In a ruling that comes as a blow to organized labor and a boon to employers in bankruptcy, the U.S. Court of Appeals for the Third Circuit recently broke new appellate ground in holding that Section 1113 of the Bankruptcy Code permits debtors to reject the terms and conditions of an expired collective bargaining agreement (CBA). This holding represents a significant exception to the requirement under the National Labor Relations Act (the NLRA) that employers adhere to the terms and conditions of an expired CBA until either a new agreement or an impasse with the union-counterparty is reached, and gives distressed companies significant leverage in labor negotiations.

In In re Trump Entertainment Resorts Inc.,[1] the court held that Section 1113 of the Bankruptcy Code allows debtor Trump Entertainment Resorts to reject its ongoing obligations under an expired CBA with one of its unions, which imposed costs on the company that jeopardized its ability to restructure. Whether Section 1113 applies to an employer’s persisting obligations under expired CBAs – or whether it is limited to unexpired CBAs – is an issue that has drawn conflicting opinions from bankruptcy courts, and the Third Circuit is the first circuit level court to rule on it.

Section 1113 provides that a debtor may “reject a collective bargaining agreement” if it convinces the bankruptcy court of three things: (1) the debtor made a proposal to employees “which provides for those necessary modifications in the employees’ benefits and protections that are necessary to permit the reorganization,” (2) “the authorized representative of the employees has refused to accept such proposal without good cause,” and (3) “the balance of the equities clearly favors rejection of such agreement.” Although the statute does not contain language restricting its application to “executory” or “unexpired” CBAs, it is silent regarding employers’ ongoing obligations under the NLRA to adhere to the terms of an expired CBA until either a new agreement or an impasse is reached.

In Trump Entertainment Resorts, the union/counterparty to the expired CBA argued that upon expiration, the CBA had ceased to be a “contract,” and that Section 1113 therefore had no application, as no contract existed for the debtor to reject. The union reasoned that because Section 1113 ceased to apply, the debtor was left subject solely to the NLRA’s requirement that an employer must maintain the status quo under an expired CBA as to mandatory subjects of bargaining until the parties reach either a new agreement or an impasse.

Not so, the Third Circuit decided, holding that Section 1113 allows a debtor to reject not only an extant CBA, but also the ongoing obligations remaining following a CBA’s expiration. The court examined Section 1113 “in the context of the Bankruptcy Code as a whole,” and concluded that the “intent of Congress … was to incorporate expired CBAs in the language of § 1113.”[2] Rejecting the union’s argument to the contrary, the court concluded that the NLRA must “yield[] to the Bankruptcy Code” when doing so is essential to the debtor’s ability to stay in business.[3] This accomplishes the Bankruptcy Code’s overarching goal of giving debtors the freedom necessary to preserve their business, while also protecting unions’ interest in preserving their CBAs and “maintaining influence in the reorganization process,” the court reasoned.[5]

Using language that undoubtedly made waves in the sea of organized labor, the court stated:

[W]hen the employer’s statutory obligations to maintain the status quo under the terms of an expired CBA will undermine the debtor’s ability to reorganize and remain in business, it is the expertise of the Bankruptcy Court which is needed rather than that of the NLRB. For that reason, whether the CBA is in effect or is expired, it is the Bankruptcy Court which should make the review and decide on the necessity of the modification. We conclude, therefore, that § 1113 applies to a CBA after it is expired.5

The effect of this decision is significant for employers in bankruptcy whose economic recovery is stymied by high labor costs. Trump Entertainment Resorts’ predicament is a prime example of the impossible position in which debtors can find themselves — with secured debt in the neighborhood of $286 million and working capital cash of only about $12 million, the CBA required the debtors to make more than $3.5 million per year in pension contributions, and $10-$12 million per year in health and welfare contributions. To alleviate some of this burden, the debtors made a proposal to the union that would have resulted in approximately $3.7 million in annual pension contribution savings, $5.1 million in health and welfare contribution savings, and $5.8 million saved through changes to work rules. “Instead of negotiating with the Debtors,” the court noted, “the Union stalled the bargaining sessions, engaged in picketing, and attempted to harm the Debtors’ business.”[6] Without the ability to reject its ongoing obligations under the CBA, the debtor may well have been forced to liquidate and terminate its employees.

The Trump Entertainment Resorts decision might also go a long way toward promoting productive negotiations between debtors and unions in the future, because it gives each side more clarity on what to expect if they do not reach an agreement. In fact, a distressed company might be able to avoid bankruptcy altogether if the unions representing its employees know that if they fail to reach agreement on a CBA soon to expire, and the company files for bankruptcy post-expiration, the company might be able to reject the otherwise-ongoing obligations under the CBA.

The court’s opinion is available here.