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.