On July 13, 2010, a three-judge panel of the United States Court of Appeals for the Third Circuit unanimously held that auto-parts supplier Visteon Corporation could not terminate health and life insurance benefits for approximately 2,100 retirees during its chapter 11 bankruptcy unless Visteon followed the specific requirements laid out in section 1114 of the Bankruptcy Code, even if Visteon would have had the unilateral right to terminate these benefits outside bankruptcy.1 The Court found that a debtor may terminate any retiree benefits in bankruptcy only if, inter alia, the debtor negotiates in good faith with the retiree representative, the representative fails to consensually agree to the needed modifications and the debtor demonstrates that the termination during the bankruptcy is necessary for the debtors’ reorganization and treats all parties fairly. Subsequently, Visteon reached a settlement with certain of its unions representing retirees, facilitating its exit from chapter 11.

The Third Circuit’s ruling directly contradicts the majority of courts (including the Second Circuit’s decisions in In re Delphi Corp.2, and In re Chateaugay Corp.3) that have previously found that section 1114 of the Bankruptcy Code does not restrict a debtor’s ability to terminate a benefits plan during bankruptcy if the debtor could terminate the benefits plan unilaterally outside of bankruptcy. The issue may be ripe for Supreme Court review and could have a profound effect on bankruptcies filed in Delaware and elsewhere because debtors in the Third Circuit may no longer be able to modify or terminate retiree benefits in bankruptcy with as much ease as previously. This could lead to shorter bankruptcy cases, or more prepackaged or pre-negotiated bankruptcies in cases with significant employee benefits liabilities – and likely increases union leverage in negotiating any changes to benefits plans.

Background

For decades, Visteon provided to its retirees health and life insurance benefits through a series of successive collective bargaining agreements, and detailed these benefits in summary plan descriptions.4 The most recent summary plan description stated that Visteon “reserves the right to suspend, amend or terminate the Plan . . . at any time and in any ma[nn] er to the extent permitted by law.”5

Upon filing for bankruptcy on June 26, 2009, Visteon requested permission from the bankruptcy court to terminate all of its retiree benefit plans for approximately 8,000 of its present and former employees.6 The bankruptcy court held that Visteon could terminate most of the retiree benefits, finding that because Visteon could terminate the benefits under applicable nonbankruptcy law, section 1114 of the Bankruptcy Code did not apply. Specifically, the Bankruptcy Court held:

As a matter of applicable non-bankruptcy law, as well as the plain meaning of the controlling documents, the Debtors would have outside of bankruptcy the right to terminate these plans at will. . . . The reason that the benefits can be terminable . . . is that they are not vested. . . . I hold that the plain meaning [analysis] as applied by Judge Venter in [Farmland Indus., Inc.] . . . is not persuasive . . . [because it] would lead to an absurd result in that it would expand retiree rights beyond the scope of state law for no legitimate purpose. Under [Butner v. United States7], which is based on constitutional principles, the statute cannot modify existing state law [absent] some specific bankruptcy reason and there is none here in connection with the issue of non-vested retiree benefits.8 Several unions representing the retirees appealed the decision to the district court and also moved for a stay of the bankruptcy court’s order. The district court denied the appeal and issued a one-month stay so that the unions could seek an expedited appeal to the Third Circuit.9

Analysis

Retiree benefits are often a central issue in large bankruptcy cases, particularly industrial companies with large union workforces, such as auto parts manufacturers. After filing for bankruptcy in 1986, LTV Steel Co. sought to terminate health benefit payments for 78,000 retirees and their dependents through the standard contract rejection process under section 365 of the Bankruptcy Code. Subsequently, LTV liquidated its assets during its bankruptcy and the Pension Benefit Guaranty Corporation took over LTV’s defined benefit plans, which were under-funded by approximately $2.3 billion.

Congress subsequently enacted section 1114 of the Bankruptcy Code in 1988. “In crafting § 1114, Congress provided certain procedural and substantive protections for retiree benefits during a Chapter 11 proceeding.”10

Section 1114(e)(1) of the Bankruptcy Code states that the debtor “shall timely pay and shall not modify any retiree benefits” except by the procedures detailed elsewhere in section 1114. Other provisions of section 1114 require that the debtor negotiate in good faith to modify retiree benefits before terminating them. Section 1114(f) of the Bankruptcy Code requires that the debtor “make a proposal to the authorized representative of the retirees . . . which provides for those necessary modifications in the retiree benefits that are necessary to permit the reorganization of the debtor and assures that all creditors, the debtor and all of the affected parties are treated fairly and equitably.”11 After making this proposal, the debtor must “confer in good faith in attempting to reach mutually satisfactory modifications of such retiree benefits.”12 Only then will the court grant a motion to modify or terminate benefits, and only if the court finds that the debtor has satisfied these obligations, the representative of the retirees has refused to accept the proposal without “good cause” and the proposed “‘modification is necessary to permit the reorganization of the debtor and assures that all creditors, the debtor and all of the affected parties are treated fairly and equitably, and [modification] is clearly favored by the balance of the equities.’”13 Moreover, section 1114(e) of the Bankruptcy Code further protects retirees by classifying any retiree benefits owed during a bankruptcy as an allowed administrative claim.  

In Visteon, the unions representing the affected retirees argued that section 1114 of the Bankruptcy Code applies to all retiree benefits regardless of the terms of the underlying benefits agreements, and that a debtor can only terminate retiree benefits during a pending bankruptcy case, if it follows the specific procedures detailed in section 1114(h) of the Bankruptcy Code. The Debtors and the Creditors Committee argued that a debtor may terminate retiree benefits, in spite of the plain language of section 1114 of the Bankruptcy Code, if the debtor could terminate those benefits at will outside bankruptcy. The Debtors and Creditors Committee relied on a line of cases (most notably including In re Chateaugay Corp.) holding that prohibiting a debtor from terminating retiree benefits that may be terminated at will outside bankruptcy “is absurd, and courts must conclude that the plain language of a statute does not reflect congressional intent if it produces an absurd result.”14

The Court found that section 1114 of the Bankruptcy Code “is unambiguous and clearly applies to any and all retiree benefits, including the ones at issue here. . . . Accordingly, disregarding the text of that statute [applying its provisions to all retiree benefits] is tantamount to judicial repeal of the very protections Congress intended to afford in these circumstances.”15 Therefore, the Court found that a debtor could only terminate or modify retiree benefits if it satisfied the standards of section 1114 of the Bankruptcy Code.16

The Third Circuit “recognized” that its ruling runs contrary to the majority of other courts, and particularly focused on In re Chateaugay Corp.17 In In re Chateaugay Corp., the debtor sought to terminate benefits under an expired CBA. The Court permitted the debtor to terminate those benefits because the CBA had expired on its terms and the debtor would not have been obligated to make the relevant payments outside bankruptcy.18 However, the Visteon Court stated that “the Second Circuit majority’s analysis [in In re Chateaugay Corp.] failed to remain faithful to the plain language of the provision the court was interpreting. The majority concluded that the statute only mandated continuation of payments the debtor was required to make under a plan, as opposed to simply payments being made under a plan.”19 The Visteon court viewed this as a misreading of the plain language of the statute and reiterated that “Congress mandated that the debtor continue to pay benefits ‘under a plan, fund, or program maintained or established by the debtor.’”20 The Third Circuit rejected a number of attempts by the Committee and Debtors to argue that section 1114 was ambiguous and that legislative history and other interpretative aids demonstrated that the Debtors were entitled to terminate the benefits. The Court dismissed each by noting the lack of ambiguity in section 1114 of the Bankruptcy Code and reiterating that the plain language of the code provision was definitive and clear: retiree benefits can only be terminated in accordance with section 1114 of the Bankruptcy code during the case.

The court also analyzed Bankruptcy Judge Robert Drain’s recent decision in In re Delphi Corp. In Delphi, Judge Drain also held that section 1114 of the Bankruptcy Code did not apply where relevant documents governing the benefit granted the debtor the right to modify those benefits at will. The Third Circuit found that the Delphi decision missed the mark.21 The Third Circuit stated that Judge Drain “did not actually begin [his] analysis with the statutory text.”22 Rather, he had “immediately turned to case law and to a consideration of ‘fundamental principles underlying the Bankruptcy Code’” in support of his view that Delphi could terminate the relevant retiree benefits.23

The Third Circuit also noted that upon emergence from bankruptcy, section 1129(a)(13) of the Bankruptcy Code ensures that a debtor that reserved the right to terminate retiree benefits has no ongoing obligation to continue to provide those benefits after confirmation of a plan of reorganization.24 Thus, the restriction on terminating retiree benefits applies only during the pending bankruptcy case. Confirmation of a plan still provides a debtor with the opportunity to terminate a plan at will.

The Impact

The Visteon ruling has the potential to alter the process followed in bankruptcy cases of debtors with significant retiree benefits obligations. No longer will debtors (at least in the Third Circuit) be able to run to court with the intent of seeking immediate relief from burdensome retiree benefits. Rather, they will have to wait until confirmation of a plan at the end of a case, or, as in Visteon’s case, negotiate a settlement with retirees. This could significantly increase administrative claims accrued by retirees during a bankruptcy case and the costs associated with the restructuring.

Section 1114(l) also restricts a debtor’s ability to modify retiree benefits immediately preceding a bankruptcy. Section 1114(l) of the Bankruptcy Code provides that a debtor may not modify retiree benefits in the 180-day period immediately preceding the filing of a bankruptcy petition if the debtor was insolvent at the time of the modification “unless the court finds that the balance of the equities clearly favors such modification.” Therefore, under the Third Circuit’s analysis in Visteon, a potential debtor likely cannot terminate its employee benefits prior to confirmation of a plan.

However, because a debtor may continue to terminate or modify benefits through a plan under section 1129(a)(13) of the Bankruptcy Code, the Visteon ruling could lead to debtors seeking to accelerate confirmation of a plan in cases with large retiree benefits (perhaps through a prepackaged or prearranged bankruptcy, or through a large-scale asset sale followed by a liquidation).

This opinion also comes in the wake of the Third Circuit’s recent ruling in In re Philadelphia Newspapers, LLC,25 on the issue of credit bidding in sales conducted under a plan. In both cases, the Third Circuit has relied on a strict statutory construction of the relevant provision of the Bankruptcy Code, thus curtailing practices the Third Circuit deemed outside the Bankruptcy Code’s plain meaning. Parties should expect the Third Circuit and the Delaware District and Bankruptcy Courts (as well as other courts in the Third Circuit) to take a close look at the plain meaning of any disputed statutory provision.

Given the Third Circuit’s role in setting law for bankruptcies filed in the District of Delaware, this decision could have wide-ranging implications on numerous bankruptcies. In fact, the impact of this decision has already been felt by other debtors. For example, Nortel Networks Corp. dropped its bid to cut off medical benefits and disability pay to 4,000 U.S. retirees and dependents on July 16, 2010, in the wake of the decision.26

Finally, in Visteon, the Bankruptcy Court recently approved a Plan of Reorganization. As part of the plan process, Visteon entered into a deal with the union agreeing to pay more than 6,000 retirees approximately $11 million, including $500,000 in attorneys fees, in exchange for the termination of the retirees’ health benefits. Retirees above age 65 as of April 1, 2010 will receive $2,000 while those under age 65 as of April 1, 2010 will receive up to a maximum of $13,000. Retirees will also have the ability to extend their coverage with out-of-pocket payments. It is unclear what impact this ruling had on those settlement negotiations.