Bankruptcy Court Permits Patriot to Modify Union Agreements

by Orrick, Herrington & Sutcliffe LLP
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Patriot Coal became the third major debtor in the last year to modify benefits or reject a CBA under sections 1113 and 1114 of the Bankruptcy Code.  Following similar rulings in the Hostess and AMR Corporation bankruptcies, Bankruptcy Judge Kathy Surratt-States on May 29, 2013 granted Patriot authorization to modify agreements with the United Mine Workers of America and reject union CBAs.  She held that Patriot had made the requisite showings that: (1) modifications or rejection are necessary for the company to emerge from bankruptcy successfully; (2) the balance of the equities favors rejection and (3) the union refused to accept the proposed modifications without good cause.  The ruling continues a recent trend allowing debtors to reject or modify union agreements and benefits, despite the elevated standard under sections 1113 and 1114 of the Bankruptcy Code.  As a result, debtors and other creditors may now have more leverage in dealing with unions in bankruptcy than had been expected historically under the heightened standards adopted by Congress in sections 1113 and 1114.  In re Patriot Coal Corp., Bankr. Case No. 12-51502-659 (Bankr. E.D. Mo. May 29, 2013) (the "Opinion").  

Background

The Standard Under Section 1113 and 1114  

Section 1113(c) of the Bankruptcy Code permits a debtor to reject or modify a CBA when: (i) the debtor makes a good faith proposal to the union; (ii) the debtor's proposal contains only those modifications that are "necessary to permit the reorganization of the debtor;" and (iii) the union refuses to accept the proposed modifications without "good cause."  Similarly under section 1114(g) of the Bankruptcy Code, a debtor may modify retiree benefits only upon a comparable showing.  

Recent Rulings Under 1113 and 1114

In 2012, courts in Hostess and AMR Corporation each considered proposals to modify union benefits or terminate CBAs.  Those Courts permitted modification or termination on the grounds that the requested changes were necessary for the successful reorganization of the company.  In each case, the Court rejected the requested relief initially but identified narrow provisions of the proposed modification that were not "necessary to permit the reorganization of the debtor."  After the debtors revised the proposed modifications, the Court permitted rejection.  These cases provided road maps of the types of modifications that may be necessary, the process by which debtors could modify union agreements and the steps courts could take in the event the debtor was seen as overreaching on specific issues within the context of a case where debtors needed modifications.  

Patriot Coal History  

The Court's 102-page opinion provides fulsome detail regarding the history of the coal industry, government involvement in the industry and the creation of Patriot Coal (and its predecessors).  Rather than try to summarize Judge Surratt-States' work, we refer the reader to the text of the lengthy opinion for as much color as the reader desires.  It bears noting that Patriot Coal was spun off from Peabody Energy Corporation in 2007.  As part of the spin off, Patriot took healthcare obligations associated with the assets spun off to Patriot.  Patriot filed for bankruptcy in 2012.  The Court identified retiree healthcare obligations as "presently at astronomical levels" by the time of the bankruptcy.  Opinion at 24.  

The Proposal  

Throughout 2013, the parties exchanged numerous proposals to modify employee benefits.  The debtors made proposals under both sections 1113 and 1114 of the Bankruptcy Code, referred to by the Court as the "Fifth 1113 Proposal" and the "Fifth 1114 Proposal" respectively.  The Court provides lengthy descriptions of both offers, but in relevant part in the Fifth 1113 Proposal, the Debtor proposed:  

  • To commit a payment stream acceptable to fund the "1974 Pension Plan" and that the Obligor Debtors would continue to contribute to and not withdraw from the 1974 Pension Plan;
  • Reduction in wages and benefits to levels consistent with non-union employees;
  • Reduction of pension contributions to levels consistent with non-union employees;
  • Reduction in bonuses and vacation;
  • Modification of health plans;
  • Elimination of a bonus on 20 years of service; and
  • The modifications would become effective June 1, 2013.

Additionally, in the Fifth 1114 Proposal, the Debtors proposed ceasing the provision of retiree benefits.  Instead, Patriot proposed the creation of a VEBA Trust to be maintained, ultimately, by the United Mine Workers.  The Debtors also proposed providing the union with a 35% equity interest in the reorganized debtors to fund the VEBA (as well as $10 million in cash).  

Court's Analysis  

Judge Surratt-States analyzed nine key components of rejection or modification under section 1113 and 1114, which ultimately tie back to the three-pronged standard detailed above.  Her analysis focused foremost on whether the proposed modifications were necessary for successful emergence from bankruptcy and whether the balance of equities favored rejection or modification.  

Are the proposed modifications necessary for emergence from bankruptcy?  

The Court held: "There is no dispute that for Debtors' survival, concessions are necessary."  Opinion at 81.  However, the United Mine Workers objected on the grounds that some of the modifications were unnecessary in light of what they viewed as a temporary problem (the declining price of coal) and overstated expenses.  The Court considered extensive testimony and ruled that the Debtors had made valid assumptions and projections in their business plan and that the Debtors needed to make the requested changes to meet certain DIP loan covenants and other obligations in the immediate term or otherwise would be unable to emerge from bankruptcy.  Accordingly the court held that the Debtors had demonstrated the necessity of the requested changes.  

Does the balance of equities favor rejection?  

The Court held that the Debtors faced grave consequences if they could not reject or modify the terms of the CBA.  "Without relief from Debtors' current Retiree Benefit costs and CBA requirements, Debtors will be forced into liquidation. . .."  On the other hand, if the relief is granted and the "the UMWA calls a strike, especially a lengthy strike . . . Debtors will be forced to liquidate. . .  If Debtors liquidate, the overwhelming majority of Debtors' current employees, which includes UMWA-represented employees, will be unemployed."  The Court asks "What is better?  Something for a time or nothing in a short time?  Half a loaf or no loaf at all?" before concluding:  "the Debtors have met their burden of persuasion in that by the preponderance of the evidence, the equities favor granting the . . . Motion."  Opinion at 98-101.  

Impact of Ruling  

The Patriot court follows recent decisions in the AMR Corp. and Hostess bankruptcies that also permitted rejection and modification of union agreements over union objections.  This runs contrary to the long-time expectation that Congress created heightened standards under sections 1113 and 1114 to make rejection or modification of union agreements more difficult than rejection of ordinary executory contracts under section 365 of the Bankruptcy Code.  

While parties had long feared that extensive union obligations could make reorganization difficult, the increasing scope of these obligations and the highly leveraged nature of many debtors have tipped the trend toward permitting modification.  These facts have made modifications necessary to emerge from bankruptcy and thus ensured modifications complied with the section 1113 and 1114 standards.  

As a result, Debtors (and other creditors) may have greater comfort now that they will be able to modify or reject union obligations in bankruptcy.  This may make reorganization in bankruptcy, and negotiations outside bankruptcy, easier for debtors with significant union obligations.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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