The negotiation efforts of Delphi Corp.'s union employees took on new urgency on March 31 as Delphi filed a motion with the U.S. Bankruptcy Court seeking to reject its collective bargaining agreements and modify its retiree benefits plans under sections 1113 and 1114 of the Bankruptcy Code. [1] If Delphi's pension and benefits obligations are ultimately rejected and then terminated, it will have a profound effect on the Pension Benefit Guaranty Corp., the federal agency that insures pension obligations. Already operating at a deficit, PBGC can ill-afford to take on any of Delphi's estimated $10.7 billion in under-funded liability for hourly employees' retirement benefits. [2] In response to the recent distress terminations of pension plans in the steel and airline industries, Congress has introduced several measure to bolster the PBGC. As a consequence, Chapter 11 debtors may find it more difficult to avoid pension liability as part of a reorganization plan.

Termination of Delphi's Executory Contracts Under the Bankruptcy Code

The Bankruptcy Code allows a trustee or debtor-in-possession to reject executory contracts subject to the court's approval. [3] The Code provides parallel provisions for granting rejection of collective bargaining agreements (including employee benefit and pension plans) under section 1113(c) and modification of retiree benefits (including health care and life insurance) under section 1114(g) insofar as the rejection or modification is necessary to permit the reorganization of the debtor. [4] In addition to meeting a heightened "balancing of the equities" standard for court approval, the trustee or debtor-in-possession is required to negotiate in good faith its termination or modification proposal with the authorized representatives of its employees towards the goal of reaching "mutually satisfactory modifications" to the proposal. [5]

Delphi reported to the court that "[w]ithout modifications to its labor agreements or to its retirement obligations... Delphi would suffer operating losses ranging from approximately $6.1 billion to $8.1 billion, and net losses ranging from approximately $11 billion to $13 billion, over the next five years." [6] Those projections to not begin to cover the long term under-funding of its retiree health, life, and pension benefit obligations. While Delphi plans to freeze and retain its defined benefit contribution plan, it acknowledges that "it will also be necessary to obtain relief from the [PBGC], Internal Revenue Service, Department of Labor and potential congressional action in order to amortize funding contributions over a longer period in its transformation plan than may have previously occurred." [7] Further, Delphi reserved the right in its Motion to later terminate the plans if necessary. [8]

The unions representing Delphi's workers, led by the UAW, complain that this filing will stall the already bitter negotiations and may lead to strike action. UAW President Ron Gettelfinger issued the following statement to that effect:

Delphi's misuse of the bankruptcy procedure to circumvent the collective bargaining process and slash jobs and wages and drastically reduce health care, retirement, and other hard-won benefits or reduce them altogether is a travesty and a concern for every American. ... In the event the court rejects the UAW-Delphi contract and Delphi imposes the terms of its last proposal, it appears that it will be impossible to avoid a long strike. [9]

As a show of good faith, Delphi requested in its Section 1113 and 1114 Motion that the court extend the 14-day limit for scheduling a hearing as prescribed in section 1113(d)(1) and instead hold the hearing on May 9th and May 10th to allow the parties time to continue negotiations. [10] Delphi CEO Steve Miller explained that:

Our fiduciary duty as the management team and the Board of Directors at Delphi is to protect the value of the estate. We need to take the steps necessary to halt losses that continue to occur at an unsustainable rate and transform our business. Although today's court filings are necessary to protect our business, we have not left the negotiating table. We have made considerable progress in recent weeks, and we intend to stay at it until we are finished. [11]

Little Recourse Available to Delphi Employees in the Event of Rejection and Termination

As indicated in the statement by Ron Gettelfinger above, the unions object to the motion on the grounds that Delphi has failed to negotiate in good faith or provide the most complete and reliable information available as required by section 1113(b) and 1114 (f). At the hearings, the UAW must show instead that Delphi's proposals failed to fulfill the statutory requirements, and that the UAW therefore refused to accept the proposals for good cause. [12] Based upon the length of the negotiations and the financial burden the agreements pose to Delphi's restructuring plan, it is likely that the UAW's objection will fail and the motion will be granted.

If the pensions provided for in the collective bargaining agreement are ultimately rejected under section 1113, and liability for health care and life insurance benefits for retired employees is eliminated under section 1114, Delphi's employees have three avenues from which to seek some relief: Delphi's bankruptcy estate, General Motors, and the Pension Benefit Guaranty Corp. As the following sections will show, none of these options will ensure full payment of accrued and future benefits to Delphi employees.

1. The Effects of Rejection of Executory Contracts Under the Bankruptcy Code

Rejection of an executory contract is generally treated as an anticipatory repudiation by section 365(g) [13] and gives rise to a general unsecured claim under section 502(g)(1) of the Code. [14] This is likewise the case for retiree benefits plans that are reduced or eliminated under section 1114's modification provisions. The employee benefit plans under section 1113, by contrast, are afforded priority unsecured statute for those benefits arising within 180 days of the bankruptcy petition up to a statutory limit. [15] Claims for lost employee benefits beyond that limit and all retiree claims are relegated to general unsecured status, which means that the employees may only recover a pro rata share with the other general unsecured creditors of Delphi's bankruptcy estate. If Delphi has insufficient assets once the secured and priority unsecured claims are paid, then the employees will receive nothing from the estate. Furthermore, since all such claims will receive final discharge in the bankruptcy proceeding, there is no future recourse against Delphi when it emerges from Chapter 11.

2. The GM Benefit Guarantee and the Section 1114(g) Modification

At the time of its 1999 spin-off from General Motors, Delphi assumed liability for the GM-UAW collective bargaining contracts of its workers. GM in turn guaranteed retiree medical and life insurance benefits for hourly employees in the even Delphi declared bankruptcy. Under section 1114(g), Delphi seeks to eliminate its obligations entirely as to employee-beneficiaries of the GM Benefit Guarantee agreement, which could cost GM as much as $12 billion. [16] For all other employees, Delphi would substitute a defined-contribution benefits plan. [17] Given GM's current financial trouble and the high number of employees not covered by the GM Benefit Guarantee, this is unlikely to be a satisfactory solution. Furthermore, since the PBGC only covers pension benefits, not health and welfare benefits, Delphi employees and retirees are looking at substantial losses if the motion is granted.

3. PBGC Distress Termination Insurance and the Section 1113(c) Rejection

PBGC was created in conjunction with the Employment Retirement Income Security Act of 1974 (ERISA). [18] It is financed by premiums paid into PBGC by providers of defined benefit contribution plans, termination penalties paid by former providers, the assets of plans that it administers, and investment income. If a plan provider proves to the bankruptcy court or PBGC that its pension and benefit plan is under-funded and that the company cannot remain in business unless the plan is terminated, then PBGC will grant an application for "distress termination." [19] The PBGC steps in as trustee of the plan and pays beneficiaries according to annual tables created under ERISA.

In a stunning reversal, recent distress terminations in the steel and airline industries have taken PBGC from a $9.7 billion surplus at the end of 2000 to its current $23.3 billion deficit. [20] United Airlines alone burdened the PBGC with an addition $6.6 billion in un-funded liabilities. [21] The Congressional Budget Office estimates that PBGC's deficit could balloon up to $141.9 billion over the next twenty years. [22]

Recent Congressional Responses to PBGC Deficits Brought on by Distress Terminations of Pension and Benefits Plans in Bankruptcy

Currently, the PBGC derives no funding whatsoever from taxpayers, and the 109th Congress introduced a series of measures aimed at keeping it that way. Pending bills include the Pension Protection Act, [23] the Pension Security and Transparency Act, [24] the Pension Fairness and Full Disclosure Act, [25] the Stop Terminating Our Pensions Act, [26] and the Bankruptcy Fairness Act. [27]

Substantial changes affecting the funding of PBGC are found in the Deficit Reduction Act of 2005, a budget reconciliation bill signed into law on February 8, 2006. This Act increases single-employer plan providers' annual premium of $19 per worker to $30, the first premium increase since 1991. [28] The premium rate increase would thereafter be indexed to inflation. The Act also imposes a termination premium payment of $1,250 per plan beneficiary (as of the date of termination) to be paid by single-employer plan providers each year for three years. For distress terminations by Chapter 11 debtors, this penalty becomes effective upon discharge or dismissal of the case. [29] The termination penalty provision will sunset after five years; however, given the extent of PBGC's deficit, the severity of pension under-funding, and the low rates of return on its investments, it is likely that this penalty will continue to be enforced indefinitely.

Incidentally, BAPCPA, the 2005 amendments to the Bankruptcy Code, did little to change the availability of rejecting or modifying pension and benefits obligations in Chapter 11. [30] However, Delphi's decision to file in advance of the October 17, 2005 effective date of BAPCPA has given it an unexpected windfall: the termination penalty provisions in the Deficit Reduction Act do not apply to those Chapter 11 cases filed before October 18, 2005. [31]

"Lemon Socialism" and the Future of Distress Terminations in Bankruptcy

Professor Chason illustrates in a recent article how the PBGC may actually encourage financially weak companies to engage in risky practices such as borrowing from their pension and benefits plan assets because of the PBGC guarantee, whereas financially strong companies tend to fully fund their pensions. The PBGC guarantee is thus a form of what professor Chason describes as "lemon socialism", the subsidization of weaker firms at the expense of stronger firms. [32] Adequately funding the PBGC to cover its existing and future obligations, while generally discouraging its use, are significant challenges for the future.

The Deficit Reduction Act's termination penalty provisions will impose new onerous burdens on Chapter 11 estates seeking to reject pension and employee benefits in the debtor's collective bargaining agreements and shift coverage to the PBGC. This will make the plan confirmation process more difficult and expensive. However, increasing burdens on the estate will also increase the bargaining incentives between the trustee/DIP and the employees' representatives to avoid this cost. The unions' common complaint is that trustees/DIPs make a mere showing of good faith intent to bargain, but nonetheless present proposals demanding impossible concessions. When the unions refuse, the trustee moves for rejection. This puts enormous power in the hands of the trustee/DIP. The plan termination penalty may in fact create some equalization, thereby increasing the chances of a successful negotiation of an assumption proposal. However, these penalties and premium increases only go so far. Unless Congress implements more substantial measures to fund PBGC and discourage debtors from distress terminations, taxpayers may be asked to open their checkbooks.

Sources

[1] Motion for Order under 11 U.S.C. § 1113(c) Authorizing Rejection of Collective Bargaining Agreements and Under 11 U.S.C. § 1114(g) Authorizing Modification of Retiree Welfare Benefits, In re Delphi Corp., No. 05-44481 (Bankr. S.D.N.Y. Mar. 31, 2006), available at http://www.delphidocket.com/Docket/SearchResults.asp?T=188 (follow "Motion for Order" hyperlink") [hereinafter Section 1113 and 1114 Motion].

[2] Memorandum of Law in Support of Motion at 10, In re Delphi Corp., No. 05-44481 (Bankr. S.D.N.Y. Mar. 31, 2006), available at http://www.delphidocket.com/Docket/SearchResults.asp?T=188 (follow "Memorandum of Law" hyperlink) [hereinafter Memorandum].

[3] 11 U.S.C. § 365(a) (West, 2006)

[4] 11 U.S.C. § 1113(b)(1)(A); 11 U.S.C. § 1114(f)(1)(A) (West, 2006)

[5] 11 U.S.C. § 1113(b) and (c)(1); 11 U.S.C. § 1114(f) and (g)(1) (West, 2006)

[6] Section 1113 and 1114 Motion, supra note 1 at 4.

[7] Press Release, Delphi Corp., Delphi Outlines Transformation Plan (Mar. 31, 2006), available at http://www.delphi.com/news/pressReleases/pr75605-03312006.

[8] Memorandum, supra note 2 at 41.

[9] See Press Release, The International Union, United Automobile, Aerospace and Agricultural Implement Workers of America, UAW Statement on Delphi Filing 1113/1114 Motions (Mar. 31, 2006) available at http://www.uaw.org/delphi/delphiupdate.cfm?duId=47.

[10] Section 1113 and 1114 Motion, supra note 1 at 2.

[11] See Press Release, Delphi Corp., supra note 7.

[12] 11 U.S.C. § 1113(c)(2); 11 U.S.C. § 1114(g)(2) (West, 2006)

[13] 11 U.S.C. § 365(g) (West, 2006)

[14] 11 U.S.C. § 502(g)(1) (West, 2006)

[15] 11 U.S.C. § 507(a)(5) (West, 2006)

[16] Section 1113 and 1114 Motion, supra note 1 at 6, 20.

[17] Id. at 6-7.

[18] codified at 29 U.S.C. § 1001 et seq.

[19] PBGC.gov, How Pension Plans End, http://www.pbgc.gov/workers-retirees/about-pbgc/content/page13170.html (last visited Apr. 9, 2006).

[20] U.S. Gov’t  Accountability Office, Report to Congressional Committees, Private Pensions: Recent Experiences of Large Defined Benefit Plans Illustrate Weaknesses in Funding Rules at 1 (2005) available at http://www.gao.gov/new.items/d05294.pdf.

[21] See Press Release, Pension Benefit Guaranty Corp., PBGC Reaches Pension Settlement with United Airlines (Apr. 22, 2005) available at http://www.pbgc.gov/media/news-archive/2005/pr05-36.html.

[22] Cong. Budget Office, The Risk Exposure of the Pension Benefit Guaranty Corporation at viii (Sept. 2005) available at http://www.cbo.gov/ftpdocs/66xx/doc6646/09-15-PBGC.pdf.

[23] H.R. 2830, 109th Cong. (2005).

[24] S. 1783, 109th Cong. (2005).

[25] H.R. 2233, 109th Cong. (2005).

[26] S. 1158, 109th Cong. (2005).

[27] S. 329, 109th Cong. (2005).

[28] Pub. L. No. 109-71, § 8101(a)(1)(A) 120 Stat. 3, 180 (2006) (to be codified at 29 U.S.C. § 1306(a)(3)(A)), available at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_public_laws&docid=f:publ171.109.

[29] Pub. L. No. 109-171, § 8101(b) 120 Stat. 3, 181-2 (2006) (to be codified at 29 U.S.C. § 1306(a)(7)(A)-(B)), available at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_public_laws&docid=f:publ171.109.

[30] Specifically, Congress added section 1114(l), which operates to reinstate retiree benefits that were modified in the 180-day period before the bankruptcy petition was filed if the debtor was insolvent at the time, unless the court finds that the balance of the equities clearly favors such modification. 11 U.S.C. § 1114(l) (West, 2006).

[31] Pub. L. No. 109-171, § 8101(d) 120 Stat. 3, 182-3 (2006), available at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_public_laws&docid=f:publ171.109.

[32] Eric D. Chason, Lemon Socialism and the Federal Guaranty of Private Pension Obligations 35 (Feb. 2006) available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=887405.