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Part II

How we got here

This story is the second part in the series Patriot Coal: An American Bankruptcy. To begin reading the story from the beginning, jump back to the first part, Take Warning.

The story of what happened to Patriot’s retirees begins with another company in another industry.

At its peak, the Studebaker Company employed 23,000 workers at its car manufacturing plants in the U.S. and Canada. When it fell on hard times in the late 1950s and early ’60s, it didn’t go through bankruptcy. It simply ceased operations, nullifying whatever promises it had made to its workers. More than 4,000 workers at the company’s South Bend, Indiana factory lost all or some of their pensions.

Studebaker stands as a precursor to action eventually taken by Congress in 1974 when it enacted the Employee Retirement Income Security Act, or ERISA, which provided insurance against underfunded and insolvent pension plans by backstopping private pension plans with government money.

A few years later, Congress created the modern Bankruptcy Code with the Bankruptcy Reform Act of 1978. Under the new code, Chapter 7 provided for the liquidation of a company’s assets while Chapter 11 created a process that allowed a company to shed much of its debt so that it could continue to operate. The theory was that it was better to save some aspects of a company rather than to let it disappear entirely.

When companies began providing defined-benefit pension plans, they weren’t required to pre-fund them, so many of them did not. They figured business would always be good, growth would continue, prices would go up and everything would be fine. They didn’t anticipate globalization, automation and the shift to alternative forms of energy. Consequently, they massively underfunded their pension plans. As it turned out, the sectors most likely to provide generous benefit packages — steel, auto and coal — were the hardest hit by changing economic circumstances in the latter half of the 20th century.

As the number of active workers in these sectors shrank dramatically, companies were no longer able to support the much larger number of retirees drawing pensions and medical benefits, and without pre-funding requirements, the system collapsed.

In 1984, the U.S. Supreme Court ruled that companies could reject previously agreed upon collective bargaining agreements with unions like any other executory contract under Chapter 11. The case had great consequences for industrial-labor relations in the U.S.

Congress responded to the ruling that same year by creating a new section in the code — Section 1113 — that required companies to negotiate with their labor unions before seeking the rejection of a collective bargaining agreement. Companies were no longer allowed to unilaterally reject such agreements; they had to attempt to reach a mutually-beneficial solution, at least regarding pension benefits.

When LTV Steel went bankrupt in July 1986 in the largest U.S. filing up to that point, the company said it would stop paying for health and life insurance for 78,000 retirees. Congress then created Section 1114, which required companies to go through the same negotiating process for medical benefits as provided for pensions under Section 1113.

There is a paradox inherent in the Bankruptcy Code. Any move to protect the interests of the employees who directly contribute to the company’s value is a hindrance to the banks and other investors who might want to lend money to the company, many of whom are not interested in taking on the obligations of paying for retiree benefits. The Bankruptcy Code transforms the company into a “debtor-in-possession” and reduces virtually every obligation owed to a “claim” against the debtor.

Andrew B. Dawson, a professor at the University of Miami School of Law, conducted a study of Chapter 11 bankruptcies from 2001 to 2007. He found that every publicly-traded company that petitioned to reject a collective bargaining agreement could do so regardless of whether the company filed in the “pro-management” Second Circuit in New York or the “pro-labor” Third Circuit in Delaware. “In effect, their different legal standards have converged,” Dawson wrote. “The fact that every large corporate debtor during a seven-year period was able to reject its CBAs suggests that the statute has provided very little protection at all.”

“I think it’s fair to say, even giving these sections their due, that they haven’t done what they were intended to do,” said retired bankruptcy attorney Babette Ceccotti. “Bankruptcy policy has been expanded to fill the needs of all these companies that really have very few places to go to address industry problems.”

“What can you control? Here’s your balance sheet. What’s on it? There are things you can control here through the bankruptcy process. You can de-lever. You could restructure your debt. You can deal with what now everybody euphemistically calls legacy obligations. You can deal with your obligations to fund a pension plan. You can deal with your obligations to provide active and retiree healthcare. It’s a strategy that tends to work for the company, not so well for the creditors. Definitely, not so well for the workers and the retirees.”

Daniel Flatley (@daniel_flatley) is a West Virginia native and a former Marine. He covered politics and government at a newspaper in upstate New York before attending the Columbia University Graduate School of Journalism, from which he will graduate in May 2017.

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