Your employer files for bankruptcy. What's next? Can jobs be saved? What will happen to wages and benefits? Among the most alarming concerns may be the question: What will happen to my pension?

As an employer takes steps to address pension plan funding and pension plan termination in the public arena of a bankruptcy case, these issues can become highly charged flash points involving a number of affected parties. The employer administering the plan, the members (and creditors) of the debtor-employer's controlled group, retirees, active employees and their union, the Pension Benefit Guaranty Corp. and, perhaps, the plan's independent fiduciary, may all become active participants, some with competing interests, in the process.

Can the debtor afford to reorganize and maintain costly plans? Will the union face the prospect of having to choose between wage or other benefit cuts and keeping the defined benefit plan? What kind of replacement plan will fairly compensate workers for a terminated plan and attract new employees to a competitive business?

Carol Connor Flowe's companion article reviews single employer pension-plan funding as well as termination considerations from the employer's perspective. Here, I will review these issues from the vantage point of the employees and their union.

Minimum funding obligations. Once an employer has started a bankruptcy case, a decision about funding a defined benefit pension plan can signal the employer's intention regarding the ultimate fate of the plan.

Companies in bankruptcy likely will be told by their professional advisers that bankruptcy concepts can be used to suspend payment of pension contributions during bankruptcy. For instance, rules generally prohibiting preferential payment of pre-bankruptcy debts and establishing the basis for paying expenses of administering the debtor's business can be applied to many payment obligations, including pension contributions.

Even though employees continue to be employed and provide services to the debtor, bankruptcy rules treat pension contributions based on their pre-bankruptcy service as pre-petition debts. United Airlines and Delta Air Lines, for example, relied on these bankruptcy rules in defense of their decisions to suspend pension funding payments during their bankruptcy cases.

But what if a collective bargaining agreement requires that the employer maintain the pension plan? A decision not to pay contributions earned prior to bankruptcy but that fall due after the bankruptcy filing may give rise to a charge that the employer has violated the collective bargaining agreement.

In addition, whether or not the employer has decided to terminate the plan, the union may be concerned that PBGC may take action to involuntarily terminate a plan where the employer fails to make the required contributions. In order to enforce its collective bargaining agreement (and stave off a decision by PBGC to seek involuntary termination), the union may seek to compel continued contribution payments. In doing so, the union can take advantage of special rules under bankruptcy law that apply to obligations under a collective bargaining agreement.

The treatment of labor agreements in bankruptcy is governed by Bankruptcy Code Section 1113, 11 U.S.C. §1113. Enacted in 1984, Section 1113 protects collective bargaining agreements in two ways. First, unlike other contracts of the debtor, collective bargaining agreements may only be rejected if the debtor follows procedures and meets a heightened standard detailed in the statute. Second, unless the debtor has met these pre-requisites, the debtor may not unilaterally change any provision of a collective bargaining agreement.

Courts have disagreed over whether the ban on unilateral modifications applies to payments that are owed under the collective bargaining agreement but that are based on pre-petition employment. Under Section 1113(f), the debtor cannot modify "any" provisionof a collective bargaining agreement prior to compliance with the Section 1113 requirements.

"Any" provision should include the obligation to make a payment owed during the bankruptcy, whether or not other bankruptcy law has created a distinction between payments based on pre-petition service and payments based on service to the debtor. However, the courts are divided on this issue, which has come up most often in the context of assigning priorities to bankruptcy claims.

In one of the leading cases on the issue, In re Ionosphere Clubs Inc. , 22 F.3d 403 (2d Cir. 1994), the court ruled that collectively bargained vacation pay based on pre-bankruptcy employment should be treated like other pre-bankruptcy obligations of the debtor and not given special payment priority as an obligation under the labor agreement. The court declined to equate claims treatment with a prohibited unilateral change in the agreement.

By contrast, in In re Unimet Corp., 842 F.2d 879 (6th Cir. 1988), the Sixth Circuit ruled that, by failing to pay retiree health benefits owed under a labor agreement, the debtor had unilaterally modified the agreement in violation of Section 1113.

Given the potential significance of continued pension funding, whether or not to fund thus may be a matter of "location, location, location." Most courts outside the Sixth Circuit have followed the Ionosphere line of reasoning. But if a debtor has a contractual obligation to fund the plan under its labor agreement, at least in the Unimet jurisdiction, the debtor may be compelled to pay. This is so even if other, affiliated companies are liable for the contribution under the statutory "controlled group" rules, as a group of secured note holders discovered in the WCI Steel bankruptcy case.

Their efforts to prevent the debtor from making the payment, and compel a deep-pocket affiliate to make the payment instead, failed because debtor WCI was obligated to fund the plan under the labor agreement. Following Unimet, the court ruled that the contribution payments were required under the labor agreement and therefore WCI was obligated to make the payments.

For the courts that have followed Ionosphere, a failure to pay is not the same as a unilateral change in the agreement because the obligation simply becomes a claim in the bankruptcy and does not disappear altogether. However, the facts in the Ionosphere-type cases generally are different from the scenario described in the companion article, where a debtor at the beginning of a bankruptcy case tries to maintain a semblance of "business as usual" through "first day" requests to make various payments that might be considered pre-petition claims.

While the collective bargaining goals of Section 1113 may not be directly at issue in the allowance of claims in a liquidating Chapter 11 case like Ionosphere, honoring a collective bargaining agreement and the attendant benefits for employee morale are important considerations in a continuing reorganization.

An early contest over funding obligations that pits active employees, through their union, against the debtor and forces general unsecured creditors (who may prefer that the debtor conserve cash), retirees, the Pension Benefit Guarantee Corp. (PBGC) and perhaps other stakeholders into a protracted dispute can undermine the debtor's efforts to stabilize the bankruptcy case. In reviewing its options, a debtor may decide that avoiding an early battle that can seriously undermine workforce morale makes sense as a means of establishing confidence in the reorganization effort.

The "contract bar" against plan termination. As described in the companion article, the plan administrator of a single employer defined benefit plan (including a debtor in Chapter 11) can terminate the plan only as permitted under ERISA. In circumstances of financial distress, the plan administrator can seek a voluntary termination according to Section 4041 of ERISA.

Where a plan is maintained according to a collective bargaining agreement, a Chapter 11 debtor cannot simply disregard that obligation and proceed to terminate the plan under the distress rules. ERISA establishes a provision known as the "contract bar." Under the contract bar, PBGC will not proceed with a termination initiated by an employer if termination would violate the terms of an "existing collective bargaining agreement." See 29 U.S.C. §1341(a)(3).

For example, because the United Airlines' pension plans were collectively bargained, United's bid to eliminate its pension funding obligations was planned as a two-step process. United first took steps to eliminate the contract obligation by bringing Section 1113 proceedings against the labor unions representing its workforce. Each of the unions received bargaining proposals to modify the labor agreements by (among other things) removing the requirement to maintain the pension plan. United also made proposals for new defined contribution plans to take the place of the defined benefit plans.

Section 1113. In general terms, under Section 1113, a debtor must engage in collective bargaining over "necessary" modifications to the labor agreement before filing an application in bankruptcy court to obtain court-ordered rejection of the agreement. The proposal must meet particular requirements, such as the requirement that it contain only "necessary" modifications and treat affected constituencies "fairly and equitably."

Congress' goal in enacting Section 1113 was to favor collective bargaining over litigation in bankruptcy where an employer seeks labor cost relief. Section 1113 was also intended to ensure that employees do not bear a disproportionate burden of the employer's bankruptcy case.

The debtor is required to provide financial or other information to the union sufficient to evaluate the proposal. Where pension issues are involved, actuarial information, in addition to financial information concerning the debtor's ability to afford the plan, will also be relevant. In order to enable the union to become fully engaged in the process with the professional advice needed for complex financial negotiations, a debtor may decide to reimburse the union's professional advisers as part of this process. United even paid for an independent financial review of its business plan.

If the bargaining process over proposed modifications fails to result in a negotiated agreement, the debtor can apply for court-ordered rejection of the agreement. The debtor must meet statutory standards designed to establish more rigorous grounds for rejection than the legal standard that applies to the rejection of ordinary commercial executory contracts.

In the event of a rejection of a labor agreement, the union may call a strike. The process is designed to motivate the parties to reach a negotiated agreement — rather than a litigated showdown — over what can be difficult, highly charged issues, particularly where the debtor is seeking not only wage concessions but an end to its obligation to maintain a defined benefit pension plan.

While Section 1113 obligates the debtor to negotiate with the union, where pension issues are involved, third parties who are not party to the labor agreement may claim an interest and attempt to participate. One such party is the pension plan's independent fiduciary. A company may face a conflict serving as the plan administrator subject to fiduciary duties under ERISA and a debtor in possession with fiduciary duties to the estate.

In these circumstances, the U.S. Department of Labor will enter into an agreement for the appointment of an independent fiduciary for the pension plan. The independent fiduciary will assume responsibility for plan funding decisions (but not for decisions such as whether to terminate the plans) and may claim a role in a Section 1113 proceeding.

In the United case, the court limited participation in the Section 1113 proceeding to the union and the debtor, as the parties legally capable of modifying the labor agreement outside of bankruptcy. In the Delphi Section 1113 proceedings, financial stakeholders were limited to the issue of whether the debtor had properly exercised its business judgment in seeking rejection of the labor agreements.

Distress plan termination. Rejection of a labor agreement is considered a breach of the agreement, in the same way that an ordinary executory contract is considered breached on rejection. For an employer seeking a distress termination, rejection of the agreement through Section 1113 eliminates the contract bar. The debtor and the union may also agree, as part of an overall modified labor agreement, that the union will not consider plan termination a breach of the contract.

But in either of those situations, the debtor still must comply with the statutory requirements under ERISA for a distress termination. The debtor must also bargain with the union regarding any replacement pension benefits.

Under one means of obtaining a distress termination under ERISA, the bankruptcy court must determine whether the debtor is only able to reorganize if the plan is terminated As described in the companion article, this test is designed to limit the instances of plan termination to cases of severe hardship. In that respect, it is akin to the standard for rejection of a labor agreement under Section 1113.

Even though some courts have said that the rejection test should be applied more flexibly, it stands to reason that the Section 1113 test for rejection of a labor agreement should not be applied in a less stringent manner than the test applied under ERISA for termination of a pension plan.

In each case, Congress sought to restrict the applications to instances of genuine financial need. Each one focuses on the ability of the debtor to reorganize in the absence of the proposed change and the same analysis should apply in both instances.

Where a debtor sponsors multiple pension plans and seeks termination in a bankruptcy case, the interaction between Section 1113 and the distress termination requirements under ERISA raises additional questions. How should the court apply the distress termination test to decide whether a debtor sponsoring multiple plans can reorganize absent termination? Can the debtor reorganize with some, but not all of the plans intact? In the Kaiser Aluminum bankruptcy, this question was answered by borrowing from the requirement under Section 1113 that a debtor's proposed modifications to the labor agreement must be fair and equitable.

Although PBGC's view was that the distress termination standard must be applied only on a plan-by-plan basis, the reviewing court concluded that the statute did not require a plan-by-plan determination. Lacking guidance from ERISA in a multiple plan situation, the court looked to equitable principles in the Bankruptcy Code to approve termination of all of the plans in the aggregate.

A termination of all of the plans was considered a more equitable result than attempting to sort out whether some plans (and which ones) could survive the bankruptcy. For employees, the Kaiser precedent raises the troubling prospect that a debtor may succeed in terminating more of the employer's plans than would be warranted strictly on the basis of financial need.

Involuntary plan termination. In a distress termination, the existence of the contract bar requires the employer to address its contractual obligation to maintain the pension plan as part of the termination process. But the contract bar does not prevent PBGC from commencing an involuntary plan termination under Section 4042 of ERISA.

In an involuntary termination, PBGC initiates the termination through an agency decision that termination is warranted under one or more factors set forth in the statute. For example, PBGC can initiate an involuntary termination where required minimum funding contributions are not paid, or where PBGC seeks to avoid an unreasonable increase in the long-run loss to the plan.

The PBGC and the employer can agree to an involuntary termination of the plan, which is then accomplished informally — without a court proceeding. The union (or the plan participants, if they are not represented by a union) can challenge the involuntary termination after the fact in an action against PBGC under Section 4003(f) of ERISA.

While the contract bar does not apply to an involuntary termination, the union and the employer can agree that the employer will not enter into an involuntary termination agreement with PBGC, as part of the employer's obligation to maintain the plan.

If for any reason the employer does not agree to an involuntary termination, PBGC applies to a court for a decree adjudicating the termination under one of three statutory standards, including whether the termination will avoid an unreasonable increase in PBGC's liability. The union, retired participants and other affected parties can intervene in the lawsuit.

If the court rules that termination meets the statutory standard, the court must also set a termination date where there is no agreement on an effective date for termination of the plan. The termination date generally establishes the date as of which participants' benefits are determined under the benefit guarantee rules. As the companion article notes, plant shutdown benefits have become a source of controversy between PBGC and labor groups seeking to cushion the blows of severe industry contraction.

Once a plan is terminated, PBGC asserts a claim against the plan administrator for the total amount of unfunded liability. The claim is satisfied through recoveries in the bankruptcy. PBGC allocates a portion of its recoveries to the terminated plans.

A controversial settlement reached between United and PBGC resulted in the termination of United's four pension plans under involuntary termination proceedings initiated by PBGC. See In re UAL Corp., 428 F.3d 677 (7th Cir. 2005). Because the settlement provided for termination under the involuntary termination rules, United did not need to pursue Section 1113 relief related to the pension plans because the contract bar is inapplicable to involuntary terminations.

PBGC received an allowed bankruptcy claim for the full amount of the termination liability as calculated under its regulations (PBGC estimated the unfunded guaranteed benefits covered by the plans at $6.6 billion), plus additional consideration in the form of securities to be distributed under United's reorganization plan. The United settlement gave PBGC a much greater recovery than in many cases in which plan terminations occur but bankruptcy recoveries are meager.

The settlement was unsuccessfully challenged by the unions who were still negotiating with United over plan termination. They contended that by reaching agreement with PBGC to initiate involuntary termination proceedings, United had circumvented the requirements of Section 1113 to bargain over United's proposal to end its contractual obligation to maintain the plans.

However, because PBGC can proceed with an involuntary plan termination notwithstanding the terms of an existing collective bargaining agreement, the settlement was said not to violate the debtor's Section 1113 obligation to bargain over pension matters, even though the unions were bargaining with United over the very subject that was under discussion with PBGC. Instead, the unions were left to challenge PBGC in a separate lawsuit.

A final word. The recently enacted Pension Protection Act of 2006 (PPA) changes pension funding rules and includes new plan termination provisions that apply in employer bankruptcies. Systemic changes through legislation such as the PPA may mean that fewer pension issues will be subject to ad hoc resolution in the inhospitable environment of business bankruptcy cases.