Rejection of a contract in bankruptcy may not always accomplish a debtor’s goal to shed ongoing contractual obligations and liabilities, especially when dealing with employee benefit plans. On October 13, 2011, the Fifth Circuit Court of Appeals highlighted this issue in its opinion in Evans v. Sterling Chemicals, Inc.1 regarding the treatment of a pre-bankruptcy asset purchase agreement which contained a provision addressing the debtor-acquiror’s post-closing ERISA retiree benefit plan obligations to its new employees resulting from the transaction.
Several years before it contemplated and ultimately filed for bankruptcy, Sterling Chemicals, Inc. (“Sterling”) purchased a fibers business pursuant to an asset purchase agreement (“Purchase Agreement”) which provided, among other things, for Sterling to offer employment to certain of seller’s employees and to continue post retirement medical and life insurance benefits as they retired at seller’s retiree plan levels. Specifically, the relevant provision of the Purchase Agreement guaranteed certain retiree benefits and levels of premiums no less favorable to the “acquired employees” than those benefits provided by the seller under its retiree benefit plans. Sterling agreed that it would not reduce the level of such benefits (or increase the premiums) without seller’s prior written consent, or if seller similarly reduced such benefits under its own plan. After the acquisition, Sterling immediately included these acquired employees as participants in its benefit plan (the “Benefit Plan”), but did not make formal changes to the Benefit Plan documents providing for the Purchase Agreement benefit guarantees, nor was the Purchase Agreement provision ever expressly referenced in any formal Benefit Plan document or multiple summary plan descriptions. For more than six years, as acquired employees became retiree participants in the Benefit Plan, they continued to pay the same level of premiums and receive the same level of benefits as the Purchase Agreement provided.
Four years after the acquisition, Sterling filed for Chapter 11 bankruptcy protection. A week before the bankruptcy court would enter its order confirming Sterling’s Chapter 11 plan, the court entered its order authorizing Sterling’s rejection of a number of executory contracts, including the Purchase Agreement. The debtors did not seek to reject any of the documents underlying the Benefit Plan, but rather, in accordance with Bankruptcy Code section 1129(a)(13),2 assumed as executory contracts all of Sterling’s Benefit Plan obligations. Ten days before Sterling consummated its Chapter 11 plan and emerged from bankruptcy, Sterling notified the acquired employees that their guaranteed premium rates and benefits would only exist through March 2003. Thereafter, Sterling raised the premium rates and adjusted the retiree benefits of the acquired employees to match those of its other employees under the Benefit Plan, all of which was done without seller’s consent.
In 2007, after two additional premium hikes, the plaintiffs (a group of acquired employees) filed suit against Sterling. The District Court denied Sterling’s motion to dismiss, finding that the Purchase Agreement modified the Benefit Plan, but did not decide what effect rejection of the Purchase Agreement had on the Benefit Plan, and the Plaintiffs were permitted to exhaust their administrative remedies. The Benefit Plan administrator denied the plaintiffs’ claims for benefits, finding that the Purchase Agreement did not modify the Benefit Plan, that Sterling’s contractual obligations to seller under the Purchase Agreement provision were terminated upon rejection, and that the increase in premiums was permitted under the Benefit Plan. The District Court then conducted a bifurcated trial and ruled in favor of Sterling, holding that the Purchase Agreement did not modify the Benefit Plan and, therefore, Sterling’s rejection of the Purchase Agreement allowed Sterling to adjust the acquired employees’ retiree benefits free of the Purchase Agreement’s limitations. The plaintiffs appealed, arguing that since the applicable Purchase Agreement provision was a valid amendment to the Plan which was assumed by Sterling when it assumed all of its retiree benefits in its Chapter 11 plan, Sterling therefore was obligated to guarantee the previous rates of retiree premiums and benefits. The Fifth Circuit held in favor of the plaintiffs, notwithstanding Sterling’s rejection of the Purchase Agreement in its bankruptcy case. Accordingly, Sterling continued to be bound by the Purchase Agreement requirements regarding the retiree benefits notwithstanding its bankruptcy rejection of the Purchase Agreement.
The Fifth Circuit focused on whether the Purchase Agreement validly amended the Benefit Plan, within its analysis in Halliburton Co. Benefits Committee v. Graves.3 In that case, involving a surviving Dresser Industries entity and the retiree medical plan sponsor following Dresser Industries’ merger with Halliburton, the Fifth Circuit ruled that the merger agreement constituted a valid amendment of an ERISA plan even though the merger agreement did not exactly follow the plan’s amendment procedures. In Sterling, the Fifth Circuit determined that Sterling’s board of directors approval and execution of the Purchase Agreement in a manner consistent with the Plan’s procedures for a plan amendment constituted an amendment, since requisite action had been taken regarding the authorization and implementation of an amendment to the Benefit Plan.
The Sterling decision is notable because it extends prior decisions relating to ERISA plan amendments in the merger context to acquisitions in the form of asset purchase deals where the acquiror made no express assumption of the seller’s retiree plans and it did not intend to effect an amendment to its own ERISA plan. Sterling was bound by the Purchase Agreement to continue to provide retiree benefits to the acquired employees post-confirmation until it obtained the seller’s written consent to change the same. Most significant from a bankruptcy standpoint, the Court found that the fact that the Purchase Agreement was a contract that could be and was rejected by Sterling did not mean that the applicable benefits guarantee provision could not also survive rejection as a separate, distinct amendment to the Benefits Plan. The Fifth Circuit’s finding in this regard is a clear warning to all bankruptcy, corporate transactions and employee benefits practitioners: “Sterling cites no statute or case law that supports the idea that contractual obligations and plan amendments are mutually exclusive concepts.”4
Practical Considerations to Take Away
As a result of this decision, it is not sufficient to analyze whether a pre-bankruptcy acquisition or other agreement is an executory contract subject to assumption or rejection, but it is also now important to consider whether the agreement satisfies an ERISA plan’s requirements to be an amendment resulting in unexpected liabilities. A review of prior acquisition agreements for employee benefits covenants which might now be construed to be plan amendments is suggested. Acquirors should also be mindful of the possible consequences of accepting a seller’s request to address in the deal documents the level of benefits acquired employees will receive post-closing.
Moreover, if construed broadly, the Sterling decision could be cited to support arguments by parties seeking to have agreements found to have “multiple personalities” in other contexts, outside of ERISA benefit plans. Accordingly, reorganizing companies, investors, acquirors and other deal makers are cautioned to consider the unintended implications of agreements which may be construed as having “multiple personalities,” or risk being subject to substantial liabilities and obligations which may not be easily shed in bankruptcy.