Once a company files a Chapter 11 bankruptcy petition (to sell its assets, reorganize or liquidate), Bankruptcy Code § 1114 sets forth a detailed procedure for the employer to follow to modify or terminate certain retiree benefits. Among other things, § 1114 imposes on the employer the burden of showing that the elimination or modification of benefits is necessary to permit reorganization. Since the enactment of § 1114 in 1988, a recurring issue has been whether these procedures need to be followed where, as is frequently the case, the retiree benefits plan contains a reservation of rights permitting unilateral amendment, modification or termination by the employer. A number of Bankruptcy and United States District Courts have ruled on this issue, with a majority of them concluding that such reservation of rights language renders § 1114 inapplicable.
On July 13, 2010, in a decision arising out of the Visteon Corporation bankruptcy, the United States Court of Appeals for the Third Circuit became the first appellate court to directly address this issue, and in doing so, parted ways with the majority. The Third Circuit ruled that § 1114 applies even where the debtor has retained the right in the plan itself to unilaterally modify or terminate retiree benefits. See In re Visteon Corp., Case No. 10-1944 (3d Cir. July 13, 2010).
Facts and the Lower Court Decisions
For many years before filing for bankruptcy, Visteon (and its predecessor, Ford Motor Corporation) had provided medical insurance and life insurance benefits to its retirees and their dependents. The applicable summary plan descriptions expressly reserved Visteon’s right to “suspend, modify or amend the benefits…, or even terminate the Plan[s] or any of the benefits provided under the Plan[s],” to the full extent permitted by law and subject to its collective bargaining agreements. Before its Chapter 11 filing, Visteon also negotiated plant closing agreements with the unions representing many of its employees which provided that those agreements did “not limit or in any way modify the provisions of any benefit plan.”
Approximately one month after its Chapter 11 filing, Visteon sought authority from the bankruptcy court under § 363(b)1 to terminate all of its United States retiree benefit plans – a move that would affect nearly 8,000 current and former employees and their dependents. Over the objections of many of the retirees, including 2,100 being represented by the unions, the bankruptcy court concluded that § 1114 did not apply “and authorized the termination based on the court’s conclusion that it was a reasonable exercise of business judgment.” The bankruptcy court relied heavily on the court’s opinion and analysis in In re Delphi Corp., Case No. 05-44481 (Bankr.S.D.N.Y. March 10, 2009).2 The district court affirmed the bankruptcy court’s findings and conclusions and granted a one-month stay to permit the retirees to seek an expedited appeal.3
Third Circuit Analysis
On appeal, the unions and retirees argued that the plain language of § 1114 applies to all retiree benefits, including those that could be unilaterally terminated outside of bankruptcy. Visteon and the Creditors Committee countered that the legislative history of § 1114 made clear that Congress did not intend the Section to apply in such circumstances and that “restricting a debtor from terminating during bankruptcy those retiree benefits that it could otherwise terminate at will is absurd” and contrary to Congress’ intent. Assuming that Visteon would otherwise have the right to unilaterally terminate the benefits outside of bankruptcy under the Employee Retirement Income Security Act, the National Labor Relations Act, the applicable collective bargaining agreements and the plan documents themselves, the Third Circuit nevertheless rejected Visteon’s arguments, holding:
“§ 1114 is unambiguous and clearly applies to any and all retiree benefits, including the ones at issue here. Moreover, despite arguments to the contrary, the plain language of § 1114 produces a result which is neither at odds with legislative intent, nor absurd. Accordingly, disregarding the text of that statute is tantamount to a judicial repeal of the very protections Congress intended to afford in these circumstances. We must, therefore, give effect to the statute as written.”
Thus, the court concluded, whether the debtor had the right to modify or terminate such benefits pre-petition was irrelevant.4
Legal and Practical Implications
The Third Circuit’s decision is not binding on lower courts in other circuits or on other circuit courts and, therefore, whether § 1114 applies to the modification or termination of retiree benefits that would otherwise be modifiable at will remains an open issue to be fought out in future cases (at least until the United States Supreme Court takes up the issue). The Third Circuit’s decision in Visteon, however, is significant for several reasons.
First, it may represent a sea change in the direction of the law under § 1114. Despite the longstanding split of authority on this issue, the Bankruptcy Court for the Southern District of New York’s decision in Delphi last year seemed to be just the latest installment in a growing consensus that § 1114 does not apply in such circumstances. The Third Circuit’s opinion to the contrary, however, is the first from a United States Court of Appeals on the issue and may therefore be accorded greater weight by courts deciding this issue in the future. It is also – however one might feel about the ultimate outcome – thorough and well-reasoned, and it comprehensively addresses and dismisses the arguments relied on by the majority of courts to find that § 1114 does not apply in these circumstances.
Second, in the Third Circuit and other jurisdictions that have adopted or may in the future adopt the Third Circuit’s approach, debtor-employers will face a more complicated and costly battle in seeking relief from their retiree benefit plans, which may be one of the reasons – if not the main reason – the debtor filed for bankruptcy in the first place. This is particularly true in the Third Circuit (which encompasses Delaware, where many corporate bankruptcies are filed) for debtor-employers operating under collective bargaining agreements. Although the Visteon court did not directly address the applicable standard for a court to use in determining whether to approve a modification or termination of retiree benefits, its decision likely also means that debtor-employers who invoke § 1114 to seek to modify or terminate their retiree benefits will have to meet the stringent standard the Third Circuit set in Wheeling-Pittsburgh Steel Corp. v. United Steelworkers of Am., 791 F.2d 1074 (3d Cir. 1984), for rejecting collective bargaining agreements under § 1113 in bankruptcy. In Wheeling-Pittsburgh – another bankruptcy-related case in which the Third Circuit took (or more accurately, established) the minority view – the court held that a debtor must show rejection of its CBA is absolutely necessary to avoid liquidation in the immediate future. In light of the textual similarities between the two statutes, it is reasonable to surmise that the Third Circuit would apply the same strict standard to debtor-employers’ applications to modify or terminate retiree benefits under § 1114. In planning for bankruptcy filings, employers would therefore be well-advised to consider whether they might be better off filing in a permissible venue other than the heretofore popular Third Circuit. For example, the less stringent standards applied to terminations or modifications of CBA’s and retiree benefits by New York/Second Circuit courts may prompt renewed interests of financially distressed companies to pursue the possibility of filing for Chapter 11 in the Southern District of New York (or elsewhere within the Second Circuit). This is especially true for employers whose bankruptcy filings may be driven largely by retiree benefit obligations that have grown too great for the company’s financial and capital structure to withstand.
Third, it is possible that the Third Circuit’s rejection of the majority view in the high-profile Visteon case will spur further attempts at legislation aimed at settling this issue once and for all. Until then, this issue is one that will likely continue to take center stage in many large bankruptcies where companies seek to resolve retiree benefits that imperil their ability to continue to operate as standalone operations.
Fourth, the Visteon decision may prompt some companies to pursue sales of their assets and impacted business operations within the time frames usually associated with § 1114,5 instead of pursuing strategies for continuing to operate as a standalone operation. Proceeding in this manner may allow debtor-employers to shield acquirers from the retiree obligations, while also limiting the extent to which retiree benefit claims prevent a company’s financial wherewithal and value from being used to satisfy other claims.
Accordingly, given the state of the law both at the pre-petition and bankruptcy stage, employers, especially those with large legacy retiree obligations, should take into account the requirements of § 1114 and plan for the possibility that it will be necessary to fulfill those requirements, including the post-bankruptcy negotiation process with a labor organization or a court-appointed committee representing the retirees.6 If the parties are unable to reach an agreement after engaging in that process for a sufficient period of time, the court may enter an order permitting the proposed modifications only if it finds that (1) the retirees’ representative has “refused to accept [the debtor’s] proposal without good cause;” (2) the proposed modification “is necessary to permit the reorganization of the debtor;” (3) the proposal treats all affected parties “fairly and equitably;” and (4) permitting the proposed modification is “clearly favored by the balance of the equities.” 11 U.S.C. § 1114(g). Thus, with Visteon, an employer whose economic viability is threatened by its retiree obligations is advised to engage in significant pre-filing analysis and planning, and may have to consider alternative restructuring strategies, including a sale of the business as a going concern or even liquidation.