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Third Circuit Prevents Plan Sponsor From Eliminating Retiree Benefits in Bankruptcy

July 27, 2010

On July 13, 2010, the U.S. Court of Appeals for the Third Circuit held, in a landmark decision, that a plan sponsor which had the right to unilaterally terminate retiree benefits outside of bankruptcy could not exercise that same right during a bankruptcy proceeding. The case, IUE-CWA v. Visteon Corp. (In re Visteon Corp.), marks the first time that a Circuit Court of Appeals ruled against a bankrupt employer in its attempt to unilaterally terminate non-vested retiree welfare benefits. Notably, the decision is contrary to a Second Circuit Court of Appeals decision and the majority of Federal district court and bankruptcy court decisions on this issue.

Background

Visteon Corporation is one of the world's largest suppliers of automotive parts. Originally a division of Ford Motor Corporation, it spun off in 2000 to become its own corporate entity, taking control of two plants in Indiana previously run by Ford.

As a result of the precipitous decline of the U.S. automotive industry, Visteon Corporation (Visteon) filed for bankruptcy on May 28, 2009. Thereafter, as part of its restructuring, it moved the Bankruptcy Court for permission to terminate its U.S. retiree benefit plans which provided retiree welfare coverage to approximately 8,000 present and former Visteon employees, their spouses and dependents. Visteon had reserved the right to unilaterally terminate these plans outside of bankruptcy.

The IUE-CWA, a union representing approximately 21,000 retirees, objected to Visteon's termination of the retiree benefit plans, arguing that the plans could not be terminated during Visteon's chapter 11 proceedings without Visteon complying with the requirements of Section 1114 of the Bankruptcy Code. The Bankruptcy Court and District Court disagreed with the union and approved termination of the benefit plans. The two courts reasoned that ruling in favor of the union would be contrary to the intent of the Bankruptcy Code, which was not to improve the prepetition contractual rights of a third party as a result of the filing of a bankruptcy case. Thereafter, the IUE-CWA appealed the lower court decisions to the Third Circuit.

Section 1114

Section 1114 of the Bankruptcy Code provides certain procedural and substantive protections for "retiree benefits" during a chapter 11 proceeding. Section 1114(e)(1) mandates,
"[n]otwithstanding any other provision of this title, the [trustee] shall timely pay and shall not modify any retiree benefits," except through compliance with various procedures set forth in the statute. "Retiree benefits" are defined to include medical, surgical, sickness, accident, disability or death benefits under any plan, fund or program maintained or established by the debtor.

To terminate retiree benefits, Section 1114 requires a debtor to make a proposal to the retiree's authorized representative and establish that its requested modifications are necessary to its reorganization and treat affected parties fairly and equitably. The debtor must meet with the retiree's authorized representative and confer in good faith on mutually satisfactory modifications to the benefit plans. In the absence of an agreement among the parties, the court can grant the debtor's motion to modify the retiree benefits, but only after finding that the debtor satisfied the Section 1114 requirements, the authorized representative refused to accept the modifications without good cause and the modifications are necessary to the debtor's reorganization and clearly favored by the balance of the equities.

Up to this point, most courts had ruled that Section 1114 did not apply to unvested benefit plans in which the debtor had reserved the right to terminate or modify the plans unilaterally.

The Third Circuit's Decision

In ruling that Visteon could not terminate its retiree benefit plans, the Third Circuit relied on the express language of Section 1114, which refers to "any retiree benefits". Given the broad language, the Third Circuit found it clear that Congress intended Section 1114 to apply to all benefits under all plans, irrespective of whether the debtor had the right to unilaterally terminate them or not. Therefore, once Visteon had commenced its chapter 11 case, there was only one way for it to terminate or modify its retiree benefits – by complying with the Section 1114 procedures. In so ruling, however, the Court recognized that its decision was at odds with the decisions of a majority of bankruptcy and district courts that have addressed the same issue.

In addition, the Court acknowledged that its reading of Section 1114 actually improved the rights of retirees in bankruptcy over those they had outside of it. However, relying on legislative history, the Court found that such a result was intended by Congress which wanted to make retirees a unique group of creditors with special protection in a chapter 11 case, because they were particularly vulnerable. Nevertheless, while Section 1114 was intended to be a "microphone" by which retirees could be heard in the chapter 11 process, it did not prohibit the termination or modification of benefit plans. It just made it a little more of a challenge for the debtor to do so.

Moreover, although this decision is a blow to employers providing non-vested retiree welfare coverage, the Third Circuit also provided some positive dicta in favor of employers. First, the Court stated that the fact that a debtor had reserved the right to unilaterally terminate its benefit plans outside of bankruptcy would remain an important factor to be considered by courts in ruling on plan terminations and modifications. Additionally, the Court made clear that Section 1114 does not dictate the duration that an employer must provide retiree benefits. Therefore, if the Section 1114 process does not yield an agreement on durational obligations, the duration is determined by the underlying contractual agreements between the debtor and its retirees. If the debtor has no obligation under its agreements to continue to provide retiree benefits (i.e., the retiree benefits are not vested), nothing in the Bankruptcy Code requires their continuation after the debtor's emergence from bankruptcy. As a result, so long as the debtor does not take on new durational obligations during the Section 1114 process, the debtor emerges from Chapter 11 as free to terminate benefits as it would have been had it never entered Chapter 11.

 
Take-Aways for Employers with Legacy Retiree Benefits

The Third Circuit's decision in Visteon is an important decision which increases the leverage of unions and the retirees they represent, in negotiations with debtors. While the Third Circuit's decision does not prevent retiree welfare plans from being terminated or modified in bankruptcy, it clearly gives retirees increased bargaining power to protest such termination or modifications. Therefore, employers who want to shed legacy retiree benefits should consider taking steps to terminate such benefits well before any bankruptcy filing. This is especially true due to the recent requirement that reinstates retiree benefits terminated or modified within 180 days prior to the filing of a bankruptcy petition. Terminations or reductions of group health coverage within a year of a bankruptcy filing also have significant COBRA implications.

Take-Aways for Creditors of Borrowers/Debtors with Legacy Retiree Benefits

The inability of a borrower to shed legacy retiree benefits can have a dramatic impact on recoveries for the borrower's lenders. In light of the Visteon decision, lenders should be careful to discuss termination options with borrowers early in a workout process to avoid options becoming foreclosed or impaired in the days leading up to and during a bankruptcy proceeding. In addition and in light of the circuit split on this issue, appropriate venue for a bankruptcy filing should also be carefully considered.