What Will Be the Consequences of the Third Circuit’s Decision to Impose 1114 Process on all Chapter 11 Debtors?

Contributed by Sunny Singh
On July 13, 2010, in one of the most significant and controversial decisions regarding retiree medical benefits in chapter 11, the Third Circuit held – contrary to the majority of lower courts that have considered the issue – that Visteon Corporation, a chapter 11 debtor, could not terminate its retiree health benefits without compliance with section 1114 and notwithstanding that Visteon had retained, as most large companies do, the unilateral right to terminate or modify retiree benefits at any time and without cause.  See In re Visteon Corp., 188 L.R.R.M. 3240 (3d Cir. 2010).
Section 1114 requires a chapter 11 debtor to continue to provide retiree health benefits unless it agrees to a consensual modification of such benefits with the retirees or if the bankruptcy court finds that, after good faith negotiations, the retirees have refused to accept the debtor’s proposal without cause and “such modification is necessary to permit the reorganization of the debtor.”  Section 1114 can be an expensive and time consuming process for debtors and, if applicable, shifts enormous leverage to retirees in a chapter 11 proceeding.
The majority of lower courts, including the recent decisions of the Bankruptcy Court for the Southern District of New York in In re Delphi Corporation and In re General Motors Corporation, have held that section 1114 is inapplicable if the debtor has retained the unilateral right to terminate or modify retiree benefits in its healthcare plan documents.  These decisions are grounded in the bedrock principle that bankruptcy preserves and enforces prepetition contractual rights; it does not vest parties with rights that do not exist under state law.  As a non-bankruptcy law matter, it is undisputed (even by the Third Circuit) that an employer may reserve the right to terminate retiree benefits without cause and may unilaterally exercise such rights.  Indeed, Visteon’s plan documents could not have been clearer:  “this handbook is not a contract, nor is it a guarantee of your coverage.”
Additionally, the majority view is also based, in part, on section 1129(a)(13), which was enacted as the counterpart to section 1114 under the Retiree Benefits Bankruptcy Protection Act of 1988 and provides that to emerge from bankruptcy, the debtor’s reorganization plan must provide for the continuation of all retiree benefits “for the duration of the period the debtor has obligated itself to provide such benefits.”  According to the majority line of reasoning, it would be inconsistent to find that section 1114 requires a debtor to continue retiree benefits during the chapter 11 case irrespective of the debtor’s reservation of rights to unilaterally terminate retiree benefits, but to allow the debtor to enforce such rights immediately upon emergence from chapter 11.  Indeed, the majority view has gained wide acceptance and many chapter 11 debtors have terminated or modified retiree benefits in the ordinary course without court approval.
In a surprising break from the majority view, the Third Circuit applied a strict statutory analysis and held that section 1114 was applicable even though the debtor in that case had retained the unilateral right to terminate or modify a retiree benefit plan.  According to the Third Circuit, section 1114 applies to all plans and does not create an exception for a plan that may be unilaterally terminated or modified by a debtor.  According to the Third Circuit, where the language of the statute is clear “[t]he fact that the debtor could have unilaterally stopped the payments had it not been in chapter 11 is therefore irrelevant.”
The Third Circuit was not persuaded by the argument that the language employed by Congress in section 1129(a)(13) at the very least creates an ambiguity over the applicability of section 1114.  Holding true to its strict statutory analysis, the Third Circuit rejected the retirees’ attempt to reconcile the two sections.  According to the Visteon retirees, section 1129(a)(13) does not come into play until the chapter 11 process has been completed and a chapter 11 debtor has obligated itself to continue retiree benefits.  Section 1129(a)(3) merely ensures that retirees who exit from the 1114 process having secured a promise from the debtor will have their benefits continued after chapter 11.  The Third Circuit held that nothing in section 1129(a)(3) refers to obligations undertaken in the 1114 process.  Thus, upon emergence from bankruptcy, the debtor would again be free, unless it agreed to modifications as a result of the 1114 process, to exercise its unilateral rights of termination or modification.  According to the Third Circuit, this result is not absurd.
The Third Circuit’s decision is troublesome to say the least.  The Court does not address the practical impact of its decision.  Where the costs of paying retiree benefits are not overwhelming, chapter 11 debtors will simply pay benefits during the case and terminate them upon emergence.  Thus, the decision and its intended purpose to uphold Congress’s goal to provide a “voice” to retirees can be easily silenced.  On the contrary, where retiree benefit costs are significant, the Third Circuit’s decision can impose serious pressures for debtors to emerge from chapter 11 as soon as possible to minimize their 1114 costs.  This holding, coupled with the limitation on a debtor’s exclusivity to no more than 18 months enacted by Congress in 2005, may force debtors that are burdened with retiree healthcare benefits to pursue quick exits from bankruptcy or to avoid chapter 11 altogether (at least in the Third Circuit).