legislative reforms will be enacted, the political and economic environment suggests that there will be pressure on legislators to enact some of the proposed reforms in the not too distant future. Whether these reforms will be sufficient to prevent bankruptcy filings by corporations with large underfunded pension plans remains uncertain.

Conclusion

The current situation facing many corporations ' high legacy costs and little or no assistance from the government in the short term ' may leave them with only one choice, a bankruptcy filing. While this is a drastic step, the Code provides alternative procedures for a company to terminate its pension plans or other retiree benefits.

In May of this year, a bankruptcy court allowed United Airlines to terminate certain of its defined benefit pension plans, clearing the way for the largest pension default in U.S. history. The default will save United an estimated $645 million a year in pension contributions, part of the $2 billion in annual savings it says it needs to emerge from Chapter 11. United's success has led to speculation that other corporations with generous and/or underfunded pension and other retiree benefit plans will also use bankruptcy to clean 'legacy costs' off their balance sheets. Modification or termination of such liabilities in Chapter 11, however, is not without difficulty.

Pension and other retiree benefits are a significant cost to any large corporation. Recently, General Motors indicated that it must reduce the costs of its pensions and other retiree benefit plans to survive. Currently, GM has 422,000 retirees for which the company will spend $5.6 billion for health-care benefits in 2005. GM's so-called 'legacy costs' amount to approximately $1500 per vehicle. Scherer R: Rising Benefits Burden. The Christian Science Monitor (abcnews.go.com/International/CSM/story?id=831879).

'Defined Benefit' Pension Plans

Federal regulation of 'defined benefit' pension plans is largely accomplished under the twin purview of the Employee Retirement and Income Security Act (ERISA) and the Internal Revenue Code. ERISA mandates that companies establish an organized funding program to cover future liabilities. The Pension Benefit Guaranty Corporation (PBGC) was established under ERISA to backstop underfunded pension schemes. Currently, the PBGC estimates that underfunding of U.S. pension plans exceeds $600 billion. With the PBGC already operating at a $23.3 billion deficit, United's default will undoubtedly lead to increased calls for pension reform.

In addition, many pension and other retiree benefit plans of large corporations are negotiated with union representatives under collective bargaining agreements (CBAs), which are governed by the National Labor Relations Act (NLRA). The NLRA prohibits modification or termination of CBAs without first satisfying certain requirements. ERISA also prohibits termination of a defined benefit pension plan if termination will violate an existing CBA. Failure to comply with the NLRA requirements constitutes an unfair labor practice under the NLRA.

In light of the considerable burdens imposed by ERISA and the NLRA, distressed companies are looking toward bankruptcy as a backdoor to eliminate legacy costs. In NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984), the Supreme Court affirmed the Chapter 11 debtor's right to reject its CBA, and thereby eliminate negotiated pension benefits. The resulting outcry from unions prompted Congress to add Section 1113 to the Bankruptcy Code (the Code), allowing for negotiated modification of CBAs while providing a process by which the debtor can unilaterally terminate or modify a CBA under certain circumstances.

In 1988, the addition of Section 1114 to the Code expressly extended similar protections to debtor programs that pay direct and indirect health and death benefits for retired workers and their spouses and dependents. Its requirements are substantively and procedurally similar to section 1113 requirements.

Current Requirements

Under sections 1113 and 1114, the debtor must adhere to the terms of CBAs until either modifications are agreed with an appointed labor or retiree representative or the court orders relief following the debtor's failure to negotiate a consensual modification plan with the representative. Absent a consensus the Court may allow the debtor to unilaterally modify benefits if:

' the debtor negotiated with the representative in 'good faith';

' the representative refused to accept the proposal without 'good cause'; and

' the debtor's proposed modifications are 'necessary' to permit reorganization, treat all affected parties 'fairly and equitably', and are clearly favored by the balance of the equities.

Good Faith

The debtor must base its proposal on the most complete and reliable information then available. The debtor has negotiated in 'good faith' when it has earnestly tried to negotiate reasonable modifications in the existing agreements, but no consensus is reached. See, eg, In re Kentucky Truck Sales Inc., 52 B.R. 797 (Bankr. W.D. Ky. 1985). A debtor's 'take it or leave it' approach might be evidence of bad faith. See, eg, In re S.A. Mech., Inc., 51 B.R. 130 (Bankr. D. Ariz. 1985).

Good Cause

The labor or retiree representative may have 'good cause' to reject the proposal if it lacks sufficient financial information or fails to treat all parties fairly and equitably. The representative may not, however, reject the debtor's proposal by persisting with demands that the debtor cannot meet and failing to offer reasonable alternatives. See, eg, In re Maxwell Newspapers, Inc., 981 F.2d 85 (B.A.P. 2d Cir. 1992).

Necessity of Modification

The applicable standard in determining whether modifications are 'necessary' is not crystal clear. One approach is that modifications must be essential to the short-term goal of preventing liquidation, not merely related to 'general long-term viability.' See, eg, Wheeling-Pittsburg Steel Corp. v. United Steelworkers , 791 F.2d 1074, 1084-91 (3d Cir. 1986). More recently, however, courts have developed a more flexible approach, holding that modifications need not be restricted to those that are absolutely essential, but should be necessary to the feasibility of reorganization. See, eg, Truck Drivers Local 807 v. Carey Transp., Inc. , 816 F.2d 82, 89 (2d Cir. 1987). Still, the proposed modifications must be more than potentially helpful; they must be directly related to the debtor's financial condition and bring significant savings to the debtor.

Fairly and Equitably

The debtor's proposal must treat all parties 'fairly and equitably' by spreading the pain of the cost-cutting measures among all parties. See, e.g, In re Century Brass Prods., Inc., 795 F.2d 265, 273 (2d Cir. 1986). The court may look at whether concessions have been made by other affected constituencies. See, eg, In re K&B Mounting, 50 B.R. 460, 464, 468 (Bankr. N.D. Ind. 1985) and Carey, 816 F.2d at 90-91. Finally, the court may consider potential consequences of its decision, including: 1) the likelihood of liquidation; 2) likely reduction in the value of creditors' claims; 3) likelihood of a strike; and 4) possibility of employee claims for breach of contract; and other aspects such as cost-spreading abilities of the various parties and good or bad faith of the parties in dealing with debtor's financial dilemma. See, eg, Carey, 816 F.2d at 93.

The standards for rejecting collective bargaining agreements or modifying other retiree benefit plans enable a bankruptcy court to consider the interests of both the employees (current and retired) and the debtor. A bankruptcy court is thus able to level the playing field for the employees by ensuring that debtors cannot easily use Chapter 11 to avoid their obligations and brush off NLRA and ERISA type requirements.

Other Considerations

There are other aspects for a debtor to consider before going into a bankruptcy court with the intent of dropping labor and retiree obligations. Withdrawal from or termination of a pension plan triggers PBGC claims in the debtor's and the debtor's affiliates' estates. In addition, organized labor is unlikely to be happy with unilateral modifications to agreements, even if a court finds such modifications necessary. Threat of strike is not uncommon where CBAs are at risk. Even where the issue is retiree benefits, current workers might be induced to strike over what they perceive as a threat to their own futures, or in support of familial relationships between retirees and current workers.

A debtor's success in withdrawing from or terminating its pension plan nevertheless triggers a claim for any unfunded liabilities and/or delinquent contributions by the PBGC against the debtor's estate. The PBGC's claim can be as much as 30% of the collective net worth of the debtor and affiliates defined to be within its 'controlled group.' The PBGC, the debtors and their experts rarely agree on the appropriate amount of the PBGC's claim, usually resulting in litigation to determine the allowed amount of the claim. Plan participants and beneficiaries may also submit claims in the debtor's estate. The PBGC's claim will generally be an unsecured claim, while individual claims will be priority claims of up to $4925 (or $10,000 under the new bankruptcy provisions effective Oct. 17, 2005), less amounts already received as priority claims for wages, salaries and commissions. The claims for deficiency that the PBGC asserts against the debtor may also be asserted, to the extent not satisfied by the debtor's estate, against debtor and non-debtor affiliates. While the PBGC has taken the position that all affiliated entities can be held liable to the PBGC in connection with a failed pension plan, the issue has not yet been resolved whether the PBGC can (or will) pursue non-debtor affiliates outside of the U.S.

Where a debtor uses the bankruptcy court to shed pension benefits governed by ERISA, the PBGC will continue to play an important role in resolving the overall case. For example, if the PBGC assumes the debtor's pension liabilities and union employees later strike, the debtor may not be able to use pensions as a negotiating tool. In PBGC v. LTV Corp. , 496 U.S. 633 (1990), the PBGC had assumed the debtor's pension plans. In settling later litigation with union workers, LTV negotiated new pension benefits that the PBGC considered a follow-on plan, which is a new benefit arrangement that wraps around the PBGC insurance benefits so as to provide substantially the same benefits as if no termination occurred. The PBGC objected to the follow-on plan, and restored the pension plans to LTV under the PBGC's ' 4047 powers, in part because LTV's subsequent negotiation of pension benefits indicated that LTV was in fact willing to continue its pension plans.

Recently, the PBGC has been taking a more active role in large, complex bankruptcy cases, gaining a wealth of experience that may be useful in its negotiations with corporations. This might explain how the PBGC negotiated a relatively beneficial settlement with United Airlines on its pension plan terminations. It should be expected that, in the future, the PBGC will be a proactive participant in large bankruptcy cases.

Pending Legislation

The large number of corporations with significantly underfunded plans, along with the declining financial status of the PBGC, has received a great deal of coverage in the press and has become a concern for the U.S. government. In addition, some corporations have taken the position that, without some assistance from the government, they may have no choice but to file for bankruptcy.

Legislation is pending in Congress (H.R. 2830, 109th Cong. (2005)) which, if enacted, would increase premiums payable to the PBGC (which hopefully will address, in part, PBGC liquidity concerns), and would require companies sponsoring defined benefit pension plans to contribute to their plans at faster rates than currently required. Among other things, such legislation would require companies to pay off any current liability funding shortfalls over 7 years (under current law, employers may have up to 30 years to fund such liability funding shortfalls), or 5 years in the case of plans that are less than 60% funded. The legislation would also focus more on the assumptions used by the PBGC to calculate termination basis liabilities (ie, the standard used by the PBGC when calculating the amount due in a standard or distress termination) rather than those assumptions used by plan actuaries to estimate liabilities on an ongoing funding basis (which latter assumptions project long-term health, mortality risk, turnover and other factors into the equation). The termination and ongoing funding approaches can produce wildly different results on the funded status of a particular plan.

The legislation also aims to limit the general practice of using historical investment return over the preceding five years as the basis for the assumed rate of return on plan assets. That look-back period would be shortened to a period within a range of three months to four years, depending upon which legislative proposal(s) might ultimately be carried forward. In addition, the legislative proposals would curtail the current practice of allowing companies having financial difficulties to use 'credit' balances in order to take a 'pension holiday' and not make contributions at a time when a plan appears to be significantly underfunded.

Lastly, plan sponsors would be permitted to contribute more to their pension plans on a tax-deductible basis than permitted currently. Under the legislation, the maximum tax-deductible contribution would be set at 150% of a plan's current liability. While there is no certainty that any of the legislative reforms will be enacted, the political and economic environment suggests that there will be pressure on legislators to enact some of the proposed reforms in the not too distant future. Whether these reforms will be sufficient to prevent bankruptcy filings by corporations with large underfunded pension plans remains uncertain.

Conclusion

The current situation facing many corporations ' high legacy costs and little or no assistance from the government in the short term ' may leave them with only one choice, a bankruptcy filing. While this is a drastic step, the Code provides alternative procedures for a company to terminate its pension plans or other retiree benefits.