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Third Circuit Underscores Bankruptcy Code's Rigorous Protection of Retirees' Benefits

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July 23, 2010 | Legal Alert

The Third Circuit Court of Appeals has ruled that a business filing Chapter 11 bankruptcy may not easily terminate its retirees' health and insurance benefits as it reorganizes.  The Court's decision in In re Visteon Corporation reverses a long-standing trend among bankruptcy judges allowing companies in Chapter 11 to routinely terminate retirees' health and life insurance benefits.   As a result of the Court's decision in Visteon, any business contemplating Chapter 11 bankruptcy must thoroughly consider its obligations to retiree benefits plans before filing. 

Bankruptcy Code Section 1114 requires a bankruptcy trustee or a Chapter 11 debtor in possession to attempt to reach an agreement with retirees, or their union, before asking the bankruptcy court to modify or terminate these benefits.  Specifically, the trustee or debtor in possession must "make a proposal to the authorized representative of the retirees ...which provides for ... modifications in the retiree benefits that are necessary to permit the reorganization of the debtor and assures that ... all parties are treated fairly and equitably."  In addition, under Bankruptcy Code Section 503, payments for retiree benefit plans must be paid during the pendency of a Chapter 11 proceeding.

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In the past, bankruptcy and district courts have found that the Employee Retirement Security Act's (ERISA) less stringent standards control.  Specifically, courts dismissed Code Section 1114 as being overly broad, unreasonably strict, and giving retirees absurdly greater rights in the bankruptcy process than ERISA gave them otherwise.  In 1974, when Congress passed ERISA and granted employers almost absolute flexibility as to whether benefits plans can be terminated, it was concerned that imposing stricter requirements - especially during bankruptcy - would discourage small businesses from offering benefits in the first place. 

However, in Visteon Corp., the Court of Appeals held that Bankruptcy Code Section 1114 trumps ERISA and offers protection to retired workers during a time when their benefits are highly vulnerable.  Echoing legislative history, the Court wrote, "[b]ankruptcies are painful for workers, communities, small business suppliers and others.  But the burden of turning a company around should not rest on the backs of retirees."  As such, the burden will now be on the debtor to demonstrate that terminating retiree benefits is necessary in order for the debtor to reorganize.

This could be a hollow victory for labor though. Bankruptcy Code Section 1114's protections terminate once the business emerges from the reorganization process.  Companies would then be free to modify or terminate retiree benefits under ERISA.  Finally, Section 1114's protections do not apply to any benefits provided for purposes other than health, accident, disability, or death, and does not apply to high-income retirees.

If you have any questions about the information contained in this alert, contact a member of the Bankruptcy Practice Group at Flaster/Greenberg.

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