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With bankruptcy reorganization strategies in the auto and airline industries seeking elimination of decades-old employee pension and health care obligations, firms could be expected to beat a path to the door of the bankruptcy court of the 2nd U.S. Circuit Court of Appeals. Like the story of the three bears, some debtors consider the 3rd Circuit too hostile to revoking union contracts in bankruptcy, the 6th Circuit law too confused, but the 2nd Circuit seems just right. Still, danger lurks in any attempt to find relief from billions of dollars in pension obligations through bankruptcy because top management essentially loses control of the company to major creditors and shareholders. Creditors could decide to break up an ailing firm, for example. “No one goes into bankruptcy just to get rid of labor contracts. They would be crazy,” said John Gallagher of Paul, Hastings, Janofsky & Walker, who currently represents Northwest Airlines Corp. and Delta Air Lines Inc. in their New York bankruptcy cases. “It is too risky,” he said. Then an unusual strategy unfolded this summer during the United Airlines bankruptcy in Chicago’s 7th Circuit that allows the undoing of union pension obligations without the risky and cumbersome legal requirements imposed under bankruptcy law. Days before a May trial in bankruptcy court on the necessity of terminating United’s union-negotiated pension plan for flight attendants, the company struck a deal with the Pension Benefit Guaranty Corp., which protects the pension plans for 30 million private sector workers nationwide. United announced on April 22 it agreed that PBGC would terminate all four airline pension plans. United committed to pay PBGC $1.5 billion in equity securities and the agency would take over the plans as trustee. It meant severe pension cuts for many employees. ‘HORRENDOUS’ IMPACT The option may have been attractive to PBGC because it has been under its own stresses. It went from a surplus in its insurance fund of $9.7 billion in 2000 to a $23 billion deficit last year to cover pensions it had taken over from companies unable to pay, according to PBGC figures. “PBGC was at the table with us while they were in secret negotiations using our plan as barter,” said Robert Clayman of Guerrieri, Edmond, Clayman & Bartos in Washington, who represents the Association of Flight Attendants. The effect of the decision was to end the scheduled commencement of a bankruptcy court trial over whether United could terminate the flight attendants’ pension plan. Clayman appealed to the 7th Circuit during the summer. Recently, the panel held that “Despite AFA’s protestations, the path taken by United and PBGC was entirely appropriate,” wrote Judge Daniel Manion. In re UAL Corp., No. 05-3200, appealed from Ass’n of Flight Attendants v. United Airlines Inc., 177 L.R.R.M. 2907 (N.D. Ill. July 21, 2005). The union “remains resolute in its assertions that pension law was violated with the termination of the Flight Attendant Pension Plan,” according to a statement by AFA United President Greg Davidowitch. He denounced the United PBGC settlement as a “backroom deal” that “destroyed the retirement security of 28,000 flight attendants.” “The impact is horrendous,” Clayman said. PBGC takes over failing pensions but often distributes a fraction of the original obligation-frequently well below the promised benefit to retirees, he said. Clayman said the deal creates a direct conflict between bankruptcy law on abrogating union pacts, under bankruptcy’s 11 U.S.C. 1113 and the Employee Retirement Income Security Act, which established PBGC. James Sprayregen, lead counsel for United, denied that anything improper was done. “The PBGC has authority under the statutory framework of ERISA and the bankruptcy code to negotiate settlements with parties,” said Sprayregen of Kirkland & Ellis. With PBGC as trustee of the pension, United, which employs 60,000 people, gets out from under an estimated $4.5 billion in pension obligations between now and 2010, according to United documents. PBGC spokesman Randy Clerihue said, “it had become increasingly clear that the pension plan would terminate even if the PBGC did not act. Only then did the PBGC try to maximize its recoveries for plan participants and the insurance fund, as it does in every case.” Sprayregen said the 7th Circuit’s action is not unprecedented. The D.C. Circuit approved a negotiated settlement of pension issues between PBGC and TWA Airlines in its first bankruptcy in 2003, Allied Pilots Ass’n v. PBGC, 334 F.3d 93 (2003). But Clayman countered that the company has “eviscerated” the statutory scheme enacted in �1113 and ERISA. “PBGC’s conduct in United serves as a template for other industries and other companies,” he warned. It could be important to a number of bankruptcy battles to eliminate union contract costs now simmering around the country. A couple of weeks ago alone, Clayman was fighting a �1113 motion by Aloha Airlines in a Hawaii bankruptcy dispute, and Delta Airlines filed an 1113 motion on Nov. 2 to void their pilots’ contract. Clayman still has an active suit in the U.S. District Court for the District of Columbia attempting to block PBGC termination of the flight attendants’ pension. Big dollars will be at stake if other companies try to follow suit. The auto parts giant Delphi Corp. filed for bankruptcy this month in New York and has a $5 billion shortfall in its pension plan, according to Robert Miller, Delphi chairman and CEO. Northwest owed close to $5.7 billion in pension payments while Delta Air Lines was in arrears $10.6 billion, according to a PBGC estimate in September. But the granddaddy would be General Motors Corp., which insists it is not filing for reorganization, but has an estimated $30 billion in underfunded pension, according to PBGC. The company also made clear that it must shave some of its $73 billion in accrued health care obligations for retirees. The company recently made a deal with the United Auto Workers union to save $15 billion in health costs over seven years. The controversy has roots in the 1980s, when the Supreme Court held that companies could shed union contracts during bankruptcy without running afoul of unfair labor practice law. Congress quickly stepped in to provide more protection for labor contracts. In 1984 it passed �1113 to allow debtors to reject labor contracts only after meeting stiff obligations to negotiate with the union in good faith, provide relevant financial information to show the union the need for labor cost cuts and allow a trial on the necessity of abandoning labor contracts. Within a few years, two circuit courts took different approaches to the standard for contract rejection under �1113. The 3rd Circuit said the labor pact might only be terminated if it is “essential” to prevent a debtor’s liquidation in the near term. Wheeling-Pittsburgh Steel v. United Steelworkers, 791 F.2d 1074 (1986). By contrast, the 2nd Circuit adopted a more moderate, long-term approach that allows rejection of labor contracts if it is “necessary” to improve the chance of successful reorganization. Truck Drivers Local 807 v. Carey, 816 F.2d 82 (1987). The 6th Circuit has set no strict rule, but various bankruptcy judges there have taken different approaches leaving the issue confused. A SPLIT OF AUTHORITY “There is a split of authority,” said Richard A. Bales, a labor and employment professor at Northern Kentucky University Salmon P. Chase College of Law. “The 2nd Circuit applies a lenient standard to get out of collective bargaining obligations.The 3rd Circuit makes it more difficult. The 6th Circuit is a mess.” If companies have the option, they are going to file in New York, he said. “The requirement that [labor contract] rejection or modification be necessary has perplexed courts for the last 20 years,” he said. Pension funds were not always in trouble. The funds were flying high in the 1990s, with many 60 percent to 80 percent invested in the rising stock market, but that changed when the market plunged in 2000, according economist Olivia S. Mitchell of the Wharton School at the University of Pennsylvania. The second event was sinking interest rates. When computing pension liability, every 2 percent drop in the interest rate increases pension liability by 25 percent, Sullivan said. “This is a perfect storm in the pension area,” she said. “Another nail in their coffins: Great swaths of American industry are facing competition they never saw before. The same thing happened in the steel industries’ slow, downward spiral,” she said. Since United’s agreement with PBGC, the two have been at odds over limits the company sought to impose on PBGC’s potential sale of the securities. “We are in discussions to hopefully consensually resolve that issue,” Sprayregen said.

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