Illinois Bankruptcy Court Narrowly Construes WARN Act’s “Liquidating Fiduciary” Exception

By Peter D. DeChiara

pdechiara@cwsny.com

Posted March 2017

Does an employer in Chapter 11 bankruptcy have to comply with the WARN Act if the employer has no intention of continuing to operate its business?  Some courts have held that a Chapter 11 debtor has no obligation to give advance notice to employees of a plant closing or mass layoff if the debtor has shown that it does not intend to continue operating.  But a recent decision by the bankruptcy court for the Northern District of Illinois parted company with those cases, concluding that the WARN Act applies to Chapter 11 debtors regardless of their intentions about the future of the business.  See In re World Marketing Chicago LLC, Case No. 15-32968 (Bankr. N.D. Ill. Feb. 24, 2017). 

The WARN Act, which requires advance notice to employees of a plant closing or mass layoff, only applies to employers who fit the definition of a “business enterprise.”  29 U.S.C. §2101(a)(1).  Some courts have taken the position that when an employer in Chapter 11 has demonstrated an unequivocal intention to close the business, it ceases to function as a “business enterprise,” and therefore no longer has any obligations under the WARN Act.  In United Healthcare System, Inc., 200 F.3d 170 (3d Cir. 1999), the lead case on this point, the Third Circuit reversed a WARN Act judgment against a hospital and healthcare services corporation that had filed for Chapter 11, when, at the time it terminated most of its employees, the Chapter 11 debtor had discharged its patients and was admitting no new ones, and its remaining employees were performing tasks solely aimed at the company’s liquidation.  The appeals court reasoned that, under those circumstances, the company was no longer operating as an ongoing business enterprise subject to the WARN Act.

In World Marketing, the recent decision from the bankruptcy court for the Northern District of Illinois, bankruptcy judge Timothy A. Barnes acknowledged the existence of the “liquidating fiduciary” exception to the WARN Act that had been applied in United Healthcare and its progeny.  He also acknowledged that the exception undoubtedly applied in Chapter 7 cases, where a court-appointed trustee winds down the debtor’s affairs.  But, in contrast to the United Healthcare line of cases, the judge took the position that the exception had no application in Chapter 11 cases, regardless of the employer’s intentions about the future of the business.

In reaching this position, the Illinois bankruptcy court relied on a 1989 U.S. Department of Labor regulation, 20 CFR Part 639, 54 Fed. Reg. 16042-01 (April 20, 1989), that explained that a fiduciary has no WARN obligations if its “sole function in the bankruptcy process is to liquidate a failed business.”  Judge Barnes reasoned that because debtors in Chapter 11 have the right to continue the business and attempt to reorganize, liquidating is not their “sole function.”  Therefore, according to the court, the plain language of the DOL regulation precludes application of the “liquidating fiduciary” exception to a Chapter 11 debtor, unless the bankruptcy court issues an order constraining the debtor’s right to operate its business.

Judge Barnes’ analysis was dictum, since he went on to hold that even under the United Healthcare analysis, the “liquidating fiduciary” exception had no application to the debtors in the World Marketing case.  He found no unequivocal evidence of the debtors’ intention to discontinue the business, even though the debtors had emailed their employees hours after filing for bankruptcy that they were “shutting down operations.”  The court noted that, despite this announcement, the debtors had filed motions to use cash collateral, claiming the cash was necessary “to operate its business,” had filed motions to pay payroll, so as not to jeopardize their asserted “ability to reorganize,” and had filed a motion for a “going concern” sale of the business.  These motions, the court concluded, left the evidence of the debtors’ intentions about the future of their business “muddied at best.”

World Marketing constitutes a welcome effort to contain the scope of the “liquidating fiduciary” exception to the WARN Act, to prevent it from spilling over from Chapter 7, where it belongs, into Chapter 11, where it does not.  The DOL regulation on which the court relied offers a helpful basis for the analysis.  But the language of the WARN Act itself supports banishing the “liquidating fiduciary” exception from Chapter 11 cases:  whatever its intentions regarding the future of its operations, a business enterprise doesn’t stop being a business enterprise simply because it files for Chapter 11 protection.

 

 

 

Delaware Bankruptcy Court Strikes Down Arbitration Clause That Prohibited Employee Class Action

By Peter D. DeChiara

pdechiara@cwsny.com

Posted October 2016

The National Labor Relations Board touched off a furious legal controversy in 2012 when it held in D.R. Horton, Inc., 357 N.L.R.B. 2277, that employer-imposed arbitration clauses violate federal law if they prohibit employees from bringing class-action claims.  Four years on, the controversy still rages, splitting courts  internally, see, e.g., Morris v. Ernst & Young, LLP, 2016 WL 4433080 (9th Cir. 2016) (2-1 split on the issue, with dissenter charging majority with “breathtaking” error), and also splitting courts one from another, with some courts rejecting the NLRB’s position, see, e.g., D.R. Horton, Inc. v. NLRB, 737 F.3d 344 (5th Cir. 2013); Cellular Sales v. NLRB, 824 F.3d 772 (8th Cir. 2016); Bekele v. Lyft, Inc., 2016 WL 4203412 (D. Mass. 2016), and others accepting it, see, e.g., Morris, 2016 WL 4433080 (9th Cir. 2016); Lewis v. Epic Sys. Corp., 823 F.3d 1147 (7th Cir. 2016).  Some bankruptcy judges might shrink from such a charged, non-bankruptcy controversy.  But Chief Judge Brendan L. Shannon of the United States Bankruptcy Court for the District of Delaware, faced recently with a class-action waiver case, strode into the fray, and with some deft strokes of legal reasoning produced an admirable decision, striking down an arbitration clause that a bankrupt employer raised as a defense to an employee class action.  See In re Fresh & Easy, LLC, Case No. 15-12220 (Bankr. D. Del. Oct. 11, 2016).

In Fresh & Easy, LLC, an employee of a grocery store chain signed an arbitration agreement that prohibited her from bringing a class-action suit against the company.  The agreement gave her 30 days to opt out of the agreement after signing it, but she didn’t opt out.  After Fresh & Easy filed for Chapter 11 protection, the employee brought a class-action adversary proceeding against it in the bankruptcy court, claiming that the company failed to give her and other employees the advanced notice of termination required by federal and state law.  Fresh & Easy moved to stay the adversary proceeding, arguing that the arbitration clause the employee signed barred the class-action claim.

Judge Shannon first tackled the question whether the arbitration agreement’s prohibition on class claims violated the National Labor Relations Act (NLRA).  With a touch of understatement, he observed that “[t]here is little consensus on this issue.”  Despite the swirl of controversy, and some federal appeals courts lined up on the other side, Judge Shannon concluded that the NLRA “unambiguously protects the right of employees to bring a collective action.”  The NLRA gives employees the right to engage in “concerted activities” for their “mutual aid or protection” and prohibits employers from interfering with that right.  According to the bankruptcy court’s analysis, the collective pursuit of claims constitutes a form of concerted activity, so arbitration agreements that prohibit class actions interfere with employees’ NLRA rights.

But does the employer dodge an NLRA violation by inserting an opt-out clause in the arbitration agreement? On that issue, Judge Shannon concluded, the NLRA provided no clear guidance.  The only appeals court decision on point, Johnmohammadi v. Bloomingdale’s, Inc., 755 F.3d 1072 (9th Cir. 2014), held that the opt-out washed the class-action waiver free of any unlawful taint.  Nonetheless, displaying an appropriate appreciation for NLRB expertise on labor matters, the bankruptcy court endorsed the agency’s position on the issue, see On Assignment Staffing Servs., Inc., 362 N.L.R.B. No. 189 (2015), rev’d, 2016 WL 3685206 (5th Cir. 2016), and held the arbitration clause unlawful despite the opt-out clause.

Finally, the court held that, with the class-action waiver at the heart of the arbitration agreement stricken, the arbitration agreement itself could not stand.  The court thus denied the company’s motion to stay the class-action proceeding.

It is decisions like Fresh & Easy that restore one’s confidence that bankruptcy courts, though focused on bankruptcy issues, can successfully and surely navigate difficult labor questions.

 

The Bankruptcy Code’s Puzzling Back Pay Provision

By Peter D. DeChiara

pdechiara@cwsny.com

Posted August 2016

How much judicial confusion can one small section of the Bankruptcy Code create?  Quite a bit, as the Bankruptcy Code’s back pay provision demonstrates.  That provision, 11 U.S.C. § 503(b)(1)(A)(ii), added to the Code as part of a package of 2005 amendments, seeks to define what types of back pay claims enjoy administrative priority status.  But the provision, which one bankruptcy court recently called “confusing on its face,” In re Calumet Photographic, Inc., 2016 WL 3035468, at *3 (Bankr. N.D. Ill. 2016), has proven to be a real head-scratcher for the courts called upon to interpret it.  And its lack of virtually any legislative history only adds to the fog.

Section 503(b) of the Bankruptcy Code, divided into nine separate subparts, defines the various types of creditor claims against a debtor that enjoy administrative status.  That status is important; unlike other bankruptcy claims, administrative expense claims typically receive payment in full.  The first subpart, Section 503(b)(1)(A), confers administrative status on claims arising from “the actual, necessary costs and expenses of preserving the estate.”  Section 503(b)(1)(A) further states that this includes two types of claims:  “wages, salaries, and commissions for services rendered after” the company’s bankruptcy filing, as set out in subsection (i), “and” certain types of back pay claims, as set out in subsection (ii).

Subsection (ii), which is the subject of this blog post, is a mouthful.  It provides administrative status to “wages and benefits awarded pursuant to a judicial proceeding or a proceeding of the National Labor Relations Board as back pay attributable to any period of time occurring after commencement of the case under this title, as a result of a violation of Federal or State law by the debtor, without regard to the time of the occurrence of unlawful conduct on which such award is based or to whether any services were rendered,” so long as the payment of such claims won’t substantially increase the likelihood of layoffs or terminations of the company’s employees.

Some of this language is relatively straightforward.  Since subsection (ii) only applies to claims resulting from an employer’s “violation of Federal or State law,” a court has concluded that claims based on violations of a collective bargaining agreement don’t qualify.  See In re Philadelphia Newspapers, LLC, 433 B.R. 164, 176 (Bankr. E.D. Pa. 2010).   Similarly, since it applies to “wages and benefits,” another court found that claims for attorney’s fees arising from an employment suit don’t qualify either.  See In re Trump Entertainment Resorts, Inc., 2015 WL 1084294, at *3 (Bankr. D. Del. 2015).

But what about the phrase “awarded pursuant to a judicial proceeding”?  Does the judicial proceeding have to be one other than the bankruptcy case in which the claim is asserted?  In First Magnus Financial Corp., 390 B.R. 667, 678 (Bankr. D. Ariz. 2008), aff’d, 403 B.R. 659 (D. Ariz. 2009), the bankruptcy court held that the judicial proceeding must be in a court of general jurisdiction, not the bankruptcy court itself.  That distinction, however, has no basis in the language of the statute.  The better view holds that proceedings in the bankruptcy court, which is after all an arm of the district court, constitute “judicial proceedings” within the meaning of subsection (ii).  See, e.g., In re Truland Group, Inc., 520 B.R. 197, 204 (Bankr. E.D. Va. 2014).

Also, does the term “awarded” mean the proceeding needs to have reached judgment before the back pay claim can be deemed administrative?  One might think that the statute’s use of the past tense suggests an affirmative answer, but, as the bankruptcy court in In re 710 Long Ridge Road Operating Co.,505 B.R. 163, 174-75 (Bankr. D.N.J. 2014), explained — doubtlessly after dipping into a grammar book — the language beginning with “awarded pursuant to …” simply acts as a “past participial phrase” modifying the type of “wages and benefits” covered by the provision.  It says nothing about the timing of the court’s judgment.

How the various phrases in subsection (ii) hang together, and how they relate to other phrases in Section 503(b)(1)(A), has raised even more questions.  The court in First Magnus, 390 B.R. at 677, convinced itself that the word “and” between subsections (i) and (ii) meant that to satisfy subsection (ii), a claim has to also satisfy subsection (i).  That would mean that only back pay claims based on services actually rendered to the company following the bankruptcy filing could enjoy administrative status.  Subsequent cases have convincingly demonstrated that, on the contrary, subsection (ii) provides an additional category of administrative claims, separate from subsection (i).  See, e.g., Truland, 520 B.R. at 202-03; Philadelphia Newspapers, 433 B.R. at 173-74.  Cautioning about a too-literal reading of the word “and,” the bankruptcy court in Philadelphia Newspapers pointed out that Section 503(b) ties together with the word “and” all nine different categories of administrative claims, including such diverse items as taxes, professional fees and the cost of closing a health care business.  No one would suggest that Congress intended that an administrative claim satisfy all nine.

Courts have also puzzled over the meaning of the phrase back pay “attributable to any period of time occurring after” the debtor filed its bankruptcy petition.  The bankruptcy court in In re Powermate Holding Corp., 394 B.R. 765, 774-75 (Bankr. D. Del. 2008), tried to pin that down by holding that back pay is “attributable” to a post-petition period if the claim vests or accrues post-petition.  Other courts have rightly rejected that reading, since the statutory text makes no mention of vesting or accruing.  Indeed, Powermate’s reading conflicts with the language later on in subsection (ii) that administrative status applies “without regard to the time of the occurrence of unlawful conduct on which such award is based.”  See, e.g., Truland, 520 B.R. at 203; Philadelphia Newspapers, 433 B.R. at 174.

Finally, how should courts reconcile the language in subsection (ii) that administrative status may attach “without regard … to whether any services were rendered” with the overarching language in Section 503(b)(1)(A) that defines administrative expenses as those needed for “preserving the estate.”  The bankruptcy court in Calumet recently relied on the latter language in concluding that a back pay claim can only be administrative if the employee performed post-petition service to the bankrupt estate.  See Calumet Photographic, 2016 WL 3035468, at **3-4.  But that reading effectively erases the more specific language in subsection (ii) stating that it doesn’t matter “whether any services were rendered.”  See Philadelphia Newspapers, 433 B.R. at 174-75.  In determining whether a back pay claim qualifies for administrative status, the safe bet is to rely on what the back pay provision says.

Congress’ intent behind Section 503(b)(1)(A)(ii) was good:  to give more back pay claims a leg up in the bankruptcy claims process.  But a bit more clarity in drafting would have helped.

Fighting a Management Bonus Plan

By Peter D. DeChiara

pdechiara@cwsny.com

Posted July 2016

After a financially distressed company files for Chapter 11 bankruptcy protection, it typically asks the bankruptcy court to allow it to pay big bonuses to the company’s top executives.  To those unfamiliar with the world of bankruptcy, this may seem odd.  Why reward those executives under whose watch the company went bankrupt?  To the company’s rank-and-file employees, who may face wage and benefit cuts during the Chapter 11, such bonus plans — typically called “key employee incentive plans” or KEIP’s — often seem grossly unfair.  This post offers some tips on how a union might oppose a company’s motion for approval of a KEIP.  (The union may not be alone in this opposition.  The U.S. Trustee’s office, or the Committee of Unsecured Creditors, two important players in a Chapter 11 case, sometimes also raise objections to a proposed KEIP).

The starting point for a challenge to a KEIP is Section 503(c)(1) of the Bankruptcy Code, 11 U.S.C. §503(c)(1).  That 2005 addition to the Code makes it all but unlawful for a bankrupt debtor to pay a bonus to an “insider” of the debtor “for the purpose of inducing such person to remain with the debtor’s business.”  (Section 503(c)(1) does permit retention bonuses for insiders in certain very narrowly defined circumstances, but those exceptions are exceedingly hard to meet and debtors almost never try).  The debtor moving for approval of a KEIP will argue that Section 503(c)(1) creates no bar because the executives to receive the bonuses aren’t insiders, or, if they are, the proposed bonus plan does not aim to induce them to remain at their jobs, but seeks to incentivize them to achieve certain performance goals (hence, the self-serving label “key employee incentive plan”).

In attacking a proposed KEIP, a union might first consider challenging the company’s claim that those eligible to receive the bonuses are too low in the corporate hierarchy to be considered insiders.  The Bankruptcy Code’s definition of a corporate “insider,” which includes an officer, director or “person in control,” see 11 U.S.C. §101(31)(B), is non-exhaustive, and job titles are not determinative.  One helpful case defines a corporate insider simply as someone “taking part in the management of the debtor.”  In re Foothills Texas, Inc., 408 B.R. 573, 579 (Bankr. D. Del. 2009).  A union opposing a KEIP might consider seeking information to show that at least some of the plan participants are insiders.

Often, a debtor’s initial motion papers contain just a sketch of the proposed KEIP’s terms, without providing actual plan documents or even a list of all those eligible to receive the bonuses.  Fortunately, the bankruptcy rules allow for pre-hearing discovery.  See Fed. R. Bankr. P. 7026-7037, 9014(c).  While depositions may be costly, a simple document request asking for the companies’ organizational charts, pay scale data and job descriptions (as they existed before the bankruptcy filing) may yield valuable information about where a particular executive fits in the corporate hierarchy.  To make a case that an executive is an insider, the union should seek evidence that he or she reports to top management, enjoys pay toward the top of the corporate pay scale, and either has discretion to set at least some company policy or to authorize the expenditure of non-trivial sums from the corporate treasury.  See, e.g., In re Global Aviation Holdings, Inc., 478 B.R. 142, 148-49 (Bankr. E.D.N.Y. 2012) (finding employees not to be insiders but providing a discussion of the factors relevant to the analysis).  Remember that the debtor, as proponent of the plan, bears the burden of proving compliance with Section 503(c).  If the union can present some evidence suggesting an executive may be an insider, the company then has the burden of coming forward with sufficient evidence to the contrary.

(In addition to proposing KEIP’s, bankruptcy debtors also often propose separate bonus plans for lower-level managers, called “key employee retention plans” or KERP’s.  Because a KERP is admittedly a tool to keep management officials on the job during the Chapter 11, the debtor must, to comply with Section 503(c)(1), prove that all those covered by it are not insiders).

A union opposing a KEIP motion should also consider challenging the company’s claim that the plan seeks to incentivize extraordinary performance.  Cases hold that a KEIP only passes muster as a true incentive plan if it awards bonuses to executives for performance targets that are difficult to achieve.  See GT Advanced Technologies, Inc. v. Harrington, 2015 WL 4459502, at *5 (D.N.H. 2015) (discussed on this blog in September 2015).

Successfully challenging a KEIP thus often requires scrutinizing the performance metrics that would trigger bonuses, looking for evidence that an executive may stand to reap an award without extraordinary effort.  For example, a KEIP that rewards work already done can hardly be described as providing an incentive to extraordinary future performance.  A KEIP proposed, say, in December would be suspect if it provided a bonus based on the company achieving a certain profit in that calendar year; most of the work to achieve that target would already have taken place.  Similarly, a KEIP would be suspect if it provided an executive a bonus upon the company achieving a certain level of sales if that executive’s job — say in IT or finance — has no direct connection to sales and his or her performance would not affect the company’s sales levels.

Another possible sign that a KEIP is really a retentive, not an incentive, plan:  if the plan provides that to get their bonuses, executives — regardless of the quality of their performance — have to stay on the job until a defined moment, such as the closing on the sale of the business or upon confirmation of a plan of reorganization.  See, e.g., In re Hawker Beechcraft, Inc., 479 B.R. 308, 314 (Bankr. S.D.N.Y. 2012).  A KEIP should also not reward company officials for doing what the Bankruptcy Code already requires them to do, such as file a plan of reorganization “as soon as practicable.”  11 U.S.C. §§1106(a)(5), 1107(a).

Even if a proposed KEIP passes muster under Section 503(c)(1), it must also comply with Bankruptcy Code Section 503(c)(3), which prohibits a management bonus plan not “justified by the facts and circumstances of the case.”  11 U.S.C. §503(c)(3).  Debtors almost always argue that 503(c)(3)’s “facts and circumstances” test requires the same deference to company decision-making as the business judgment rule, and thus, in their eyes, constitutes barely a speed bump on the road to approval of the plan.  The better interpretation of Section 503(c)(3), however, holds that it requires independent judicial scrutiny, not deference to a self-interested decision by management to pay itself bonuses.  See, e.g., In re Pilgrim’s Pride, 401 B.R. 229, 236-37 (Bankr. N.D. Tex. 2009).

Even those courts that apply the business judgment rule under Section 503(c)(3) nonetheless ask a host of questions, including whether the proposed KEIP discriminates unfairly; whether its cost is reasonable; whether it is consistent with industry standards; and whether the debtor received independent counsel regarding it.  See In re Dana Corp., 358 B.R. 567, 576-77 (Bankr. S.D.N.Y. 2006).  A union challenging a KEIP should probe whether the company satisfied these factors.

The union may argue, for example, that by limiting bonus recipients to top executives, the KEIP unfairly discriminates against others, not least the company’s rank-and-file workers who face losses in the bankruptcy.  On this point, the language of now-retired bankruptcy judge Stephen Mitchell in In re U.S. Airways, Inc., 329 B.R. 793 (Bankr. E.D. Va. 2005), is worth quoting.  After noting that management bonus plans in bankruptcy “have something of a shady reputation,” Judge Mitchell goes on to point out that “[a]ll too often they have been used to lavishly reward—at the expense of the creditor body—the very executives whose bad decisions or lack of foresight were responsible for the debtor’s financial plight. But even where external circumstances rather than the executives are to blame, there is something inherently unseemly in the effort to insulate the executives from the financial risks all other stakeholders face in the bankruptcy process.”  Id. at 797.

While unfairness goes to the heart of the matter, a union challenging a KEIP may also seek to cast doubt on its validity in other ways.  For example, the proposed KEIP may aim to give bonuses similar in size to those given to management pre-bankruptcy, but companies often file bankruptcy when their industry is in financial distress.  Does the size of the proposed bonuses ignore the now depressed state of the industry?  An outside financial firm may claim to have counseled the company regarding the proposed KEIP, but did it in fact just bless what management had already decided to pay itself?  And is the outside firm really independent, or is it one long retained by the company for other matters?

Challenging a KEIP isn’t easy.  Many ultimately receive bankruptcy court approval, particularly if crafted with the help of sophisticated counsel and if the debtor, in response to objections, displays a willingness to engage in a bit of plan trimming and tucking to reduce potential legal risks.  Yet challenging a KEIP may be a battle worth fighting.  These bonus plans for top management almost invariably exacerbate existing inequities within the firm, and almost inevitably demoralize the rank-and-file workforce on whose labor the debtor critically depends for a successful reorganization.

A Company’s Bankruptcy Filing Typically Provides No Shield Against Grievances, Arbitrations and Unfair Labor Practice Charges

By Peter D. DeChiara

pdechiara@cwsny.com

Posted June 2016

A company’s bankruptcy filing triggers the Bankruptcy Code’s “automatic stay,” which broadly prevents creditors from pursing claims against the bankrupt debtor.  So does the automatic stay, set out in Section 362 of the Bankruptcy Code, 11 U.S.C. §362, shield an employer in Chapter 11 bankruptcy from grievances, arbitrations or unfair labor practice charges?  Fortunately for unions, the answer is generally no.

NLRB proceedings can go forward by virtue of the exception to the automatic stay set out in Section 362(b)(4) of the Bankruptcy Code.  That provision allows a government entity, in the exercise of its “police and regulatory power,” to pursue an action or proceeding against a debtor.  Although a union or employee filing an unfair labor practice charge is not a government entity, the filing of the charge initiates the NLRB proceeding, and cases have repeatedly held that NLRB proceedings fall within the protection of the “police and regulatory power” carve-out to the automatic stay.  See, e.g., NLRB v. 15th Avenue Iron Works, Inc., 964 F.2d 1336, 1337 (2d Cir. 1992) (collecting cases); NLRB v. Ctr. Constr. Co., 2013 WL 1858213 (E.D. Mich. 2013).  Indeed, as early as 1942, the Third Circuit held that the status of an employer in bankruptcy “is no different, so far as the National Labor Relations Act … is concerned, than that of any other employer.”  NLRB v. Baldwin Locomotive Works, 128 F.2d 39, 43 (3d Cir. 1942).  Unions and employees, therefore, should not shy away from filing a meritorious labor board charge simply because the company has filed for bankruptcy.

However, while NLRB proceedings may go forward to establish that a bankrupt employer committed unfair labor practices, the collection of any back pay or other monetary remedies must, absent special permission from the bankruptcy court, take place in bankruptcy court and in accord with the Bankruptcy Code’s claims procedures.  (Note that under Section 503(b)(1)(A)(ii) of the Bankruptcy Code, claims arising from NLRB back pay awards may enjoy administrative priority status if the back pay is attributable to any period after the company filed for bankruptcy.)

As for grievances, so long as a union’s collective bargaining contract remains in effect and has not been rejected by the bankrupt employer, a union or employee can pursue grievances under the contract’s grievance-arbitration procedure.  The lead case here is the Second Circuit’s decision in Ionosphere Clubs, Inc. v. Air Line Pilots Ass’n, 922 F.2d 984 (2d Cir. 1990).  In Ionosphere, the court relied on Section 1113(f) of the Bankruptcy Code, 11 U.S.C. §1113(f), which prohibits a  bankrupt employer that has not rejected a collective bargaining agreement from unilaterally terminating or altering any provision of the agreement.  The Second Circuit reasoned that the automatic stay does not bar an arbitration since applying the stay “would allow a debtor unilaterally to avoid its obligation to arbitrate.”  Courts have consistently followed Ionosphere’s reasoning in allowing arbitrations to proceed against bankrupt employers.  See, e.g., Chestnut Hill Rehab Hosp., LLC, 387 B.R. 285, 289-90 (Bankr. M.D. Fla. 2008); Fulton Bellows & Components, Inc., 307 B.R. 896, 903-04 (Bankr. E.D. Tenn. 2004).

While unions may pursue grievances against bankrupt employers up to and through arbitration, once they obtain a grievance settlement or arbitration award in their favor, they generally may only obtain payment via the bankruptcy court’s claims procedure.  One exception:  where the bankrupt company “assumes” (agrees to accept) the collective bargaining agreement, either in its original form or as modified after negotiations, grievance settlements and arbitration awards will often be paid in full in the ordinary course, outside of the bankruptcy claims procedures.

Whether a Claim is Pre- or Post-Petition Is Critical But Often Far from Clear, as a Michigan Bankruptcy Court Decision Shows

By Peter D. DeChiara

pdechiara@cwsny.com

Posted May 2016

Whether a claim against a bankrupt employer arose before or after it petitioned for bankruptcy protection often makes a critical difference.  For example, pre-petition claims often receive pennies on the dollar under reorganization plans, while post-petition claims, which enjoy high priority status, are often paid in full.  While determining the pre- or post-petition status of a claim makes a huge difference, no easy test applies for making that determination, frequently requiring courts to make a judgment call based on the particular facts of the case.

The bankruptcy court overseeing the Detroit bankruptcy case recently had to make such a judgment call concerning a claim by a former employee of the city.  In re City of Detroit, Case No. 13-53846 (Bankr. E.D. Mich. April 19, 2016), the Bankruptcy Court for the Eastern District of Michigan found a fired police sergeant’s claim to be pre-petition and ordered her to dismiss her suit challenging her termination, even though at the time of the city’s bankruptcy filing the sergeant’s discharge had only been recommended and she was still on the city’s payroll.

In October 2012, Detroit’s police department suspended Tanya Hughes from active duty after she refused to follow department procedures in connection with a random drug test, but she continued after the suspension to receive her pay and benefits.  Later that year, a police trial board recommended her discharge from the police force but Hughes appealed that recommendation to arbitration.  Detroit filed for Chapter 9 bankruptcy in July 2013, well before the arbitration took place.  Detroit only cut off Hughes’ pay and benefits in December 2014, the day after an arbitrator affirmed the trial board’s recommendation.  In February 2015, Hughes sued the city in Michigan state court, claiming that by firing her the city had violated her civil rights.The city then filed a motion in the bankruptcy court demanding that Hughes be ordered to dismiss her lawsuit, arguing that her claim was pre-petition and was thus discharged under the terms of the city’s 2014 court-approved reorganization plan (which, in Chapter 9 cases, is called a plan of adjustment).

Bankruptcy judge Thomas Tucker began his analysis of Hughes’ claim by pointing out that Section 101(5)(A) of the Bankruptcy Code defines a “claim” as a “right to payment,” and expressly includes in the definition rights that are “contingent” and “unmatured.”  On the other hand, the judge noted, due process considerations limit how remote or contingent a right to payment can be and still be deemed a bankruptcy claim.  In surveying the relevant case law, the judge noted that the courts have tried different tests for determining when a bankruptcy claim arises.  He asserted that the most widely adopted test, which he referred to as the “fair contemplation” test, asks whether the possible claim was “within the fair contemplation of the creditor” at the time the debtor filed its bankruptcy petition.  Application of this open-ended test, the judge acknowledged, may require a judgment call, based on a number of case-specific factors, such as the debtor’s conduct, the parties’ pre-petition relationship, the parties’ knowledge, and the elements of the underlying claim.

Applying the “fair contemplation” test, the bankruptcy court found Hughes’ claim to be pre-petition.  Judge Tucker explained that Hughes knew before Detroit filed for bankruptcy that the police trial board had recommended her discharge.  The judge rejected her argument that at the time of the bankruptcy filing she had no claim because was still receiving her pay and benefits from the city.  He also rejected her argument that she had no claim at the time because she did not know whether the arbitrator would accept the trial board’s discharge recommendation.  “Ms. Hughes may not have known for certain that she would have an actionable claim against the City,” the court wrote, “but certainty is not the standard.  The standard is whether the contingent claim was within Ms. Hughes’s fair contemplation.”

While Judge Tucker’s conclusion was not unreasonable, the “fair contemplation” test leaves ample room for different possible outcomes, and the case could have gone the other way.  As of the date of Detroit’s bankruptcy filing, the police trial board had only recommended Hughes’ termination, leaving her on the payroll and financially unharmed, and thus arguably without a “right to payment” from the city.

That Judge Tucker in the same case found the wrongful termination claim of another employee to be post-petition only underscores the uncertainty of these claim determinations.  Cedric Cook, a former programming analyst for Detroit, was charged with workplace misconduct that allegedly occurred before the City filed for bankruptcy.  Although it was uncertain at the time the City would fire him, one could argue that the possibility was within Cook’s “fair contemplation,” especially given prior discipline he had received.  Yet, in Cook’s case, Judge Tucker deemed the possibility too remote to find that Cook had a pre-petition claim.

The Detroit case may have relevance to unions asserting bankruptcy claims that arise from an employer’s discharge of an employee.  But more broadly, the case serves as a reminder to unions and benefit funds asserting claims in employer bankruptcy cases how critical, yet potentially uncertain, a claim’s pre-versus post-petition status can be.

U.S. Court of Appeals for the Third Circuit Rules that Debtor May Reject Expired Collective Bargaining Agreement

By Joshua J. Ellison

jellison@cwsny.com

Posted February 2016

Chapter 11 debtors often ask the bankruptcy court to permit them to reject their collective bargaining agreements with the unions that represent their employees.  Section 1113 of the Bankruptcy Code permits a debtor to reject a collective bargaining agreement only if the debtor can meet certain requirements, including demonstrating that rejection of the agreement is necessary for it to reorganize.  Bankruptcy courts have split, however, as to whether a debtor may utilize Section 1113 to reject a collective bargaining agreement that has already expired.  Outside of bankruptcy, the National Labor Relations Act (NLRA) requires an employer to maintain the status quo established by the terms and conditions of employment in an expired collective bargaining agreement until it and the union have bargained to impasse.  Debtors in bankruptcy have sought to reject expired agreements to avoid this obligation.  In a decision at odds with the plain language of the Bankruptcy Code, the Third Circuit Court of Appeals, the first federal court of appeals to decide whether an expired contract may be rejected, has now answered “yes” in In re Trump Entertainment Resorts, No. 14-4807 (January 15, 2016).

In Trump Entertainment, the owner and operator of the Trump Taj Mahal casino in Atlantic City sought to reject its collective bargaining agreement with UNITE HERE Local 54 so that it could terminate its obligations to contribute to the pension and health care plans of its union-represented employees.  That agreement expired a few days after the casino filed for bankruptcy.  After the casino moved to reject the agreement, the bankruptcy court (in a decision discussed on this blog in November 2014) held that even though Section 1113(c) permits rejection of “a collective bargaining agreement” and makes no mention of status quo obligations under the NLRA, it nonetheless authorized the debtor to reject the collective bargaining agreement after it had expired.  In findings cited by the Third Circuit, the bankruptcy court found the evidence “alarming in showing the Debtors were literally begging the Union to meet while the Union was stiff-arming the Debtors.”

On appeal, the Third Circuit agreed with the bankruptcy court.  While the Court held that the language of Section 1113 was not limited to agreements still in force, the Court’s opinion focused on the overall language and goals of the Code and policy considerations.  The appeals court reasoned that there might be situations where avoiding a debtor’s continuing obligation to maintain the statutory status quo would be necessary for the debtor to reorganize successfully, and that bankruptcy courts have the expertise required to make that necessity determination.  The court also emphasized that Congress intended the Bankruptcy Code to grant debtors “flexibility and breathing space” in restructuring their obligations to creditors, and that permitting rejection of the terms of an expired collective bargaining agreement was consistent with that intention.  What the court described as its “broad, contextual view” of Section 1113 led it to conclude that a debtor can reject an expired agreement, even though nothing in Section    1113(c) refers to rejection of agreements that have expired or the NLRA status quo.

The court rejected the union’s argument that since Section 365 of the Bankruptcy Code does not allow a debtor to reject an expired contract or lease, a debtor should not be allowed to reject an expired collective bargaining agreement.  The court noted that the terms and conditions of a non-labor contract do not continue to apply post-expiration while those of a collective bargaining agreement do.  The union also argued that because Section 1113(e) allows a debtor, under emergency circumstances, temporarily to reject a collective bargaining agreement that “continues in effect,” while Section 1113(c), by contrast, makes no mention of collectively-bargained obligations that “continue[] in effect,” Congress must have intended Section 1113(e), but not 1113(c), to apply to the NLRA’s post-expiration status quo obligation.  The court, however, dismissed this argument as “hyper-technical parsing” of the statutory language.

It is unfortunate that the first decision from a court of appeals addressing this question takes a results-oriented approach and expands a debtor’s power to avoid its obligations to its workers beyond what is authorized by the plain language of the Code.  The decision is particularly unfortunate because the Third Circuit has jurisdiction over bankruptcy courts in Delaware, the site of a large number of major corporate bankruptcies.  The decision is also surprising since the Third Circuit in the Wheeling-Pittsburgh case, 791 F.2d 1074 (3d Cir. 1986), issued one of the most pro-employee rulings on Section 1113, holding that a debtor must meet a very high burden to satisfy Section 1113’s necessity requirement.  The ruling also shows that no matter how strong a union’s apparent position on a legal issue in bankruptcy, there are often significant negative consequences if a court, as here, views the union as failing to wholeheartedly commit to bargaining.

Companies’ Actions to Avoid Withdrawal Liability, While Making Payments to Insiders, Violated “Good Faith” Requirements of the Bankruptcy Code, Says Tennessee Federal Court

By Babette A. Ceccotti (Retired Partner)

bceccotti@cwsny.com

Posted February 2016

Companies file for bankruptcy to avoid the obligation to paying debts of all kinds.  But are there circumstances where the use of bankruptcy to evade debt obligations violates the Bankruptcy Code’s “good faith” requirements and triggers violations of law that can sink a debtor’s reorganization plan?  One district court has said yes, ruling that a bankruptcy aimed at avoiding the payment of withdrawal liability lacked good faith, violated ERISA, and ran afoul of the requirement that a bankruptcy plan not be proposed “by any means forbidden by law.”  See Bricklayers and Trowel Trades International Pension Fund, et al. v. Wasco, Inc. and Lovell’s Masonry, Inc., No. 3:15-cv-00977 (M.D. Tenn. December 23, 2015).

Bricklayers involved the bankruptcy cases of two family-owned masonry businesses in Tennessee, Wasco, Inc. (“Wasco”) and its wholly-owned subsidiary, Lovell’s Masonry, Inc. (“Lovell’s”).  The companies were in default on withdrawal liability payments assessed by the Bricklayers pension fund under amendments to ERISA known as the Multiemployer Pension Plan Amendments Act of 1980 (“MPPAA”), 29 U.S.C. §§ 1381-1346.  The fund had obtained a court ruling enforcing the payments, but before entry of the court’s order, the companies filed Chapter 11 bankruptcies.  In addition, in the years just prior to bankruptcy filings, and at the same time they were failing to make their interim withdrawal liability payments and claiming financial distress, Wasco and Lovell’s had undertaken a number of financial transactions that benefitted company “insiders”—essentially, family member shareholders who ran the business.  These transactions included payments of significant sums in bonuses and other compensation to the family members individually and to their affiliated businesses, sums sufficient to have funded the withdrawal liability payments.  Once in bankruptcy, the companies proposed a reorganization plan that would pay the pension fund only a fraction of its withdrawal liability claims, while other creditors would be largely paid in full.  In addition, under the proposed plan, family shareholders would be allowed to pay certain sums to the reorganized companies in order to retain their ownership interest and control of the companies, and, on top of that, be released from potential liability, including for their pre-bankruptcy conduct.   Bankruptcy law generally does not permit shareholders to retain an interest in the reorganized business if creditors are not paid in full, but the law has carved out an exception where the shareholders contribute new infusions, or “new value,” to the reorganized business.

The pension fund objected to the bankruptcy plan on the grounds that plan violated the requirement under bankruptcy law that a bankruptcy plan be “proposed in good faith and not by any means forbidden by law.” 11 U.S.C. § 1129(a)(3).  The fund asserted that the companies’ bankruptcy and pre-bankruptcy conduct were evidence of bad faith, and were “transactions” under the MPPAA’s “evade or avoid” limitation on an employer’s ability to avoid withdrawal liability.  Under the MPPAA, if “a principal purpose of any transaction is to evade or avoid [withdrawal] liability,” then the liability shall be “determined and collected[] without regard to such transaction.” 29 U.S.C. § 1392(c).  The pension fund also moved to dismiss the entire bankruptcy case “for cause,” see 11 U.S.C. § 1112(b), on the grounds that the bankruptcy petition had been filed in bad faith.

The bankruptcy court overruled the pension fund’s objections and approved the reorganization plan. The court also denied the fund’s motion to dismiss the bankruptcy. On appeal, however, the U.S. District Court for the Middle District of Tennessee reversed, both as to the denial of the motion to dismiss and the approval of the bankruptcy plan. According to the decision of Judge Todd Campbell, the companies had improperly used the bankruptcy to frustrate the ability of its largest creditor—the pension fund—to collect withdrawal liability. In support of its ruling under a “totality of the circumstances” test, the court cited factors such as the companies’ having filed bankruptcy to avoid the court order compelling the withdrawal liability payments and the generally harsh treatment afforded to the pension fund’s withdrawal liability claim compared to the claims of other creditors who were largely unaffected by the bankruptcy.  The court also noted a press release put out by the companies announcing the bankruptcy.  The press release,  captioned “WASCO filed Chapter 11 to Resolve Issue With Union,” attributed the bankruptcy to a “disagreement with the Union” regarding a “miscalculated” withdrawal liability “penalty,” and stated its intention that the bankruptcy go “unnoticed” by its other stakeholders. Referring to the pre-bankruptcy insider transactions, Judge Campbell also cited the companies’ payment of “vast sums” of money “pour[ed] into insider bonuses, additional compensation and insider pension fund payments” – money which would have covered the withdrawal liability payments the companies failed to make.  Noting the high bar for a dismissal on grounds of bad faith, the court concluded that the circumstances presented an “egregious case,” warranting dismissal of the bankruptcy petition.

The district court also reversed the bankruptcy court’s approval of the reorganization plan.  Unlike the bankruptcy court, the district court accepted that the MPPAA could be a source for the requirement that a bankruptcy plan be “proposed in good faith and not by any means forbidden by law.”  It ruled that the companies had run afoul of the MPPAA’s “evade or avoid” rule, citing the pre-bankruptcy insider transactions as well as the bankruptcy filing and plan, which left the withdrawal liability significantly compromised.  Judge Campbell also cited the bankruptcy court for legal error in permitting the insiders to make new value payments which, in effect, would have allowed them to “buy their way out of” the bad faith insider transactions.

Bricklayers is a helpful ruling for a pension fund that can make the case that a company has used bankruptcy to single out withdrawal liability for adverse treatment, and a cautionary ruling for companies that a bankruptcy strategy targeting withdrawal liability can backfire.

Bankruptcy Code’s Automatic Stay Does Not Extend to Alleged Alter Egos of the Debtor, New York Federal Court Says

By Peter D. DeChiara

pdechiara@cwsny.com

Posted October 2015

If a pension fund brings suit for unpaid contributions against a group of affiliated companies, contending they are alter egos of one another, does the Bankruptcy Code’s automatic stay apply to all the companies if one of them files for bankruptcy?  No, according to a recent decision of the federal district court for the Eastern District of New York, see Pavers & Road Builders District Council Welfare Fund et al. v. Core Contracting of N.Y., LLC, et al., Case No. 15-cv-0207 (E.D.N.Y. Aug. 18, 2015), the automatic stay applies only to the bankrupt debtor, not to its alleged alter egos

 In Pavers, administrators of a pension fund brought a delinquent contributions suit in federal district court against four corporations, claiming that the defendants were signatories to the applicable collective bargaining agreement and were also alter egos of one another.  One of the defendants, Canal Asphalt, Inc. (“Canal”), filed for Chapter 11 protection.  The defendants in the district court suit then claimed that the automatic stay in Section 362 of the Bankruptcy Code applied to all of them and blocked the suit.  As precedent, the defendants cited In re Adler, 494 B.R. 43 (Bankr. E.D.N.Y. 2013), aff’d, 518 B.R. 228 (E.D.N.Y. 2014), a case in which a bankruptcy court wrote that the automatic stay applied to a debtor’s alter egos since the debtor and alter egos are “one and the same entity.”  494 B.R. at 53.

District judge Brian Cogan disagreed with the defendants’ position and allowed the fund’s collection suit to continue against Canal’s alleged alter egos.  “Just because two entities are alter egos does not make them both debtors under the Bankruptcy Code,” he explained.  “It simply means they are liable for each other’s debts.”  He wrote that the bankruptcy court in the Adler case, by indicating otherwise, had ignored the plain language of the Bankruptcy Code.  Another problem with extending the automatic stay to alleged alter egos, the judge wrote, is that it would make the automatic stay “into a provision that can only be applied with the benefit of hindsight,” since determining whether one entity is in fact the alter ego of another typically requires litigation.  Applying a stay of litigation only after the litigation has occurred makes little sense.

While holding that the automatic stay does not reach alleged alter egos, Judge Cogan explained that a bankruptcy court may, when circumstances warrant, protect certain non-debtors from suit, either by issuing an anti-suit injunction under Section 105(a) of the Bankruptcy Code or by approving a provision in the debtor’s plan of reorganization that prevents litigation against specified non-debtors.  Judge Cogan, who once co-authored a chapter on bankruptcy in a legal treatise, devoted part of his opinion to a discussion of what circumstances might justify such bankruptcy court protection of non-debtors.  However, Judge Cogan wrote that whether the particular circumstances in Canal’s bankruptcy would justify such non-debtor protection was a question entirely for the bankruptcy court, adding “[t]hat is just not my problem.”

Pavers is a sensible decision that sheds some needed light on the sometimes murky intersection of bankruptcy law and the alter ego doctrine.

Validity of Bonus Plan for Insiders Turns on Difficulty of Performance Targets, New Hampshire Federal Court Rules

By Peter D. DeChiara

pdechiara@cwsny.com

Posted September 2015

Chapter 11 debtors often ask the bankruptcy court to approve a bonus plan for “insiders” like corporate officers and top management.  These proposed bonus plans frequently meet opposition, particularly in cases where the debtor also seeks to cut the pay and benefits of its unionized workforce.  Whether a bonus plan for “insiders” passes muster generally depends on its purpose.  Section 503(c)(1) of the Bankruptcy Code all but outlaws insider plans aimed at keeping the top corporate executives on the job.  On the other hand, courts have interpreted Section 503(c)(1) to permit bonus plans aimed at inducing the insiders to achieve financial targets or other corporate goals.  In the decade since Section 503(c)(1)’s enactment, the courts have  struggled to divine the true nature – retentive versus incentive – of  proposed insider bonus plans.  The recent decision of the New Hampshire federal district court in GT Advanced Technologies, Inc., Case No. 15-cv-069 (D.N.H. July 21, 2015), reversing a bankruptcy court’s rejection of an insider plan, is one of the latest additions to this developing case law.

In GT Advanced, a technology company filed for Chapter 11 protection and proceeded to lay off seventy percent of its workforce.  It then moved for approval of a bonus plan, of up to approximately $3.3 million, for nine senior management employees.  Payment of the bonuses depended under the plan on the executives’ performance toward achieving certain goals, such as maximizing the value received for certain assets or minimizing the cost of “deinstalling” certain equipment.  Objections to the proposed insider plan were filed by a shareholder and by the U.S. Trustee (the U.S. Justice Department official assigned to monitor bankruptcy cases).

The bankruptcy court denied the debtor’s insider bonus plan motion, finding the proposed plan to be nothing other than a “disguised retention agreement.”  Bankruptcy judge Henry Boroff explained that during the hearing on the motion, whenever he inquired about the plan, the debtor’s witnesses testified only about how damaging it would be to the company if the top management team quit.  The bankruptcy judge also concluded that the executives would not work any less diligently without the promise of the bonuses.

On appeal, the district court ruled that the bankruptcy court had erred, and remanded to the bankruptcy court for further consideration.  District judge Landya McCafferty held that the “key question” in determining whether an insider bonus plan is retentive or incentive is whether it incorporates performance targets that are difficult to achieve.  Quoting prior case law, she wrote that  “[a] plan that does not require affirmative action beyond that contemplated prepetition is not incentive, but is retentive and cannot be approved under the more lenient standards for incentive plans.”  The judge noted that while cases evaluating proposed insider bonus plans typically contain detailed analyses of the plan, here the bankruptcy court’s ruling relied exclusively on statements from debtor witnesses about the importance of the executive team to the debtor’s reorganization.  The district judge instructed the bankruptcy court on remand to determine whether the debtor’s proposed plan had “sufficiently stringent metrics” to qualify as an incentive plan.

On a separate issue, the district court in GT Advanced ruled that the bankruptcy court also failed to apply the proper analysis in evaluating the debtor’s second proposed bonus plan, this one for a group of non-insider employees.  Judge McCafferty explained that such a plan required application of the “facts and circumstances” test of Section 503(c)(3) of the Bankruptcy Code, not Section 363(b)(1)’s “business judgment” test.  Moreover, although some courts have found the two tests to be equivalent, Judge McCafferty endorsed the better view, expressed by some courts, that the “facts and circumstances” test requires more scrutiny of the proposed plan than would the deferential “business judgment” test.

Cases like GT Advanced show that in opposing insider bonus plans, unions or employee benefit funds should focus their attack on the performance metrics in the plan.  They should focus on holding the debtor to its burden of demonstrating that the targets require the executives to “stretch” in performing their duties.

Union’s Consumer Boycott Does Not Violate Automatic Stay, Delaware Bankruptcy Court Says

By Peter D. DeChiara

pdechiara@cwsny.com

Posted August 2015

If a union launches a consumer boycott against an employer that has filed for Chapter 11 bankruptcy, does the bankruptcy court have authority to enjoin the union’s conduct?  That was the question faced by the bankruptcy court for the District of Delaware recently in Trump Entertainment Resorts, Inc., Case No. 14-12103 (Bankr. D. Del. July 21, 2015).  There, the court found that the Norris-LaGuardia Act of 1932, 29 U.S.C. §§101-15 – which divests federal courts of jurisdiction to issue labor injunctions – prohibited issuance of an injunction against the union, despite the debtors’ claim that the union’s actions violated the Bankruptcy Code’s automatic stay, 11 U.S.C. §362.

In Trump, the debtors, who owned and operated a casino in Atlantic City, filed for Chapter 11 protection in September 2014.  That same month, they filed a motion – which the bankruptcy court granted – to reject the casino’s expired collective bargaining agreement with UNITE HERE Local 54.   (See Nov. 2014 blog post below.)  Around the same time, the union, to bring pressure to bear on the casino, began writing to organizations that were planning to hold conferences there, informing these customers of the union’s dispute with the casino and encouraging them to hold their events elsewhere.

In October 2014, the debtors filed a motion demanding that the bankruptcy court stay the union’s boycott efforts, arguing that the union’s conduct violated the automatic stay’s prohibition on acts taken to obtain or exercise control over estate property or to collect monies owed from the debtor.  See 11 U.S.C. §§362(a)(3), (a)(6).  The union responded that both the Norris-LaGuardia Act and the First Amendment shielded its conduct from judicial interference.  By the time the bankruptcy court held a hearing on the stay motion months later, in April 2015, the debtors had already achieved confirmation of their plan of reorganization and were just waiting for it to go into effect.  As a result of the changed posture of the case, the debtors abandoned most of the relief they had originally sought in the stay motion, asking the court for what amounted to no more than a declaratory judgment.

In denying the debtors’ stay motion, Bankruptcy Judge Kevin Gross noted that the Norris-LaGuardia Act prohibits injunctions against unions for “[g]iving publicity to the existence of, or the facts involved in, any labor dispute,” 29 U.S.C. §104(e), and he found that Local 54’s boycott efforts fell squarely within the scope of this statutory protection.  The judge also noted that a consumer boycott is a lawful economic weapon and that depriving the union of its use would diminish the union’s leverage in negotiating a new collective bargaining agreement.  In addition, he cited two court of appeals cases, In re Petrusch, 667 F.2d 297 (2d Cir. 1981), and  In re Crowe & Associates, Inc., 713 F.2d 211 (6th Cir. 1983), holding that a union does not violate the automatic stay by engaging in strikes or picketing to pressure the debtor to pay contributions owed to union benefit funds.  The courts in those cases reasoned that if Congress had intended the automatic stay to trump the Norris-LaGuardia Act, it would have so indicated in either the text or legislative history of the Bankruptcy Code.

Despite all this, Judge Gross nonetheless felt that the protections afforded the debtors by the Bankruptcy Code’s automatic stay required the court to “walk an interpretative tightrope” and to engage in a  “searching analysis” to arrive at the decision to deny the stay motion.  In fact, the court could have reached the result it did with greater ease.  Applying the automatic stay to the union’s boycott efforts in this case was questionable at best, since the union was not in any direct fashion trying to obtain possession or control of estate property or seeking to collect monies owed.  Moreover, the case was all but over by time the court resolved the stay motion.  The automatic stay serves to prevent dismemberment of the bankruptcy estate prior to an orderly liquidation or a reorganization.  Since the casino had a confirmed plan of reorganization, the automatic stay had, as a practical matter, already served its purpose.  That the debtors abandoned most of the relief they originally sought in the motion signaled that they believed far less was now at stake.

Although the court in Trump may have struggled more than necessary to get there, it came down with the correct decision, and should be applauded for having done so.

Third Circuit Holds Structured Dismissals May in “Rare” Cases Deviate from Bankruptcy Code’s Priority Scheme

By Peter D. DeChiara

pdechiara@cwsny.com

Posted July 2015

Traditionally, Chapter 11 reorganization cases have ended with either a confirmed plan of reorganization, a conversion to Chapter 7, or a “no strings attached” dismissal of the case that restores the pre-bankruptcy status quo.  It has become increasingly common, however, for Chapter 11 cases to end with a “structured dismissal,” where a bankruptcy court dismisses the case by approving the terms of a settlement agreement between certain parties.  Unions have on occasion supported structured dismissals, when the settlement provides a distribution to employees that exceeds what the employees would have recovered, in a Chapter 7 liquidation or otherwise, had the Bankruptcy Code’s priority scheme been applied to their claims.  In many liquidations, secured lenders and secured creditors have often recovered all remaining assets, leaving nothing for employees.

The growing use of structured dismissals has made it more important than ever to resolve whether they are permissible, and, if so, whether payments approved as part of the dismissal may deviate from the creditor priorities set forth in Section 507 of the Bankruptcy Code.  In a much anticipated decision, the Third Circuit recently held that structured dismissals are permitted when the bankruptcy court determines that traditional methods for exiting Chapter 11 are unavailable and, moreover, that the settlement may deviate from Code priorities in those “rare” cases where the bankruptcy court determines that the deviating settlement is the best way to serve the interests of the bankruptcy estate and its creditors.  See In re Jevic Holding Corp., Case No. 14-1465 (3d Cir. May 21, 2015).

In Jevic, a trucking company was acquired by a private equity firm in a leveraged buyout financed by a group of lenders.  In 2008, in deep debt and with its business struggling, the company filed for Chapter 11, ceased operating, and laid off its employees.  The shutdown triggered two lawsuits.  The company’s drivers brought a WARN Act suit, claiming that the company failed to provide them required advanced notice of the shutdown.  The drivers later estimated that their WARN suit gave them a priority wage claim against the estate in the amount of $8.3 million.  In addition, the unsecured creditors committee sued the lenders on behalf of the bankrupt company’s estate, claiming that the leveraged buyout had saddled the company with debts that it couldn’t service.  The bankruptcy court later found that the committee’s fraudulent conveyance suit stated certain viable claims.

By 2012, with the bankruptcy case still pending, the debtor’s only remaining assets were the creditors committee fraudulent conveyance suit and $1.7 million in cash that was subject to the private equity firm’s lien.  At that point, the committee, the debtor and the lenders reached a settlement agreement that provided for, among other things, dismissal of the Chapter 11 case and the committee’s fraudulent conveyance suit and distribution of the cash, first to tax and administrative creditors and then pro rata to general unsecured creditors.  The drivers received nothing under the settlement, even though their priority wage claim put them ahead of the general unsecured creditors under the priority scheme in Section 507 of the Bankruptcy Code.  Over the drivers’ objection, the bankruptcy court approved the settlement and dismissed the Chapter 11 case.  The district court affirmed.

On appeal to the Third Circuit, the drivers argued that the bankruptcy court lacked authority to approve a structured dismissal, at least to the extent that a settlement agreement incorporating such a dismissal deviates from the Code’s payment priorities.  In a 2-1 decision, the Third Circuit disagreed.  Writing for the majority, Judge Thomas Hardiman explained that the bankruptcy court had the discretion to approve a structured dismissal in an appropriate case, absent a showing that the dismissal has been contrived to evade the Code’s safeguards for plan confirmation or for conversion of the case to Chapter 7.  The court accepted the bankruptcy court’s conclusions that in this case there was no prospect of confirmation of a plan of reorganization and that a conversion to Chapter 7 would have resulted in the secured creditors taking all that remained in the estate.  Stressing the value of settlements to the bankruptcy process, Judge Hardiman also wrote that payments under a settlement approved as part of a structured dismissal may skip over an objecting creditor class in those “rare “ cases where there are “’specific and credible’” grounds for deviating from the priority scheme.   While the court found it “regrettable” that the drivers had been excluded from the settlement, it nonetheless found the settlement justified.  The settlement, the majority opinion reasoned, was the “least bad” alternative, since it was the only one that provided a recovery to at least some creditors other than the secured lenders.

In his dissent, Judge Anthony Scirica agreed that a settlement may under certain circumstances depart from the Code’s priorities but he disagreed that this was one of the “extraordinary” cases where such departure was warranted.  The dissent argued that deviation from the priority rules is justified only when the settlement maximizes the value of the estate and here, he asserted, the settlement only maximized the recovery of certain creditors.  Judge Scirica also warned that because, in his view, circumstances like those in Jevic were not unusual, approval of the settlement in Jevic would undermine the general prohibition against settlements that deviate from the Code’s priority scheme.  Recognizing that disapproval of the settlement would have led to conversion of the case to Chapter 7, with only the secured creditors recovering anything, Judge Scirica wrote that he would have required the bankruptcy court to determine the amount of the priority WARN claims and applied the proceeds to those claims before claims in a lower priority.

In holding that a settlement approved outside of a plan of reorganization may deviate from the Bankruptcy Code’s order of priorities, the Third Circuit parted ways with the Fifth Circuit and cited with approval the approach of the Second Circuit.  In In re AWECO, Inc., 725 F.2d 293, 298 (5th Cir. 1984), the Fifth Circuit held that a bankruptcy court abuses its discretion by approving a settlement that fails to provide more senior creditors full priority over more junior ones.  In In re Iridium Operating LLC, 478 F.3d 452, 464-65 (2d Cir. 2007), the Second Circuit rejected this per se approach, holding that while compliance with the priority scheme is the most important factor to consider, a settlement outside of a plan may deviate from the Bankruptcy Code’s priority rules when factors weigh “heavily” in favor of the settlement.  

Since Delaware (which is in the Third Circuit) attracts a disproportionate share of Chapter 11 filings, the Jevic decision means that many employers who file for reorganization may now have the flexibility, in an appropriate case, to use a “structured dismissal” to exit bankruptcy, at least in circumstances where they are not evading a confirmable plan or conversion, and may also be able to exit via a settlement outside of a plan that deviates from the Code’s priority scheme.  In the Jevic case, the settlement hurt the truck drivers who received nothing for their priority WARN claim.  But in other cases, employees with junior claims may benefit from a settlement if, had the Code’s priority scheme been applied, more senior creditors would have left them no recovery.

Municipal Bankruptcy Poses More Limited Threat to Public-Sector Pensions Than Once Feared

By Peter D. DeChiara

pdechiara@cwsny.com

Posted June 2015

The December 2013 bankruptcy court decision allowing Detroit to cut accrued pension benefits, see In re City of Detroit, 504 B.R. 907 (Bankr. E.D. Mich. 2013), created alarm that municipal bankruptcies might soon threaten public-sector pensions nationwide.  However, while Chapter 9 municipal bankruptcies remain a concern, they appear to pose a more limited threat to public-sector pensions than once feared.

First, it is important to keep in mind that municipal bankruptcies are not permitted in many states.  As part of the Bankruptcy Code, Chapter 9 is federal law.  But to avoid running afoul of the Constitution’s Tenth Amendment reservation of states’ rights, Chapter 9 only allows a city or other municipality to file for bankruptcy if state law authorizes the filing.  See 11 U.S.C. §109(c)(2).   According to a study published by Governing magazine, about half of the states today either have no law specifically authorizing municipal bankruptcies, narrowly restrict the types of public entities eligible to file for Chapter 9 protection, or prohibit municipal bankruptcies altogether.  In about half the country, therefore, public-sector pensions now face little to no risk from Chapter 9.

Illinois, for example, is the state with the highest level of public-sector pension liability, measured as a percentage of state revenue.  Republican Governor Bruce Rauner, a former private-equity executive and harsh critic of public-sector unions, has called for use of Chapter 9 as a means to relieve Illinois cities, including Chicago, of their pension debt.  But Illinois law does not authorize its municipalities to file bankruptcy (with the sole exception of the Illinois Power Agency).  So long as the state legislature remains in Democratic hands, Illinois law will likely remain unchanged, meaning Chapter 9 poses no risk to public pensions in that state.

But even if a state authorizes municipal bankruptcies, a bankruptcy court sitting in that state may not allow pension cuts if the state’s constitution provides special protection to public-sector pensions.  In the Detroit case, the bankruptcy court ruled that public-sector pensions enjoy no more protection under Michigan law than ordinary contracts, even though the constitution of that state prohibits public employee pensions from being “diminished or impaired.”  See Detroit, 504 B.R. at 150-54.  Bankruptcy courts construing the constitutions of other states may come to a different conclusion.  For example, in 2014, the Arizona Supreme Court interpreted the pension clause in that state’s constitution, which was virtually identical to Michigan’s, as giving public-sector pensions greater than ordinary contract protection.  See Fields v. Elected Officials’ Retirement Plan, 234 Ariz. 214, 218-19  (2014).  Just last month, the Illinois Supreme Court, in a resounding rejection of pension reform legislation that would have cut accrued pension benefits, interpreted the pension clause in that state’s constitution as giving pensions protection exceeding mere contract status.  See In re Pension Reform Litigation, 2015 IL 118585, at *20 (May 8, 2015).  Were Chapter 9 filings ever authorized in Illinois, a bankruptcy court sitting in that state might be hard pressed, in light of the Illinois Supreme Court’s recent ruling, to follow the Detroit case’s conclusion that public-sector pensions enjoy no more protection in bankruptcy that ordinary contracts.

Assuming that a bankruptcy court held that an insolvent city could lawfully cut pensions, the next question is whether a city would seek to cut them.  Citing Stockton, California as an example, Stanford law professor Michelle Wilde Anderson argues that while cities in Chapter 9 more readily cut bond obligations and seek to reduce retiree health benefits, they tend to avoid pension cuts.  She explains that cutting pensions for retirees not only deepens the level of concentrated poverty in a city but that pension reductions also make it harder for the city to attract and retain qualified employees.  See  Onlabor: Workers, Unions, Politics, onlabor.org (May 1, 2015).  The bankruptcy plan formulated last month by another insolvent California city, San Bernardino, lends support to Anderson’s argument.  See May 18, 2015 San Bernardino Plan of Adjustment .  San Bernardino, which describes itself as a “poor city,” plans reductions to its bond and retiree health obligations, but – citing “severe retention and recruitment problems” – plans to leave pension benefits untouched.  Of course, not all Chapter 9 debtors will make the same economic and political calculus as the ones that prompted Stockton and San Bernardino to spare pensions, but those two recent examples show that pension cuts do not follow inexorably from a bankruptcy filing.

The Detroit decision created a pernicious precedent, but there appears to be less danger than originally feared that Chapter 9 filings will, any time soon, unravel public pensions across the country.  Most pensions will likely remain safe from the bankruptcy axe so long as Chapter 9 remains unavailable in many states, many state constitutions continue to provide pensions with heightened protection, and many city governments continue to see pension cuts as not just unfair but also as bad for the city’s economic and material well-being.

California Bankruptcy Court Finds Employer’s Debt For Unpaid Benefit Fund Contributions To Be Dischargeable

By Peter D. DeChiara

pdechiara@cwsny.com

Posted May 2015

An employer that files for bankruptcy generally has its debts discharged, including debts for unpaid contributions owed to employee benefit funds.  However, Section 523 of the Bankruptcy Code contains a list of debts that, as an exception to the general rule, are not dischargeable.  In particular, Section 523(a)(4) makes debts non-dischargeable if they are for “fraud or defalcation while acting in a fiduciary capacity.”  Under what circumstances can an employee benefit fund use Section 523(a)(4) as grounds for preventing an employer from being discharged of its liability for unpaid contributions?  That was the issue before the bankruptcy court for the Eastern District of California in Bensi v. Eshelman, Case No. 10-31713-A-7, Adv. No. 10-2473 (Bankr. E.D. Cal. March 31, 2015), a decision finding that under the particular facts of that case, the employer’s debt for unpaid contributions was dischargeable and that Section 523(a)(4) did not apply.

Eshelman owned a family-run construction business that had collective bargaining agreements with a local of the International Union of Operating Engineers.  In a 2006 audit, auditors for the pension and welfare funds affiliated with the union determined that the company was liable for unpaid contributions, including contributions that Eshelman had failed to pay for probationary employees.  In 2010, after Eshelman filed Chapter 7 bankruptcy on behalf of himself and his company, the funds brought an adversary proceeding in the bankruptcy court claiming that Eshelman’s debt for the unpaid contributions was non-dischargeable under Section 523(a)(4) because his failure to make the required contributions to the funds constituted fraud or defalcation while acting in a fiduciary capacity.

ERISA defines a fiduciary to include someone who exercises control or discretionary authority over plan assets.  See 29 U.S.C. §1002(21)(A).  In Carpenters Pension Trust Fund for Northern California v. Moxley, 734 F.3d 864 (9th Cir. 2013), the U.S. Court of Appeals for the Ninth Circuit, which includes California, wrote that a “persuasive case” could be made that if documents governing an employee benefit plan define unpaid contributions as plan assets, an employer that controls those assets is a plan fiduciary.  The Ninth Circuit also held, in In re Hemmeter, 242 F.3d 1186 (9th Cir. 2001), that a fiduciary of an ERISA-governed employee benefit plan is a fiduciary for purposes of Section 523(a)(4).

In their adversary proceeding against Eshelman, the funds pointed out that their trust agreement defined unpaid contributions owing as plan assets.  They argued that he was therefore a fiduciary and that he breached his fiduciary duty by not paying contributions due.  In his decision finding Eshelman’s debts to the funds to be dischargeable, bankruptcy judge Michael McNanus pointed out that the amendment to the trust agreement defining unpaid contributions as plan assets came after the period for which the funds’ auditors found that Eshelman owed contributions.

In addition, the bankruptcy court found that even if Eshelman were deemed a fiduciary by virtue of the contributions he owed, his debt would still be dischargeable because the funds failed to establish that his failure to pay the contributions constituted “fraud or defalcation” under Section 523(a)(4).  In Bullock v. BankChampaign, N.A., 133 S. Ct. 1754 (2013), the Supreme Court held that a fiduciary only commits “defalcation” within the meaning of Section 523(a)(4) by violating his or her duty knowingly or with reckless disregard of that duty.  Applying that standard, Judge McNanus concluded that Eshelman did not commit fraud or defalcation within the meaning of Section 523(a)(4).  He found, for example, that Eshelman reasonably and in good faith believed that he owed no contributions for probationary employees, especially since the funds had been aware of his failure to contribute for probationary employees but never challenged his practice prior to the audit.

Despite the disappointing outcome for the benefit funds in Eshelman, the case suggests that under a more favorable set of facts, an employer’s debt for unpaid contributions might be found to be not dischargeable.  In particular, a benefit funds case would be stronger if, at the time the contributions became due, the trust agreement provided that unpaid contributions were plan assets and if the funds could show that the employer knew that its failure to pay the contributions owed constituted a violation of the plan terms.

Award of attorney’s fees, costs and interest in FMLA suit not entitled to administrative or priority status, Delaware bankruptcy court rules

By Peter D. DeChiara

pdechiara@cwsny.com

Posted April 2015

Many employment statutes provide that if an employee successfully sues his employer for violation of the statute, the employee can collect his attorney’s fees and costs, as well as pre- and post-judgment interest.  If a court awards such payments to a prevailing plaintiff after the employer has filed for Chapter 11 protection, do the amounts awarded give rise to an administrative, or at least a priority, claim in the bankruptcy case?  No, according to a recent decision of the Delaware bankruptcy court, which held that an employee’s claim for attorney’s fees, costs and interest arising from his successful suit against the debtor constituted a general unsecured claim.  See re Trump Entertainment Resorts, Inc., Case No. 14-12103 (Bankr. D. Del. March 9, 2015).

In Trump, a former employee sued the casino for firing him in violation of the Family and Medical Leave Act (FMLA).  The FMLA gives an employee the right to take medical and other types of leave under certain circumstances without losing his or her job.  A few months before Trump filed bankruptcy, the former employee prevailed against it in a jury trial in federal district court, obtaining a back pay award of $47,500.  He attached that amount in the casino’s bank account.  After Trump filed for Chapter 11 protection, the bankruptcy court lifted the bankruptcy stay and the district court ordered the casino to transfer the back pay amount from its bank account to the plaintiff.

The district court then issued an order finding that Trump was also liable to the former employee for another approximately $105,000, for his attorney’s fees and costs and pre- and post-judgment interest.  Based on the district court’s order, the former employee asserted a priority claim for that amount in the Chapter 11 proceedings and also moved for it to be paid as an administrative expense.

Bankruptcy judge Kevin Gross concluded that the claim for attorney’s fees, costs and interest was entitled to neither administrative nor priority status.   The judge first considered whether the claim had administrative expense status under Section 503(b)(1)(A)(ii) of the Bankruptcy Code, which provides such status, under certain circumstances, to “wages and benefits awarded pursuant to a judicial proceeding.”  Judge Gross noted that whether attorney’s fees, costs and interest in an FMLA action give rise to an administrative claim was a matter of first impression and that there was no relevant legislative history under Section 503(b)(1)(A)(ii).  Nonetheless, the bankruptcy court had no hesitation disposing of the administrative expense motion.  Relying on the plain language of the statute, the bankruptcy court concluded that attorney’s fees, costs and interest do not fall within the ordinary meaning of the term “wages and benefits.”  The bankruptcy court was swayed neither by policy arguments regarding the claimed importance of attorney fee-shifting in employment litigation nor by the argument that attorney’s fees, costs and interest should be no less payable than the back pay judgment under which they arose.  The bankruptcy court took a similarly straightforward approach to finding that the claim for attorney’s fees, costs and interest also lacked priority status.  Section 507(a)(4) of the Bankruptcy Code grants priority status to certain claims for “wages, salaries, or commissions.”  Claims for attorney’s fees, costs and interest, the bankruptcy court concluded, do not fall within the ordinary meaning of “wages, salaries, or commissions.”  Accordingly, the bankruptcy court deemed the former employee’s claim to be a general unsecured claim.

In the context of the WARN Act, at least one court has held that attorney’s fees accrued post-petition are entitled to administrative expense status, even if the underlying WARN Act claims accrued pre-petition.   See Jamesway Corp., 242 B.R. 130, 134-36 (Bankr. S.D.N.Y. 1999).  The court in Jamesway relied in part on the policy behind the statute’s fee-shifting provision, which is intended to encourage lawyers to accept plaintiff employment cases.

Bankruptcy Court May Not Approve Request by Chapter 7 Trustee to be Paid from Assets of Debtors’ 401(k) Plan, Second Circuit Rules

By Peter D. DeChiara

pdechiara@cwsny.com

Posted March 2015

In a Chapter 7 bankruptcy, the Chapter 7 trustee often performs services administering, then terminating, the debtor’s 401(k) plan.  Can the assets of the 401(k) plan be used to compensate the Chapter 7 trustee for those services?  According to a recent decision of the U.S. Court of Appeals for the Second Circuit, a bankruptcy court lacks jurisdiction to grant a request by a Chapter 7 trustee to be paid from 401(k) plan assets for services the trustee performed in connection with the plan.  See In re Robert Plan Corp. (2d Cir. Feb. 5, 2015).

In Robert, two corporations filed a Chapter 11 reorganization case in the bankruptcy court for the Eastern District of New York.  After a few months, the case converted to Chapter 7 and the Chapter 7 trustee assumed the role of administrator of the debtors’ 401(k) plan.  The trustee hired legal and accounting professionals and, with their assistance, worked to terminate the 401(k) plan and distribute its assets to plan participants.

The Chapter 7 trustee then filed a request with the bankruptcy court for compensation for his work and that of the professionals, asking for payment from assets of the 401(k) plan.  The United States Department of Labor objected, claiming that the bankruptcy court lacked jurisdiction to grant the request.  The bankruptcy court rejected the DOL’s argument but, on appeal, the U.S. District Court of the Eastern District of New York reversed.

The Second Circuit affirmed the district court’s holding that the bankruptcy court lacked jurisdiction to grant the trustee’s request for payment from the assets of the 401(k) plan.  The court noted that a bankruptcy court only has jurisdiction over matters either arising under the Bankruptcy Code or related to a bankruptcy case.

The court held that the matter of the trustee’s compensation did not “arise under” the Bankruptcy Code even though Section 704(11) of the Code puts a trustee in the role of administrator of the debtor’s 401(k) plan.  That Code provision, the Court reasoned, was just a procedural vehicle; it is ERISA, not the Bankruptcy Code, that governs substantive rights and obligations regarding the plan.  The court next concluded that the matter of the trustee’s pay request did not “relate to” a bankruptcy case because a matter only relates to a bankruptcy case if it might affect the debtor’s estate.  The court reasoned that since the Bankruptcy Code, in Section 541(b)(7), explicitly excludes employee benefit plan assets from a debtor’s bankruptcy estate, the trustee’s request for payment from plan assets could not possibly have affected the debtors’ estate.

While holding that the bankruptcy court could not grant the trustee’s application for compensation from the 401(k) plan’s assets, the Second Circuit expressed no view on the question whether the bankruptcy court could approve use of assets from the debtors’ bankruptcy estate to compensate the trustee for services administering the plan.

Pre-petition WARN Violation Can Give Rise to Administrative Expense Claim, According to Virginia Bankruptcy Court

By Peter D. DeChiara

pdechiara@cwsny.com

Posted February 2015

The WARN Act generally requires an employer to give employees 60 days’ notice before a plant closing or mass layoff.  Can a claim that a bankrupt employer violated the statute constitute an administrative expense claim if the plant closing or mass layoff came before the employer filed for bankruptcy?  Yes, at least in part, concluded a November 2014 decision of the bankruptcy court for the Eastern District of Virginia.  See In re Truland Group, Inc., Case No. 14-12766, 520 B.R. 197 (Bankr. E.D Va. Nov. 26, 2014).

According to the class action WARN suit filed in that case, the employer, an electrical contractor with approximately a thousand employees, terminated them all three days before it filed for Chapter 7 bankruptcy.  The Chapter 7 trustee argued that because the employer terminated the employees pre-petition, the WARN Act claim could not be an administrative expense claim.

In reviewing Section 503 of the Bankruptcy Code, which defines administrative claims, bankruptcy judge Brian Kenney noted that Section 503(b) originally limited employee administrative claims to wages, salaries and commissions “rendered after the commencement of the case.”  However, in 2005, Congress amended Section 503(b) to also include “wages and benefits awarded pursuant to a judicial proceeding … as back pay attributable to any period of time occurring after commencement of the case … without regard to the time of the occurrence of unlawful conduct on which such award is based.”

Judge Kenney noted that in Powermate Holding Corp., 394 B.R. 765, 775 (Bankr. D. Del. 2008), the court interpreted this amendment, now codified as Section 503(b)(1)(A)(ii), to provide administrative expense status to WARN claims only when the violation occurs post-petition, reasoning that only in such cases is back pay “attributable” to a post-petition period.

Judge Kenney correctly rejected such reasoning, reading the phrase “without regard to the time of the occurrence of unlawful conduct” to mean that even if an employer violates the WARN Act before it files for bankruptcy, the resulting WARN claim enjoys administrative expense status to the extent any back pay awarded as a result of the violation applies to the period following the bankruptcy filing.

The Chapter 7 trustee in Truland also argued that the WARN Act claim cannot fall within Section 503(b)(1)(A)(ii) because no back pay had been previously awarded “pursuant to a judicial proceeding.”  The court rejected that argument too, finding that nothing in the language of the section requires that there be an award in a judicial proceeding before the bankruptcy is filed, and that the bankruptcy court’s allowance of the WARN claim itself constitutes a “judicial proceeding” under the statute.

The court’s reading of Section 503 in Truland, and its analysis of WARN Act claims, is the sensible approach, squarely grounded on the statute’s plain language.  Indeed, it is consistent with the approach recently recommended by the ABI’s commission on review of Chapter 11 (see January 2015 post below).

American Bankruptcy Institute Calls For Reform of Chapter 11, Including Provisions Related to Unions, Employees and Retirees

By Peter DeChiara

pdechiara@cwsny.com

Posted January 2015

After an extensive three-year study of Chapter 11 of the Bankruptcy Code, a group of prominent bankruptcy practitioners and scholars has issued a report calling for reform of the statute, including certain proposed changes that concern unions, employees and retirees.  The December 2014 report by the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 asserts that the time has come for an overhaul of the law governing corporate reorganizations, which was enacted in its current form in 1978, with only limited modifications since.  The commission counted among its members now retired Cohen, Weiss and Simon LLP partner Babette A. Ceccotti.  Those changes proposed in the 396-page report that directly address labor and employment issues are generally sensible and, if ever enacted, would be a step in the right direction towards needed reform of the bankruptcy system.

For example, the commission recommended that the per-employee cap for priority wage and benefit claims be raised to $25,000, double its current amount.  It also recommended that such priority claims no longer be limited to claims arising within 180 days before the employer’s bankruptcy filing or the cessation of the employer’s business, thereby eliminating disputes over when the compensation was earned.

The commission also responded to concerns from witnesses at its field hearings that Section 1113 of the Bankruptcy Code does not in its current form do enough to promote meaningful collective bargaining negotiations before allowing the corporate debtor to launch litigation to reject the union’s labor contract.  The ABI commission declined to recommend a mandatory minimum negotiating period prior to the court considering a rejection request, or to propose a requirement that the debtor negotiate to impasse prior to seeking court-approved relief.  However, it did propose several refinements to Section 1113 intended to more clearly separate the bargaining process from the contract-rejection litigation process.  Under the proposed recommendations, the Code would require the debtor to provide formal notice of its intent to seek modifications to the labor agreement; provide the union with its proposal; indicate the information to be made available to the union; and initiate a court status conference at which the parties could raise  issues related to the bargaining process.  Issues at the conference could include whether the appointment of a mediator would help the bargaining  process and whether adequate information regarding the debtor’s proposal has been provided to the union.  If the parties fail to reach agreement after a period of negotiations, the debtor could then request a further court conference to address the litigation of a rejection motion by the debtor.

The ABI commission also recommended that the Code be amended to clarify that rejection of a collective bargaining agreement constitutes a breach of the agreement and gives rise to a claim for damages.  Such an amendment would overrule cases like Northwest Airlines Corp., 483 F.3d 160 (2d Cir. 2007), which deem rejection to be an “abrogation” of the contract and thus could be read to leave the union whose contract is rejected without a damages claim.

The commission also weighed in on the question – over which the courts are split – whether a business debtor seeking to cut retiree health benefits in bankruptcy must satisfy the bargaining and other requirements of Section 1114 of the Code if those benefits would be terminable at will under non-bankruptcy law outside of Chapter 11.  The commission’s recommendation reflects the approach of the Third Circuit in Visteon Corp., 612 F.3d 210 (3d Cir. 2010), which holds that Section 1114 applies regardless of whether the retiree health benefits would be terminable under non-bankruptcy law.  In proposing its recommendation, the commission recognized the difficulty of engaging in complex “terminable at will” litigation in the context of a bankruptcy case, as well as the benefits of including in the bankruptcy negotiations the retirees’ representatives appointed pursuant to Section 1114.

Regarding the WARN Act, which generally requires an employer to give 60 days’ notice before a plant closing or mass layoff, the commission rejected the position taken by some courts that a claim for damages based on a corporate debtor’s violation of the act is an entirely pre-petition claim if the date on which the WARN notice should have been given preceded the bankruptcy filing.  Rather, the report reasoned that when the plant closing or mass layoff that triggered the WARN Act violation occurs after the employer files for bankruptcy, a claim for damages under the statute should be treated as a post-petition claim, and thus qualify as an administrative expense, to the extent the period of the violation occurred post-petition.  For example, under the commission’s proposal, if, after the debtor filed for bankruptcy, it closed a plant on only 20 days’ advance notice, and the court determined that the employees were entitled under the WARN Act to an additional 40 days’ notice, the employees would have an administrative expense claim for that number of the 40 days of violation that occurred post-petition.

While taking a position favorable to employees on the classification of WARN Act claims, the commission went the other way on the issue of severance pay.  Courts in the Second Circuit hold that when an employee is terminated after the employer files for bankruptcy, the employee’s claim for severance pay is entirely a high priority post-petition claim, even if the severance amount was based on the employee’s length of service and some of that service occurred pre-petition.  See Straus-Duparquet, Inc. v. Local Union No. 3, Int’l Bhd. of Elec. Workers, 386 F.2d 649 (2d Cir. 1967).  Unfortunately, the commission embraced the alternative approach of those courts that deem such severance claims to be administrative claims only to the extent the services of the employee used to calculate the amount of the severance were rendered post-petition.  See, e.g., Roth American, Inc., 975 F.2d 949 (3d Cir. 1992).  Babette Ceccotti dissented from the report on this point.

The ABI is a respected part of the bankruptcy establishment and its opinions carry weight.  So it is conceivable that at least some of the commission’s recommendations could someday find their way into legislation if Congress were ever to take up bankruptcy reform.  While the commission did not propose the type of sweeping reforms that would be needed to level the playing field in bankruptcy for unions and employees (compared to, for example, the proposed legislation discussed in the July 2014 post below), enactment of many of the ABI’s proposals, though modest, would be an improvement on existing Chapter 11 law.

Detroit may cut pensions less than other claims, Michigan bankruptcy court holds

By Peter DeChiara

pdechiara@cwsny.com

Posted December 2014

Does a bankruptcy plan for an insolvent municipality “discriminate unfairly” within the meaning of the Bankruptcy Code if it spares pension claims from cuts as deep as those imposed on other creditors of the city?  No, according to the recent decision of the bankruptcy court for the Eastern District of Michigan approving Detroit’s bankruptcy plan.  See In re City of Detroit, Michigan, Case No. 13-53846 (Bankr. E.D. Mich. Nov. 12, 2014).

The issue arose in the Detroit Chapter 9 bankruptcy, the largest municipal bankruptcy  in US history, because there the insolvent city targeted its employees’ and retirees’ pensions as a major source of potential savings.  At the outset of the case, city employee unions, retiree associations, and even Detroit’s own retirement system vigorously objected to proposed cuts to accrued pension benefits, citing the express prohibition in the Michigan state constitution against vested public-sector pension benefits being “diminished or impaired.”  Bankruptcy judge Steven Rhodes ruled, however, that once the city filed bankruptcy, pension claims enjoyed no greater protection than ordinary contracts.

Although the court gave Detroit the green light to cut the pensions of its employees and retirees, the city, after  obtaining a promise of financial aid from the state, requested court approval for a plan of adjustment that sought lesser pension reductions than the city had earlier proposed.  The plan proposed recoveries for pension claims that the court estimated to be as high as 60 cents on the dollar, while providing certain bond claimants who had voted to reject the plan with a recovery of about 44% and other unsecured creditors who also rejected the plan with a recovery of about 13%.

Section 1129(b)(1) of the Bankruptcy Code, which applies both in Chapter 11 corporate reorganizations and Chapter 9 municipal bankruptcies, requires that the debtor’s plan must, among other things, not “discriminate unfairly” with respect to classes of claims that are impaired by the plan and do not vote to accept it.  In the Detroit case, certain creditors, including the bond creditors, argued that the city’s plan unfairly spared pension claims.  Certain academic commentators also weighed in on the issue, opining that the Bankruptcy Code does not tolerate recovery levels for pension claims higher than those of other claims.

In his order approving Detroit’s plan of adjustment, Judge Rhodes concluded that the higher level of recovery for pension claims did not constitute unfair discrimination under Section 1129(b)(1).  He reasoned that different treatment was justified for pensions because the city’s recovery depended in large part on “its ability to marshal the support of … its retirees, employees and their labor unions.”  The judge also noted that the different levels of recoveries reflected various settlements that had been reached between the city and its creditors, and that such settlements were themselves reasonable.  Finally, Judge Rhodes reasoned that the “special protection” given to government pensions by the Michigan constitution justified differential recoveries, since such constitutional protection for pensions should have caused other creditors to expect to receive less.  (The judge did not explain, however, why this “special” state-law protection was sufficient to shape the expectations of creditors at the plan confirmation phase of the case, but was not special enough to elevate pensions above ordinary contracts at the outset of the case and protect them from being cut at all.)

That a city’s bankruptcy plan does not “discriminate unfairly” when it spares pension claims was also the conclusion reached by bankruptcy judge Christopher Klein in his October 30, 2014 bench ruling approving Stockton, California’s plan of adjustment.  In that case, City of Stockton, No. 12-32118 (Bankr. E.D. Cal.), the court had earlier ruled that California state law did not shield pensions from being cut in a Chapter 9 case.  Nonetheless, according to media reports (the October 30 bench ruling is not yet public), the judge approved a plan of adjustment for the city that substantially reduced the claims of bondholders but left pensions untouched.

By allowing any cuts to previously earned pensions that enjoy special state law protection, the Detroit and Stockton cases set worrisome precedent.  But at least these courts were sensible enough in their interpretation of the “discriminate unfairly” test to give the cities flexibility to spare pensions from cuts as deep as those of other creditors.

Employer Can Reject Expired Collective Bargaining Agreement, Delaware Bankruptcy Court Holds

By Peter DeChiara

pdechiara@cwsny.com

Posted November 2014

Can a Chapter 11 debtor reject a collective bargaining agreement that has already expired? Some bankruptcy courts have said yes, others no. The bankruptcy court for the District of Delaware weighed in on that question in an October 2014 decision, concluding that an employer may use Section 1113(c) of the Bankruptcy Code to avoid having to comply with the terms of an expired labor contract.  See In re Trump Entertainment Resorts, Inc., No. 14-12103 (Bankr. D.Del. Oct. 20, 2014).

In Trump Entertainment, the operator of an Atlantic City casino – driven into bankruptcy by competition from online gaming and legalized gambling in surrounding states – sought relief from its obligations to make pension and health contributions for its unionized workforce. The casino’s collective bargaining agreement with UNITE HERE Local 54 expired several days after the casino filed its Chapter 11 petition, but the National Labor Relations Act (NLRA) required that the casino maintain the status quo established by the expired agreement, including the pensions and health contributions. Claiming that these contributions would drive it into liquidation, Trump filed a motion under Section 1113(c), which provides that a debtor, upon making certain requisite showings, may reject a “collective bargaining agreement.”  The motion was filed after the contract had expired.

The union argued that while Section 1113(c) authorizes a bankruptcy court in certain circumstances to relieve an employer’s contractual obligations, it gives a bankruptcy court no right to override a debtor’s statutory obligation under the NLRA to maintain the status quo after a labor contract expires. For support, the union cited a number of bankruptcy court decisions, including the 2012 decision of the bankruptcy court for the Southern District of New York in Hostess Brands, Inc. 477 B.R. 378.  There, Bankruptcy Judge Robert Drain concluded that use of Section 1113(c) to relieve a debtor of its status quo obligations under the NLRA would “stretch” the language of Section 1113(c) “too far.”

In Trump Entertainment, by contrast, the Delaware bankruptcy court reasoned that Section 1113(c) serves the policy of facilitating the reorganization of ailing employers, and that it would be “illogical” to allow the expiration of the labor contract to stand in the way of providing an employer the relief that the court believed the employer needed to survive.

Although Section 1113(c) only allows rejection of a “collective bargaining agreement,” Section 1113(e) permits interim changes in emergency circumstances during a period when “the collective bargaining agreement continues in effect.” Bankruptcy Judge Kevin Gross reasoned that the “continues in effect” language in Section 1113(e) includes the post-expiration status quo.  He reasoned further that, even though Section 1113(c) does not have the “continues in effect” language, application to the post-expiration status quo is “implicit” in Section 1113(c).  Concluding otherwise, the court reasoned, would yield the “absurd result” that a debtor could use Section 1113(e), but not Section 1113(c), to escape its NLRA status quo obligation.

Trump Entertainment is an unfortunate decision that strays too far from the plain language of the statute. Section 1113(e) never mentions post-expiration relief.  And even if the “continues in effect” language in Section 1113(e) could be construed as allowing for post-expiration relief under emergency circumstances, the absence of such language in Section 1113(c) must mean that Congress intended a different result in Section 1113(c) cases.

New York Federal Court Holds That Only The Union, Not A Separate Group Of Employees, May Object To Employer’s Contract Rejection Motion

By Peter DeChiara

pdechiara@cwsny.com

Posted October 2014

The Bankruptcy Code provides, in Section 1113(d)(1), that “[a]ll interested parties” may appear and be heard when a Chapter 11 debtor files a motion to reject its collective bargaining agreement with a union.  Does that mean one or more employees interested in the outcome may object to the employer’s motion, separately from any objection raised by the union?  The answer is a clear no, according to an October 2014 decision of the federal district court for the Southern District of New York.  See In re AMR Corp., No. 11-15463 (S.D.N.Y. Oct. 17, 2014).

AMR concerned the motion of American Airlines to reject its collective bargaining agreement with the Allied Pilots Association, which represents the airline’s pilots.  One provision of that agreement purported to guarantee no changes to the retirement program offered to pilots hired before a certain date in 1983.  The bankruptcy court granted American’s rejection motion, as well as a subsequent motion modifying American’s pilot pension plan to eliminate the option of lump-sum payments.  The bankruptcy court also approved a new collective bargaining agreement between American and the pilots’ union that resolved all pending grievances, including those of pilots nearing retirement who grieved the change in the pension program.  A group of these pilots appealed the bankruptcy court’s rejection of the old collective bargaining agreement and its approval of the new one, arguing that their pension-related rights were not subject to change.

Before reaching the merits of the appeal, the district court considered whether the group of pilots that was challenging the bankruptcy court’s contract rejection ruling were “interested parties” entitled to object under Section 1113(d)(1).  The Bankruptcy Code contains no definition of “interested parties” that limits the reach of that phrase.  And the pilots approaching retirement who were denied a lump-sum option clearly had an interest in the outcome of the rejection motion.

Nonetheless, Judge Colleen McMahon, in a sensible decision, held that the pilots were not eligible to participate in the Section 1113 contract rejection proceedings.  Section 1113, she explained, “establishes a central role for a union and the debtor, but not for disaffected groups within the union.”

According to Judge McMahon, allowing groups of employees to participate in Section 1113 proceedings would run contrary to federal labor policy: Section 1113 proceedings require negotiations over the employer’s proposed contract modifications and federal labor law vests in the union the exclusive right to negotiate with the employer.  The judge further explained that a broad reading of “interested parties” would “throw a wrench” into the Section 1113 proceedings, by permitting every employee or group of employees to have their say.

With the AMR decision, the New York federal court now joins the Seventh Circuit U.S. Court of Appeals in construing “interested parties” under Section 1113(d)(1) to refer to only the debtor and the union.  See UAL Corp., 408 F.3d 847, 851 (7th Cir. 2005) (pension fund fiduciary not eligible to participate in Section 1113 proceedings).

Unions And Funds Should Consider Seeking A Seat On The Creditors Committee In Employer Chapter 11 Cases

By Peter DeChiara

pdechiara@cwsny.com

Posted September 2014

In nearly all Chapter 11 cases, shortly after the petition is filed, the U.S. Trustee’s office appoints a committee of unsecured creditors.  The committee plays a key role in the Chapter 11 case, speaking as the voice of the unsecured creditors on all manner of issues that come before the court.  The committee also receives substantial amounts of non-public information from the debtor concerning its operations, finances and future plans.  Because of the committee’s key role in helping to shape the outcome of the case, and because of its access to information, it is generally a good idea for a union or fund with a sizeable stake in the case to consider seeking a seat on the committee.  To do so, the union or fund should write to the U.S. Trustee’s office as soon as the Chapter 11 case is filed, expressing its interest in serving on the committee and explaining why it qualifies for the committee.

The creditors committee ordinarily consists of  those creditors willing to serve on the committee who hold the seven largest claims against the debtor.  Section 101(10)(A) of the Bankruptcy Code defines a creditor as an entity with a claim against the debtor that arose before or at the time of the bankruptcy filing.  Section 101(5), in turn, defines a claim as a “right to payment,” whether fixed or contingent, liquidated or unliquidated.

Unions and funds are eligible to sit on a creditors committee so long as they are creditors of the Chapter 11 employer.  A union is a creditor if, for example, at the time the employer filed for bankruptcy, the employer owed wages or benefits to employees under the union’s collective bargaining contract, had failed to satisfy pending grievances or arbitration awards, or had failed to pay to the union dues that the employer had withheld from employees’ paychecks.  A fund may be a creditor if, for example, the employer owed it contributions or withdrawal liability.

In In re Altair Airlines, Inc., 727 F.2d 88 (3d Cir. 1984), the leading case on union eligibility to serve on a creditors committee, the Third Circuit rejected the debtor’s argument that a union seat on the committee would be inappropriate because the union’s interest in preserving jobs may put it at odds with trade creditors on the committee interested in maximizing the recovery on their claims.  The bankruptcy court for the Southern District of New York in In re Barney’s, Inc., 197 B.R. 431 (Bankr. S.D.N.Y. 1996), similarly held that a multi-employer pension fund with a contingent withdrawal liability claim was properly a member of the creditors committee even though the fund might disagree with other committee members over committee objectives and strategy.

While unions and funds qualify to sit on a creditors committee if they are creditors of the debtor, they should be aware that, as members of the committee, they would have a fiduciary duty to the entire group of unsecured creditors and must conduct themselves on the committee accordingly.  In addition, information about the debtor obtained by the union or fund by holding a seat on the committee may not be disseminated except in a manner consistent with the confidentiality agreement entered into between the debtor and the committee’s members.  Breach of either the fiduciary duty or of confidentiality could result in the union or fund being dismissed from the committee.  Finally, a union or fund considering serving on a creditors committee should be aware that doing so is a commitment of time and resources:  if appointed to the committee, the union or fund would need to have one of its representatives attend committee meetings, which are typically held on a regular basis, by telephone, throughout the duration of the case and participate in the committee’s deliberations.

Bankruptcy Does Not Discharge Withdrawal Liability When The Employer’s Pension Plan Withdrawal Comes After The Bankruptcy, New Jersey District Court Holds

By Peter DeChiara

pdechiara@cwsny.com

Posted August 2014

Courts have debated whether an employer’s Chapter 11 bankruptcy can discharge pension plan withdrawal liability when the employer’s withdrawal from the plan occurs after the bankruptcy.  A sensible July 2014 decision by the federal district court for the District of New Jersey held that no, a bankruptcy that precedes the employer’s withdrawal does not discharge any portion of the withdrawal liability.  See Einhorn v. Dubin Bros., Civil Action No. 12-6814 (D.N.J. July 16, 2014).

In that case, a lumber company that was obligated to make contributions to a Philadelphia-based Teamster pension plan filed Chapter 11 bankruptcy in 2002.  In 2004, it received a discharge of its debts.  After emerging from bankruptcy, the company continued to operate and contribute to the pension plan, until it withdrew from the plan in 2011.

The pension plan then sued the company for withdrawal liability under the Multiemployer Pension Plan Amendments to ERISA, which make an employer liable for its share of a multiemployer pension plan’s unfunded vested benefits.  The suit sought withdrawal liability for unfunded pension benefits for the period 1979 to 2010.

The company argued that the 2004 discharge it received from its Chapter 11 bankruptcy eliminated that portion of the withdrawal liability that predated the discharge.

The court disagreed.  Judge Simandle reasoned that the earlier bankruptcy could not have discharged any portion of the withdrawal liability because the withdrawal liability only came into existence with the company’s 2011 withdrawal from the plan.  Since there was no claim for withdrawal liability in the earlier bankruptcy, no such claim could have been discharged.

The court acknowledged the split in the case law on this issue.  For example, in In re CD Realty Partners, 205 B.R. 651 (Bankr. D. Mass. 1997), the bankruptcy court in Massachusetts held that an employer’s bankruptcy that preceded the employer’s withdrawal from a pension plan nonetheless discharged the employer’s withdrawal liability.  The court there reasoned that although the employer’s withdrawal from the plan triggered the liability, a contingent claim for withdrawal liability existed at the time of the bankruptcy and that such contingent claim was sufficiently certain to be discharged in the bankruptcy.  The court in CD Realty Partners explained that by simply participating in a pension plan, an employer becomes responsible for its share of the plan’s unfunded liability, and that the employer’s withdrawal from the plan some day is almost inevitable.

CD Realty Partners is a thoughtful, philosophically interesting decision, but the New Jersey district court in Einhorn took the proper approach.  A participating employer may never become liable for withdrawal liability:  the plan may never be underfunded, or the employer may never withdraw.  A prior bankruptcy should not be held to discharge a withdrawal liability claim that at the time does not exist and that may well never exist.

Senate Bill Would Heighten Worker, Retiree Protections In Corporate Bankruptcies, Limit Management Bonuses

By Peter D. DeChiara

pdechiara@cwsny.com

Posted July 2014

It will never become law so long as Republicans control the House of Representatives.  But the bankruptcy reform bill introduced on July 10 by Senator Richard Durbin (D. Illinois) provides a comprehensive roadmap of Bankruptcy Code amendments that the bill rightly asserts are “urgently needed” to better protect the interests of workers and retirees in corporate bankruptcies, and to lessen the ability of corporate management to use bankruptcy as an opportunity for self-enrichment.  See S. 2589, entitled the Protecting Employees and Retirees in Bankruptcy Act.  A companion bill on the House side was introduced in 2013 by House Judiciary Committee member John Conyers (D.) of Michigan.

The Senate bill, co-sponsored by Sens. Harkin (D. Iowa), Whitehouse (D. Rhode Island), Brown (D. Ohio) and Franken (D. Minnesota), would, among other things, make it much more difficult for corporate debtors to reject their collective bargaining agreements and to avoid paying health and other benefits to retirees.

For example, Sections 1113 and 1114 of the Bankruptcy Code now say that a debtor can only propose modifications to a collective bargaining agreement or to retiree benefits that are “necessary” to the debtor’s reorganization.  Many courts, however, following the lead of the Second Circuit in Truck Drivers Local 807 v. Carey Transportation, 816 F.2d 82 (2d Cir. 1987), have interpreted this language to mean that the employer’s proposed cuts need not be limited to the minimal essential for its reorganization.  The Durbin bill would overrule the Second Circuit’s approach and adopt the more stringent standard set forth by the Third Circuit in Wheeling-Pittsburgh Steel Corp. v. United Steelworkers, 791, F.2d 1074 (3d Cir. 1986), by expressly limiting bankrupt employers to proposing only those changes to labor contracts and retiree benefits that provide “the minimum savings essential to permit the debtor to exit bankruptcy.”

The bill would also overrule the Second Circuit’s decision in In re Northwest Airlines Corp., 483 F.3d 160 (2d Cir. 2007), holding that employees under the Railway Labor Act may not strike even after their employer rejects their collective bargaining agreement.  The bill provides that a union can engage in “economic self-help” after a court grants an employer’s request to reject the labor contract.

The bill would also resolve the controversy over whether a corporate debtor must satisfy the requirements of Section 1114 of the Code to cut retiree health benefits even if those benefits would be terminable-at-will outside of bankruptcy.  In Visteon Corp., 612 F.2d 210, 218-37 (3d Cir. 2010), the Third Circuit parted company with the Second Circuit and many other courts on this issue, correctly holding that the protections of Section 1114 apply to all retiree benefits, including those that could have been terminated at will under state law.  The Durbin bill would effectively codify Visteon, by clarifying that Section 1114 shields retiree benefit payments “without regard to whether the debtor asserts the right to unilaterally modify” them.

In addition, the bill would make it much harder for corporate debtors to give bonuses or other financial rewards to top management.  Since the 2005 bankruptcy amendments, Section 503(c) of the Bankruptcy Code has effectively prohibited debtors from giving bonuses to directors, officers and other “insiders” if those bonuses are aimed at keeping the insiders from leaving the company.  Corporate debtors have often successfully skirted this prohibition by styling the extra pay not as a retention bonus but an “incentive” bonus aimed at boosting the individual’s work performance.  The bill would nail this loophole closed, by extending the prohibition on bonuses to “performance or incentive compensation, or a bonus of any kind.”  It would also expand the scope of the prohibition beyond “insiders” to include senior executives, as well as the twenty next most highly paid managers or consultants.

Going beyond such needed fixes, the reform bill would impose certain innovative measures to ensure equity in Chapter 11 between rank-and-file workers and upper management.  For instance, the bill provides that if a debtor under Sections 1113 or 1114 cuts worker pay or retiree benefits by a certain percentage, an action may be brought against the debtor’s officers to claw back their pay by the same percentage.

The bill proposes numerous other changes, including giving priority status to an increased portion of a claim for unpaid wages or benefit fund contributions; recognizing administrative pay status for certain backpay claims under the National Labor Relations Act or the WARN Act; and requiring a bankruptcy court, when considering a sale of the debtor’s business to competing bidders, to weigh the extent to which each bidder would preserve the jobs of the debtor’s employees.

If even some of these changes were to ever become law, bankruptcy court would be a less threatening, and more equitable, arena for workers and retirees.

Bankruptcy Stay Offers No Protection To Principals Of Chapter 7 Debtor Sued For Delinquent Fund Contributions, Nevada District Court Rules

By Peter D. DeChiara

pdechiara@cwsny.com

Posted June 2014

Does the automatic stay of Section 362 of the Bankruptcy Code sweep within the scope of its protection principals and key management employees of a bankrupt employer when those individuals are sued for delinquent benefit fund contributions that the employer failed to make?  Not if those company officials are sued under a breach-of-fiduciary duty theory, says a June 2014 decision of the federal district court for the District of Nevada.  See Unite Here Health v. Gilbert, No. 2:13-CV-00937 (D. Nev. June 4, 2014).

In that case, a Las Vegas restaurant bound to a collective bargaining agreement with UNITE HERE owed over half a million dollars in unpaid benefit fund contributions to the union benefit funds when it went belly up and filed Chapter 7 bankruptcy.  The trustees of the funds filed suit in federal district court against the restaurant’s managers, principals and key employees, alleging that their discretionary control over whether contributions to the funds would be paid made them fund fiduciaries and that they breached their fiduciary duties by allowing the contributions to go unpaid.

The defendants moved to dismiss, asserting that the Section 362 automatic stay shielded them from the litigation.  District judge Jennifer Dorsey rejected their argument, explaining that if they had been sued as alter egos of the Chapter 7 debtor, they would have been seen as legally identical to the debtor.  But, the court held, the stay could not protect them from an independent breach-of-fiduciary duty claim.  The court allowed the trustees to proceed on that claim.

The court similarly reasoned that when the employer was discharged in bankruptcy, and its debts to the benefits funds washed clean, the non-debtor company officials would not enjoy the benefit of the discharge.

The Unite Here decision provides a helpful roadmap for benefit fund trustees seeking alternative ways to collect delinquent contributions when the employer’s bankruptcy blocks suit against the employer itself.

Illinois Bankruptcy Court Lets Employer Reject Its Collective Bargaining Agreements Even After It Went Out Of Business

By Peter D. DeChiara

pdechiara@cwsny.com

Posted May 2014

Section 1113 of the Bankruptcy Code permits a company in Chapter 11 bankruptcy to reject its collective bargaining agreements if it can prove, among other things, that it needs relief from the agreements to successfully reorganize its business.  So should an employer in Chapter 11 that is already out of business be permitted to reject its collective bargaining agreements?  In a May 2014 decision, the bankruptcy court for the Northern District of Illinois said yes, even a liquidating Chapter 11 debtor may reject its collective bargaining agreements under Section 1113.  See In re In re Chicago Construction Specialities, Inc., Case No. 13-31265 (Bankr. N.D. Ill. May 8, 2014).

The employer, Chicago Construction Specialities, Inc., had ceased all business operations and auctioned off substantially all of its assets before filing for Chapter 11 bankruptcy.  Once in bankruptcy, it filed a motion to reject its collective bargaining agreements with the Laborers’ Union.  Bankruptcy judge Timothy Barnes granted the motion, over the objection of the union and its affiliated pension and welfare funds.

The judge acknowledged that Section 1113 only permits relief from collective bargaining agreements when needed for the “reorganization” of the debtor.  But Judge Barnes – stretching the common understanding of the word – reasoned that liquidation is a type of Chapter 11 “reorganization.”

The practical effect of contract rejection after a company is out of business is to reduce the priority of labor claims.  For example, claims for unpaid benefits to the union’s pension or health plan, which might have enjoyed high-priority administrative status if the union contract were in place, would arguably be reduced to general unsecured claims after contract rejection.

The Illinois court’s decision that Section 1113 applies to debtors no longer in business is not the first of its type.  In 2001, the Eighth Circuit’s bankruptcy panel held that a Chapter 11 debtor could reject its collective bargaining agreement even after it had sold virtually all its assets.  See In re Family Snacks, Inc., 257 B.R. 884 (B.A.P. 8th Cir. 2001).

Nonetheless, the court’s holding that a debtor can seek Section 1113 relief even after it has closed its doors is unfortunate:  when it enacted Section 1113, Congress clearly intended it to apply narrowly to those situations in which a company in Chapter 11 needs relief from its labor contracts in order to continue in business.

Bankrupt Law Firm Denied WARN Act Defense When It Failed To Give Employees Written Explanation For Shortened Notice, New York Bankruptcy Court Rules

By Peter D. DeChiara

pdechiara@cwsny.com

Posted April 2014

The WARN Act generally requires an employer to give its employees 60 days’ advance notice of a shutdown or mass layoff, but it contains exceptions:  the employer can give fewer than 60 days’ notice, for example, if the shutdown is caused by business circumstances that weren’t reasonably foreseeable or if giving full advance notice would have stymied the employer’s efforts to continue operations.  The statute says that an employer relying on one of these exceptions must not only give as much notice to its employees as practicable but must “at that time” give a “brief statement” explaining the reasons for the shortened notice.  The statute is silent as to whether this “brief statement” must be in writing and included in the WARN Act notice that the employer issues to its employees.  In the Chapter 11 case of the failed law firm Dewey & LeBoeuf, the bankruptcy court for the Southern District of New York ruled that the “brief statement” must be part of the employer’s written WARN Act notice, and that explanations given to employees at meetings do not suffice.  See In re Dewey & LeBoeuf LLP, Case No. 12-12321 (Bankr. S.D.N.Y. April 10, 2014).

A global law firm with a venerable history, Dewey & LeBoeuf collapsed in 2012, terminating its remaining employees in a mass layoff shortly before filing for Chapter 11 bankruptcy.  Fewer than 60 days before the layoff, it sent WARN letters to the employees, but the letters contained no explanation for the shortened notice.  In meetings held with most of the employees, firm management explained that the firm had been unsuccessful in extending its credit facility and in its other efforts to continue operations.  After the Chapter 11 was filed, the terminated employees brought an adversary proceeding over the law firm’s failure to provide them the full 60 days WARN notice.

In striking the law firm’s shortened notice defense, Bankruptcy judge Martin Glenn adopted a sensible reading of the statute, that the “brief explanation” for any shortened notice must be written into the WARN Act notice given by the employer.  He reasoned that “[e]ven under the most extenuating circumstances” an employer can give its explanation in writing to employees and doing so prevents information “from trickling out in piecemeal fashion.”

In so holding, the New York court parted company with the bankruptcy court for the Eastern District of Michigan, which in Richards v. Advanced Accessory Systems LLC, 443 B.R. 756 (Bankr. E.D. Mich. 2011), permitted an employer to explain its reasons for shortened notice in employee meetings.  The Michigan court requiring only that the employer convey its explanation in a manner “practicable under the circumstances.”  Judge Glenn expressly rejected the Michigan court’s permissive reading of the statute, insisting that the written explanation requirement was a bright-line rule.

The WARN Act, meant to protect workers and their families by giving them time to prepare for job loss, is already riddled with exceptions.  The Dewey case commendably resists the effort of an employers to read out of the statute one of the few bright-line rules the statute does contain.

Reorganization Plan Releases Employers’ Non-Debtor Affiliates From NLRB Backpay Liabilty

By Peter D. DeChiara

pdechiara@cwsny.com

Posted March 2014

Section 524(e) of the Bankruptcy Code provides that the discharge of a debtor does not affect the liability of any other entity.  So is it contrary to Section 524(e) to have an employer’s Chapter 11 plan of reorganization release from NLRB backpay liability certain corporate affiliates of the employer that were not themselves in the Chapter 11 case?  In a March 2014 decision, the bankruptcy court for the District of New Jersey said such releases were permissible when the corporate affiliates were making financial contributions that were critical to the plan of reorganization.  See In re 710 Long Ridge Road Operating Company, Case No. 13-13653 (Bankr. D.N.J. March 5, 2014).

The Chapter 11 case in 710 Long Ridge Road grew out of a bitter labor dispute between District 1199, SEIU and five affiliated nursing home operators in Connecticut, a dispute that included failed contract negotiations, a strike and the hiring of permanent replacements.  The NLRB,  which charged the companies with unlawfully imposing their final contract offer before reaching bargaining impasse with the union, obtained a preliminary injunction requiring reinstatement of the replaced strikers and of the expired labor contract pending outcome of the unfair labor practice case.  Faced with this injunction, the companies sought refuge in Chapter 11.  In the bankruptcy case, the union and the Labor Board both filed claims for backpay and other relief related to the unfair labor practice proceedings.

The debtors’ plan of reorganization put the labor claims in a separate class and proposed some partial funding for them, funding that was to come from the ultimate parent company of the debtors and from another corporate affiliate.  The plan also contained a third-party release discharging from all liability these corporate affiliates, as well as the managers, directors and officers of the debtors and of the corporate affiliates.  In the plan confirmation hearing, the union and the NLRB claimed that these third party releases violated Section 524(e).

Bankruptcy judge Donald Steckroth began his analysis by noting that certain circuits – the Fifth, Ninth and Tenth – read Section 524(e) as prohibiting third-party releases, period.  Judge Steckroth explained that no such prohibition exists in the Third Circuit, where bankruptcy courts assess the validity of third-party releases on a case-by-case basis.  He concluded that the third party releases for the corporate affiliates were valid in this case because the affiliates were contributing financially to the reorganization and because, the judge concluded, their contribution was critical: “[m]ake no mistake,” he wrote, “without these contributions … there is no Plan and Debtors’ reorganization is impossible.”

The judge, however, struck the third-party releases for the companies’ individual managers, directors and officers because these individuals were making no substantial financial contribution to the plan.  Just performing their jobs, the court concluded, wasn’t enough to warrant giving them a release.

The bankruptcy court in 710 Long Ridge Road acted prudently in not stretching the third-party release blanket to cover the company executives.  But its decision to bless the release of the corporate affiliates downplayed two factors that under applicable case law were important:  that those with backpay claims had voted to reject the plan and that they were not being paid in full or even substantially on their claims.

What clinched the decision for the judge was the fact that the corporate affiliates held the money need to make the plan work and they demanded the releases as the price of their financial contribution.  As is often the case in bankruptcy, once the complex legal analysis is stripped away, it is such pragmatic considerations that drive the decision.