First Impressions: Third Circuit Rules That a Terminated Collective Bargaining Agreement May Be Rejected Under Section 1113

In In re Trump Entm’t Resorts UNITE HERE Local 54, 810 F.3d 161 (3d Cir. 2016), the U.S. Court of Appeals for the Third Circuit answered a question of apparent first impression among the circuit courts of appeal by ruling that section 1113 of the Bankruptcy Code permits a bankruptcy trustee or chapter 11 debtor-in-possession (“DIP”) to reject a collective bargaining agreement (“CBA”) even after the agreement has expired. Lower courts have been divided over whether such terminated contracts can be rejected or if the surviving terms of an expired CBA continue in force until a new agreement is executed.

Collective Bargaining Agreements in Bankruptcy

Under section 365 of the Bankruptcy Code, a trustee or DIP has the ability to assume, assume and assign, or reject “executory contracts,” which are contracts where material performance is due by both parties as of the bankruptcy petition date. Rejection does not result in termination of an executory contract. Rather, it is considered a court-authorized breach of the contract, relieving the debtor from any obligation to continue performing.

An unexpired CBA, much like any employment agreement, is an executory contract because both the employer and the covered employees have material ongoing obligations. However, given the special attention Congress often provides to issues regarding employees and retirees, lawmakers added section 1113 to the Bankruptcy Code in 1984 to provide a specific process by which a trustee or DIP may assume, reject, or modify a CBA, thereby removing such contracts from the umbrella of section 365 of the Bankruptcy Code in chapter 11 cases.

Section 1113 of the Bankruptcy Code was passed in response to the Supreme Court’s decision in National Labor Relations Board v. Bildisco & Bildisco, 465 U.S. 513 (1984). In Bildisco, the Court ruled that a CBA can be rejected under section 365 if it burdens the estate, the equities favor rejection, and the debtor made reasonable efforts to negotiate a voluntary modification without any likelihood of producing a prompt, satisfactory solution. The Court also held (by a five-to-four majority) that the debtor need not follow the contract modification procedures set forth in the National Labor Relations Act (the “NLRA”) because, for purposes of the NLRA, a CBA is “no longer immediately enforceable, and may never be enforceable again.”

Congress changed that later the same year, when it enacted section 1113 of the Bankruptcy Code in response to a groundswell of protest from labor interests. Section 1113 provides CBAs with enhanced protection by mandating an expedited negotiation process for modifying a CBA and by mandating judicial evaluation of a motion to reject a CBA if negotiations are unsuccessful. Specifically, section 1113 provides that a trustee or DIP may reject a CBA only if the bankruptcy court determines that: (i) the trustee or DIP has made a proposal (supported by relevant information necessary to evaluate it) to the authorized representative of covered employees “which provides for those necessary modifications in the employees[’] benefits and protections that are necessary to permit the reorganization of the debtor and assures that all creditors, the debtor and all of the affected parties are treated fairly and equitably”; (ii) the authorized representative refused to accept the proposal “without good cause”; and (iii) “the balance of the equities clearly favors rejection of such agreement.” Section 1113(f) explicitly forbids a trustee or DIP from terminating or altering any provision of a CBA prior to complying with these requirements.

Under the NLRA, once a collective bargaining relationship has been established, an employer may not make a change affecting certain mandatory bargaining subjects without affording the union the opportunity to bargain over the change. Even when a CBA expires, the employer must maintain the status quo under the agreement until the employer enters into a new CBA or bargains to an impasse. See 29 U.S.C. § 158(a)(5); NLRB v. Katz, 369 U.S. 736 (1962) (an employer commits an unfair labor practice if, without bargaining to an impasse, it unilaterally changes existing terms or conditions of employment).

Unlike section 365, which expressly allows a trustee or DIP to assume or reject “any executory contract or unexpired lease” (with certain specified exceptions), section 1113 does not specifically require a CBA to be “executory” in order to be assumed or rejected. Thus, bankruptcy courts and a handful of appellate panels have been divided on whether section 1113 permits a trustee or DIP to reject an expired CBA. Compare In re Hoffman Bros. Packing Co., 173 B.R. 177, 184 (B.A.P. 9th Cir. 1994) (CBA “continues ‘in effect,’ as recognized by § 1113(e) and as was implicit in § 1113(c)”); In re 710 Long Ridge Rd. Operating Co., II, 518 B.R. 810 (Bankr. D.N.J. 2014) (section 1113 applies to CBAs that have expired prepetition); In re Karykeion, Inc., 435 B.R. 663 (Bankr. C.D. Cal. 2010); In re Ormet Corp., 316 B.R. 662 (Bankr. S.D. Ohio 2004), appeal dismissed, 2005 BL 80155 (S.D. Ohio Aug. 19, 2005), with In re San Rafael Baking Co., 219 B.R. 860 (B.A.P. 9th Cir. 1998) (section 1113(c) is applicable only to unexpired CBAs; rejecting Hoffman Bros. as dicta); In re Hostess Brands, Inc., 477 B.R. 378 (Bankr. S.D.N.Y. 2012); In re Sullivan Motor Delivery, Inc., 56 B.R. 28 (Bankr. E.D. Wis. 1985); see also In re Chas. P. Young Co., 111 B.R. 410 (Bankr. S.D.N.Y. 1990) (noting that rejection of a CBA pursuant to § 1113(c) is a moot issue if the agreement expired by its own terms and before the bankruptcy court holds a hearing on rejection). According to a leading commentator, the position that section 1113 does not apply to an expired CBA is the majority rule. See Collier on Bankruptcy ¶ 1113.02[d] (16th ed. 2016).

The Third Circuit addressed this issue as a matter of apparent first impression in the circuit courts of appeal in Trump Entertainment.

Trump Entertainment

Trump Entertainment Resorts Inc. and its affiliates (collectively, “TER”) own and operate the Trump Taj Mahal Casino in Atlantic City, New Jersey. The casino has 2,953 employees, 1,467 of whom are unionized. UNITE HERE Local 54 (the “union”) is the largest of the employee unions.

The most recent CBA between the union and TER provided that it would “remain in effect until 11:59 p.m. on September 14, 2014 and shall continue in full force and effect from year to year thereafter, unless either party serves sixty (60) days written notice of its intention to terminate, modify, or amend the Collective Bargaining Agreement.”

Under the CBA, TER was required to make more than $3.5 million per year in pension contributions, as well as $10 to $12 million per year in health and welfare contributions—payments it could not afford if it were to continue operating. Its financial health deteriorating, TER attempted to negotiate a new agreement in 2014.

On March 7, 2014, TER gave the union notice of its “intention to terminate, modify or amend” the CBA and asked the union to begin negotiations for a new agreement. The union did not respond. On April 10, 2014, TER repeated its request. The union responded on April 30 that “while [it is] also anxious to commence bargaining, the Union is simply not ready, some five months out [from expiration of the CBA], to commence negotiations,” but it would “contact [TER] within the next several months.”

On August 20, 2014, TER and the union met to discuss the terms of a new CBA. Although TER disclosed its critical financial situation, the union was not receptive to negotiations, and no agreement was reached. TER filed for chapter 11 protection in the District of Delaware on September 9, 2014. Two days afterward, TER asked the union to extend the term of the CBA, but the union refused, unless TER agreed to terminate the extension upon the filing of a motion under section 1113. With no new agreement in place and with TER having served notice in March 2014 to terminate, modify, or amend the existing agreement, the CBA expired on September 14, 2014. After providing the union with a proposal to modify the CBA, together with documentation of its financial condition, TER filed a motion on September 26, 2014, to reject the CBA.

The Bankruptcy Court’s Ruling

The bankruptcy court granted the motion. Among other things, the court concluded that even an expired CBA can be rejected under section 1113:

Congress did not use the word “executory” anywhere in Section 1113 but instead selected the phrase “continues in effect” in Section 1113(e). There is a good reason why Congress made this selection as it could have very easily used the word “executory” to mirror Section 365 of the Bankruptcy Code. . . . The Court is persuaded that Congress selected the phrase “continues in effect” in Section 1113(e) with the intention of giving debtors the authority to modify the continuing effects of an expired collective bargaining agreement. It follows that the concept that a post-expiration collective bargaining agreement which “continues in effect” may be rejected is implicit in Section 1113(c) since there is “no logic to support Congressional intent allowing interim modifications to an expired CBA if essential to a Debtor’s business or to avoid irreparable harm to the estate as permitted by [Section] 1113(e) but not allowing the rejection of the expired CBA terms if necessary to further the purpose of reorganization provided the conditions of Section 1113(c) are satisfied.”

In re Trump Entm’t Resorts, Inc., 519 B.R. 76, 85 (Bankr. D. Del. 2014) (quoting 710 Long Ridge, 518 B.R. at 829).

The bankruptcy court explained that interpreting section 1113(c) to permit rejection of an expired CBA “also comports with the legislative policies underlying Section 1113 and the Bankruptcy Code generally.” In enacting section 1113, the court noted, “Congress struck a balance between affording debtors the flexibility to restructure their labor costs on a comparatively expedited basis . . . while interposing a certain level of court oversight and requirements for good faith bargaining.” However, unlike the NLRA, section 1113 does not require the trustee or DIP to bargain to an impasse. Thus, the bankruptcy court emphasized, it is clear that “Congress intended for rejection under § 1113 to be a far more expedited process than collective bargaining under the NLRA.”

Noting that, in many cases, “time is the enemy of a successful restructuring,” the bankruptcy court concluded that “[t]his concern applies with equal force in a situation where the debtor is bound by the terms of a recently expired collective bargaining agreement pursuant to its status quo obligations under the NLRA.” According to the court, to rule otherwise would “effectively give labor unions the power to hold up a debtor’s bankruptcy case until the union’s demands were met, but only in cases where there is an expired but still controlling collective bargaining agreement.” Although giving a union such hold-up power may be appropriate or even necessary outside of bankruptcy, “in a bankruptcy case it wholly ignores the policy and bargaining power balances Congress struck in Section 1113 and exalts form over substance.”

The Third Circuit granted the union’s motion to certify a direct appeal of the bankruptcy court’s ruling that an expired CBA may be rejected under section 1113.

The Third Circuit’s Ruling

A three-judge panel of the Third Circuit affirmed.

In holding that Congress intended to incorporate expired CBAs under the purview of section 1113, the Third Circuit, like the bankruptcy court, focused on the gap between the NLRA and section 365 of the Bankruptcy Code, which section 1113 was designed to bridge:

§ 1113 was enacted to balance the needs of economically-stressed debtors in avoiding liquidation and the unions’ needs in preserving labor agreements and safeguarding employment for their members. Section 1113 meets a gap in the schemes to permit reorganizations when labor obligations will prevent the success of a reorganization. . . . Section 1113 was enacted to ensure that relief from a CBA was granted only in situations where relief was necessary to permit the reorganization. It is a counter to the precedent in Bildisco which permitted modification of a CBA without close scrutiny by the Bankruptcy Court. Under § 1113, approval will be granted only if the debtor’s modifications are necessary to permit reorganization. In this context, when the employer’s statutory obligations to maintain the status quo under the terms of an expired CBA will undermine the debtor’s ability to reorganize and remain in business, it is the expertise of the Bankruptcy Court which is needed rather than that of the [National Labor Relations Board]. For that reason, whether the CBA is in effect or is expired, it is the Bankruptcy Court which should make the review and decide on the necessity of the modification. We conclude, therefore, that § 1113 applies to a CBA after it has expired.

The Third Circuit flatly rejected the union’s argument that because a debtor cannot reject an expired executory contract under section 365 of the Bankruptcy Code, rejection under section 1113 would be improper. This contention, the court wrote, “ignores an important distinction” between a CBA and any other executory contract. Namely, the court explained, “the key terms and conditions of a CBA continue to burden the debtor after the agreement’s expiration . . . [such that] [r]ejection of those terms . . . is not a moot issue as would be in the case of other contracts or leases.”

Outlook

The Third Circuit’s ruling in Trump Entertainment attempts to harmonize two statutes that are sometimes at odds but share the goal of promoting good faith bargaining. The NLRA effectively allows a CBA to live on after its expiration. By doing so, it prevents employers from “running out the clock” and refusing to negotiate with employee representatives. However, the enduring nature of an expired CBA can create leverage for unions by giving them an incentive to delay coming to the table in an effort to extract concessions from an employer. If the trustee or DIP could not reject an expired CBA under section 1113, the terms of the CBA would remain in effect, preserving the status quo and leveraging union bargaining power, while pressuring the employer to negotiate a new agreement.

The Bankruptcy Code cannot abide such delay, at least according to the Third Circuit and most of the lower courts that have considered the issue. As the Supreme Court noted in Bildisco, “[T]he fundamental purpose of reorganization is to prevent a debtor from going into liquidation, with an attendant loss of jobs and possible misuse of economic resources.” Section 1113 of the Bankruptcy Code shares the goal of the NLRA in compelling both unions and employers to come to the table and bargain in good faith, but section 1113 recognizes that the process in bankruptcy must be expedited, even with respect to expired CBAs.

It remains to be seen how other courts will react to the Third Circuit’s ruling in Trump Entertainment. If other circuit courts disagree, the resulting split may invite U.S. Supreme Court review of an issue that has already divided many lower courts. In fact, stating that the case “involves a crucial intersection between bankruptcy law and federal labor law,” the union filed a certiorari petition on April 14, 2016, asking the Supreme Court to review the Third Circuit’s ruling. See UNITE HERE Local 54 v. Trump Entm’t Resorts, Inc., No. 15-1286 (cert. petition filed Apr. 14, 2016).

Notably, the National Labor Relations Board filed an amicus brief with the Third Circuit, taking the position that an expired CBA cannot be rejected under section 1113 and that an employer is obligated under the NLRA to abide by the terms of the CBA until an impasse is reached in NLRA-regulated negotiations.

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