Employment-Related Issues in Bankruptcy

CRS Report for Congress
Employment-Related Issues in Bankruptcy
November 1, 2005
Robin Jeweler
Legislative Attorney
American Law Division

Congressional Research Service ˜ The Library of Congress

Employment-Related Issues in Bankruptcy
This report provides an overview of the status of employee wages and benefits,
including retiree benefits, when an employer files in bankruptcy, and the amendments
made to the U.S. Bankruptcy Code by the Bankruptcy Abuse Prevention and
Consumer Protection Act. Private pensions, regulated by the Employee Retirement
Income Security Act, are generally protected, although defined benefit pension plan
payments may be substantially reduced. Health and life insurance benefits, which
are not required by federal law, are vulnerable to an employer’s bankruptcy-driven
modification or termination. This report examines those provisions in the U.S.
Bankruptcy Code which govern the priority of employee wage and benefit claims,
including severance payments; procedures for a chapter 11 debtor to modify benefits
under a collective bargaining agreement; and procedures for a chapter 11 debtor to
modify retiree life and health insurance benefits. It examines the role of employees
on creditor committees and procedures in bankruptcy that facilitate lawsuits that may
be directed at an employer/debtor. Finally, it considers the treatment accorded some
aspects of managerial compensation, such as retention bonuses.

Employee Benefits.............................................1
Active employees of an employer in a chapter 11 reorganization.....1
Rejection of collective bargaining agreements...................2
Active employees of an employer in liquidation..................3
Severance benefits.........................................4
Pension benefits...........................................5
Retiree benefits...........................................7
COBRA continuation coverage...............................8
Employee Participation in Bankruptcy Proceedings...................9
Employee representation on creditor committees.................9
Employee litigation-based claims against an employer............11
Managerial Compensation in Bankruptcy ..........................14

Employment-Related Issues in Bankruptcy
This report provides an overview of employment related issues when a business
files in bankruptcy under the U.S. Bankruptcy Code, 11 U.S.C. § 101 et seq., as
amended by the Bankruptcy Abuse Prevention and Consumer Protection Act
(BAPCPA).1 A business employer will generally file under one of two of the
operative chapters of the Code. It may seek to cease operation and liquidate under
chapter 7, or to continue in business and reorganize under chapter 11. The status of
basic benefits, such as wages, pensions, and health care for active and retired
employees, which have to date been the subject of greatest concern to employees of
a company in bankruptcy. are examined.
The behavior and compensation of a debtor’s executives have become more
controversial in recent years, corresponding to many high-profile bankruptcies, for
example, those of Enron and Worldcom, that were caused, in part if not solely, by
managerial malfeasance as opposed to external economic factors. This report
considers compensation of debtor’s management as well.
Employee Benefits
Many employees, especially retirees, fear loss of all employment benefits upon
learning that their employer has filed in bankruptcy. Fortunately, this is not
necessarily the case, although some benefits may be subject to modification or
termination. It is important to know that employee benefits, including retiree
benefits, have no universal legal referent; they may be covered by a wide variety of
federal and state laws. More important though is the fact that specific employee
welfare benefit plans are governed by contract terms which vary from plan to plan.
And, each bankruptcy – and the consequences for each of the debtor’s creditors,
including its employees – is highly case specific. Unique to bankruptcy, however,
is the demarcation between prepetition (pre-filing) and postpetition (post-filing)
claims. Because the entire bankruptcy process is concerned with debt forgiveness of
pre-bankruptcy indebtedness, the classification of a claim as pre- or postpetition is
of great consequence. Determining whether a claim accrues pre- or postpetition is
not always clear cut.
Active employees of an employer in a chapter 11 reorganization.
Typically, a chapter 11 debtor will get an order from the bankruptcy court permitting
it to continue business and to compensate its employees just as it had prior to filing.
Postpetition operating expenses are considered to be high priority administrative
expenses, i.e., “the actual, necessary costs and expenses of preserving the estate,
including wages, salaries, and commissions for services rendered after the

1 P.L. 109-8 (2005).

commencement of the case.”2 Thus, in many instances, employees of a chapter 11
debtor will realize no change in the terms and conditions of their employment. The
BAPCPA amended the Code to also include back pay (i.e., prepetition wages) due
to employees as a consequence of illegal behavior by the debtor as an administrative
expense. The bankruptcy court must determine that the inclusion of back pay will
not substantially increase the probability of layoff or termination of current
em pl oyees. 3
In traditional employment-at-will situations, a debtor/employer may lay off
employees or attempt to renegotiate the terms of employment, just as the employee
is free to accept a different compensation structure or terminate the employment
relationship. These contingencies may occur in connection with the
debtor/employer’s bankruptcy. But there are special requirements for a chapter 11
debtor seeking to renegotiate collective bargaining agreements with union employees.
Rejection of collective bargaining agreements. In 1984, the U.S.
Supreme Court held that a collective bargaining agreement (CBA) could be rejected,
i.e., terminated, by a debtor.4 In response to the Court’s interpretation, Congress
enacted a statute which prescribes the procedures that a debtor in chapter 11 must
take before it may alter the terms of or terminate a collective bargaining agreement.5
After a petition is filed, if the debtor wishes to alter or terminate the collective
bargaining agreement, it must supply the authorized representative of the employees
complete and reliable information to demonstrate the need, in order to facilitate a
reorganization, for the modifications to the employees’ benefits and protections. The
employees and debtor are required to engage in “good faith” negotiations with
respect to proposals for alteration or termination of such agreements.
If the debtor files an application to reject a CBA, the court is directed to
schedule a hearing for not later than fourteen days after the filing. All interested
parties may attend and participate in the hearing and the court should rule on the
application within thirty days after the beginning of the hearing.
The court may approve the application for rejection only if it finds (i) that the
debtor, prior to the hearing, provided the authorized representative of the employees
with the necessary information; (ii) the authorized representative has refused to
accept the proposal without good cause; and, (iii) the balance of the equities clearly
favors rejection.

2 11 U.S.C. § 503(b).
3 Id. at § 503(b)(1)(ii).
4 National Labor Relations Board v. Bildisco & Bildisco, 465 U.S. 513 (1984), holding that
collective bargaining agreements are “executory contracts” under 11 U.S.C. § 365 and may
be rejected by a debtor unilaterally if the debtor can show that the agreement burdens the
estate and that the equities balance in favor of rejection.
5 11 U.S.C. § 1113.

In addition the court may, after a hearing, authorize interim changes in the
terms, conditions, wages, benefits or work rules provided by a collective bargaining
agreement, when it is still in effect, if it is essential to the continuation of the debtor’s
business or is necessary to avoid irreparable damage to the estate. The
implementation of interim changes does not, however, moot the procedures and
requirements for an application for rejection.
Active employees of an employer in liquidation. If an employer must
shut down, it is likely to file under chapter 7. In this chapter, the court appoints a
trustee who oversees the debtor’s liquidation. The debtor’s assets are reduced to cash
and distributed among creditors. Although chapter 7 traditionally governs
liquidation, a debtor may also liquidate its business under chapter 11. When a
business closes, health and life insurance benefits are terminated because, unlike
pensions, they are not pre-funded. Pension assets, for the reasons discussed below,
are generally held in trust for the employee and are not available to the debtor’s
A common scenario in bankruptcy involves an employer who, at the time of
filing, is in arrears in the payment of wages or contributions to employee benefit
plans that require continuous funding. Employees who have a contractual claim to
payment are considered “unsecured” creditors.
The Code establishes priorities for the payment of unsecured claims.6 With the
exception of administrative expenses, discussed above, priority claims generally
cover prepetition debts. Because priority unsecured claims are paid before
nonpriority claims there is a much greater chance for a creditor to realize payment for
those having priority status. As amended by the BAPCPA, fourth priority is
designated for unsecured claims for wages, salaries, or commissions, but only to the
extent of $10,000 for each individual, including vacation, severance and sick leave
pay earned by an individual or corporation within 180 days before the date of filing
or the date of the cessation of the debtor’s business, whichever occurs first; or, for
sales commissions earned by an individual or by a corporation with only one
employee acting as an independent contractor in the sale of goods or services for the
debtor. 7
Fifth priority is similar to the fourth but governs unsecured claims for
contributions to an employee benefit plan arising from services rendered within 180
days before the filing or cessation of the debtor’s business, but only to the extent of
the number of employees covered by each such plan multiplied by $10,000 less (1)
the aggregate amount paid to such employees under the fourth priority and (2) the
aggregate amount paid by the estate on behalf of such employees to any other
employee benefit plan. Hence, the fourth and fifth employee priorities together have
an aggregated cap of $10,000 per employee. Creditors covered by this priority may

6 11 U.S.C. § 507.
7 This amount will be adjusted at three-year intervals to reflect changes to the Consumer
Price Index. 11 U.S.C. § 104.

include, in addition to the employees themselves, entities that administer employee
benefits, such as health or worker’s compensation insurers.8
Severance benefits. The bankruptcy priority for prepetition employee wages
and benefits, including severance pay, is an important benchmark. In a liquidation
scenario, it means that each employee with a claim in this category will be near the
head of the line for distribution of the priority amount. Nonpriority unsecured claims
will be distributed pro rata among unsecured creditors, including employees.
The priority is significant in a reorganization as well. The priority amount must
be paid through the reorganization plan in order for it to be confirmed by the court.
As noted above, the priority is conferred on claims accruing prior to the bankruptcy
filing. Severance earned postpetition, however, may qualify for an administrative
expense priority.9 Claims for severance, particularly those asserting priority as
postpetition administrative expenses, will be evaluated according to several factors
and decided under the law of the federal circuit. The court will consider the terms
of the agreement establishing severance, including whether it is payable in a lump
sum or is based on length of service, and when it was agreed to. A determination of
when the benefit accrues – pre- or postpetition – is not always readily apparent and
rules governing it may also vary among the circuits.
Prior to the BAPCPA, the priority amount for prepetition employee benefits,
including severance, was capped at $4,925 earned within 90 days of the bankruptcy
filing. Nevertheless, at least one court took advantage of the flexibility inherent in
the bankruptcy process to enlarge the amount allocated to employee severance pay.
Invoking the court’s equitable authority,10 the U.S. Bankruptcy Court for the
Southern District of New York permitted an increased allowance for prepetition
employee severance payments in both the Enron and WorldCom bankruptcies. The
Enron decision implemented a settlement of litigation brought by former employees
of Enron.11 The court also allowed creditor committees to bring avoidance actions
to recover certain prepetition lump sum payments made to selected employees
labeled as “90-day retention bonuses” to help fund the severance claims. Parties

8 See In re J.G. Furniture Group, Incorp., 405 F.3d 191 (4th Cir.), cert. denied sub nom. Ivey
v. Great-West Life & Annuity Ins. Co., 2005 WL 2414231 (Oct. 3, 2005); Howard Deliveryth
Service, Inc. v. Zurich American Ins. Co., 403 F.3d 228 (4 Cir. 2005).
9 See In re AcoustiSeal, Inc., 290 B.R. 354 (Bankr.W.D.Mo. 2003)(employees that debtor
had terminated postpetition would be allowed administrative priority for the pro rata share
of severance pay actually earned postpetition; and severance pay claims asserted by
nonexecutive employees were in part prepetition claims entitled to priority to the extent that
they were earned within 90 days of filing, and in part postpetition claims entitled to priority
as administrative expenses to the extent they accrued postpetition.)
10 11 U.S.C. § 105.
11 In re Enron Corp., Case Nos. 01-16034, Order of Final Approval, under 11 U.S.C. §§
105(a), 363(b), 1103(c)(5) and 1109(b) and Fed. R. Bankr. P. 9019, Approving Settlement
of Severance Claims of Similarly-Situated Claimants and Authorizing the Official
Employment-Related Issues Committee to Commence Certain Avoidance Actions on Behalf
of Estates, Aug. 28, 2002 at [http://www.elaw4enron.com/default.asp].

agreeing to the settlement received a maximum allowance of $13,500 per employee.
In the WorldCom bankruptcy, the debtor requested – and the court granted –
permission to pay prepetition severance pay due to terminated employees over the
amount set by statute.12 The debtor justified its request by asserting that adverse
publicity from the terminated employees could negatively impact WorldCom’s
relationship with its current employees. The payments were necessary to restore the
confidence of current employees, whose cooperation and loyalty were essential to the
reorganization effort.
Pension benefits. Federal law does not require an employer to provide
health insurance or pensions to employees. Although the tax laws are designed to
encourage employers to provide these benefits, they may be altered or terminated
within or outside of bankruptcy.
The creation and administration of private sector pension plans are governed13
exclusively by the Employee Retirement Income Security Act (ERISA). In 1974,
Congress enacted ERISA to protect the interests of private sector participants and
beneficiaries in a wide variety of employee welfare benefit and pension plans. A
prime underlying policy of the act, articulated by the Supreme Court, is the
congressional guarantee that “‘if a worker has been promised a defined pension
benefit upon retirement – and if he has fulfilled whatever conditions are required to14
obtain a vested benefit – he will actually receive it.’” Because of ERISA’s
comprehensive regulatory scheme, pension benefits are the least likely of employee
benefits to be affected by bankruptcy, although they may be diminished or reduced
in several situations. Thus, employees in many of the defined benefit “legacy”
industries, such as steel, airlines, and, more recently, automobile parts
manufacturers, have experienced substantial reductions in their pensions as a result
of bankruptcy-related distress terminations.
There are a wide variety of tax-qualified employee pension programs. Among
the most common are defined contribution and defined benefit plans. In the former,

12 In re WorldCom, Inc., Case Nos. 02-13533, Order Authorizing the Payment of Severance
Benefits and Related Obligations to Terminated Employees and Rejection of Certain
Severance Agreements, Oct.1, 2002 at [http://www.elaw4enron.com/WorldComdefault.asp].
13 29 U.S.C. § 1001 et seq. Pension benefit plans generally fall into one of two broad
categories, namely, defined contribution plans or defined benefit plans. The former is a plan
in which contributions are fixed, but not benefits, e.g., a fixed amount or percentage of
compensation is invested in the plan and comprises the basis for accruing plan benefits. The
latter, a defined benefit plan, is a pension plan that specifies the benefits or method of
determining the benefits, but not the contribution. The sponsor of the defined benefit plan
bears the risk of investment performance and must compensate for any discrepancies
between the amounts invested and the amounts promised to be paid as benefits. ERISA
regulates private sector defined benefit and defined contribution plans. See CRS Report
95-926 EPW, Regulating Private Pensions: A Brief Summary of ERISA, by Patrick
14 Connolly v. Pension Benefit Guaranty Corp., 475 U.S. 211, 214 (1986), quoting Pension
Benefit Guaranty Corp. v. R.A. Gray & Co., 467 U.S. 717, 720 (1984).

which includes 401(k) plans, the employee, and perhaps the employer, makes
contributions to the retirement account on behalf of the employee. The fund, though
managed by an employer in accordance with requirements of ERISA and the U.S.
Tax Code, is property of the employee. In the event of the employer’s bankruptcy,
defined contribution trust funds are not assets available to the debtor’s creditors.
Under a defined benefit plan, an employee is promised a set payment, typically one
based upon salary and years of service. According to the Pension Benefit Guaranty
Corporation (PBGC), there is a significant trend away from traditional defined
benefit plans, discussed below, to new “hybrid” pension plans, such as cash balance
plans, which are a form of defined benefit plan insured by the PBGC.15
Defined benefit pension plans may be terminated voluntarily by an employer or
involuntarily by the PBGC. An employer may terminate a plan voluntarily in one of
two ways. It may proceed with a standard termination only if it has sufficient assets
to pay all benefit commitments. A standard termination does not, therefore,
implicate PBGC insurance responsibilities.
If an employer wishes to terminate a plan whose assets are insufficient to pay
all benefits, the employer must demonstrate that it is in financial distress as defined
by ERISA. The concern connected with a distress termination is the adequacy of the
plan’s funding. That is, is there enough money to support payment of the pension
commitment? This is where the PBGC’s pension insurance program, which is
funded by employer paid premiums, is implicated.16 If an under-funded corporate
pension plan is terminated, the PBGC insurance program guarantees some payment
to covered employees. The PBGC then seeks recovery of the deficiency from the
employer, asserting a lien therefor, if necessary. Although the PBGC guaranty
program is designed to minimize the impact of corporate bankruptcy on the debtor’s
retirees, when an under-funded pension plan is terminated, the PBGC imposes a
statutory ceiling on guaranteed payments. Thus, beneficiaries of an under-funded
terminated plan may receive payments that are substantially less than promised.
Neither a standard nor a distress termination by the employer is permitted if
termination would violate the terms of an existing collective-bargaining agreement.
But negotiations in bankruptcy are influenced by the prospect of the debtor’s possible
liquidation. The PBGC may, nonetheless, terminate a plan involuntarily,
notwithstanding the existence of a collective-bargaining agreement. Likewise,
termination can be undone and restoration ordered by PBGC. When a plan is
restored, full benefits are reinstated and the employer, rather than the PBGC, is again
responsible for the plan’s unfunded liabilities.

15 PBGC, A Predictable, Secure Pension For Life: Defined Benefit Plans 6 at
[http://www.pbgc.gov/publications/defined_benefit_pens.htm]. See CRS Report RL30196,
Pension Issues: Cash-Balance Plans, by Patrick Purcell.
16 Under ERISA pension regulation, participation, vesting, and funding standards are
administered by the Internal Revenue Service; fiduciary standards and reporting and
disclosure requirements are regulated by the Department of Labor; benefit insurance
provisions are regulated by the Pension Benefit Guaranty Corporation.

The largest pension default in U.S. history occurred with the termination – and
transfer to the PBGC – of four defined benefit plans administered by United
Airlines.17 Over the strenuous objection of its union employees, United Airlines, in
reorganization under chapter 11 of the Code, entered into negotiations with the
PBGC, which agreed to assume them, invoking its involuntary termination authority.
The plans, covering pilots, ground employees, flight attendants, and others, were
collectively underfunded by $9.8 billion, of which $6.6 billion is guaranteed. The
courts have, to date, upheld the plans’ termination and transfer to the PBGC despite
challenges by the Union of Flight Attendants.18
Retiree benefits. Pensions. As discussed above, retiree pension benefits are
held in trust for the retiree and are regulated by ERISA.
Health and Life Insurance Benefits. Many employers reserve a right to modify19
or terminate employee welfare benefit plans and do so outside of bankruptcy.
Courts reviewing plan alteration or termination generally base their decisions on the
specific terms of a plan’s documents or associated collective bargaining agreement.
In bankruptcy, the status of retiree life and health insurance benefits is largely
determined by the nature of the action – chapter 11 reorganization versus liquidation
under chapter 7 or chapter 11.
The reorganization of the LTV Corp. proved to be a prime force behind
clarification of the Bankruptcy Code’s treatment of retirees’ health and life insurance
benefits during reorganization. On the same day it filed in bankruptcy in 1986, LTV
Corp. notified more than 66,000 retirees of its intention to terminate health and life
insurance coverage under the company’s employee benefit plan. Acting swiftly to
express its disapproval of LTV’s interpretation of the Bankruptcy Code’s
requirements, Congress enacted legislation blocking LTV’s cessation of insurance20
payments on the retirees behalf. Then, in 1988, Congress amended the Code by
adding new 11 U.S.C. § 1114 entitled “Payment of insurance benefits to retired
employees.” The procedures for a debtor’s termination of retiree insurance benefits
are modeled after those for termination of collective-bargaining agreements in
chapter 11.
In summary, § 1114 provides that a debtor in reorganization may not terminate
health and life insurance payment programs maintained for retirees and their spouses

17 Judge Affirms Pension Default Pact Between United Airlines and PBGC, 17 BNA BANKR.
L. J. 659 (U.S. District Court for the Northern District of Illinois affirms decision of
bankruptcy court).( July 28, 2005).
18 See Assoc. of Flight Attendants-CWA v. PBGC, 372 F. Supp.2d 91 (D.D.C. 2005); In re
UAL Corp., 2005 WL 1154264 (Bankr.N.D.Ill. 2005), aff’d, ___F.3d ___, 2005 WLth

2848938 (7 Cir., Nov. 1, 2005).

19 See U.S. Dept. of Labor, Can the Retiree Health Benefits Provided By Your Employer Be
Cut?, at [http://www.dol.gov/dol/pwba/public/pubs/brief1.htm]. For general background,
see CRS Report RL32944, Health Insurance Coverage for Retirees by Hinda Ripps
Chaikind and Fran Larkins.
20P.L. 99-591, § 608 (1986); P.L. 99-656 (1986); P.L. 100-41 (1987).

and dependents without first negotiating proposed modifications in benefit payments
with representatives of the retirees, and second, seeking and receiving court approval
to make the modifications. If the debtor and the retirees cannot agree upon
modifications, and the debtor believes them to be necessary to permit reorganization,
the court may permit modifications, subject to statutory guidelines. The debtor must
have negotiated with the representative of the retirees in good faith, and the court,
after a hearing in which all parties have had an opportunity to be heard, must find that
the proposed modification is 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. Thus, in the course of a chapter 11 reorganization in which the debtor
continues to operate the business, it must continue to pay retiree health and life
insurance benefits unless it has negotiated necessary modifications – or termination
of payments – with the representatives of the affected group, or has received the
bankruptcy court’s permission to do so. Payments made are accorded high priority
“administrative expense” status.
The BAPCPA amended § 1114 to add a “look back” provision for eve-of-filing
modification of retiree insurance benefits. If the debtor, while insolvent, modifies
retiree benefits within 180 days of filing, the court may reinstate the benefits unless
the balance of equities supports modification.21
If a corporate debtor’s reorganization is unsuccessful, it may liquidate. In a
liquidation, the retirees’ claims for lost insurance benefits would be unsecured
claims. The fourth and fifth priorities for employee benefits apply only to payments
on behalf of present employees, not retirees. When Congress passed § 1114 ensuring
the continuation of payments of retiree health and life insurance benefits throughout
a reorganization if the debtor could afford to pay them, it did not appear to address
the status of these claims in liquidation. Nor did it amend § 507 of the Code, which
creates high priority unsecured claims. Obviously, when a company ceases
operation, it cannot continue to incur business-related operating expenses. Retirees
with insurance claims would be unsecured creditors of the debtor, and any amount
they might recover would depend upon the nature and amount of claims outstanding
relative to the funds available to satisfy them.22
COBRA continuation coverage. Under the provisions of Title X of the
Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA),23 as amended,
employers are required to permit employees or family members to continue their
group health insurance coverage at their own expense, but at group rates, if they lose24
coverage because of designated work or family-related events. Among the

21 11 U.S.C. § 1114(l).
22 At least one court has held that § 1114 does not apply if the case is converted to chapter
7. Retiree benefit payments have administrative expense status only while a debtor operates
under chapter 11. In re Ionosphere Clubs, Inc., 134 B.R. 515 (Bankr. S.D.N.Y. 1991) .
23 P.L. 99-272 (April 7, 1986).
24 See U.S. Dept. of Labor, Health Benefits Under the Consolidated Omnibus Budget
Reconciliation Act, COBRA at

“qualifying events” which trigger COBRA’s continuation coverage is an employer’s
filing a case under the Bankruptcy Code (on or after July 1, 1986) with respect to a
covered employee who has retired.25 “To lose coverage” for COBRA purposes
includes a substantial elimination of coverage that occurs within twelve months
before or after the date on which the bankruptcy proceeding begins.26
In general, a “covered employee” is an individual who is provided coverage by
virtue of employment (or previous employment) with the employer. Hence, the
definition includes retirees who receive health coverage in addition to their pension.
In the case of a retiree of a bankrupt employer, the continuation coverage must be
available until the death of the covered employee or the qualified beneficiary. In this
situation, a “qualified beneficiary” includes a covered employee who has retired on
or before the date on which coverage was eliminated, and any other individual who,
on the day before the bankruptcy proceedings, was a beneficiary under the plan,
either as the spouse, dependent child, or surviving spouse of the covered employee.
For the surviving spouse or dependent children of the covered employee, the period
of coverage is limited to 36 months after the death of the covered employee.
Although COBRA provides retirees’ lifetime coverage, it is contingent upon the
employer’s maintaining the plan for current employees. Continuation coverage for
all qualified beneficiaries terminates on the date when the employer ceases to provide
any group health plan to any employee, i.e., when the plan ends.
COBRA may be a useful safety net if an employer in bankruptcy terminates a
retiree health plan but continues to offer health benefits to current employees. In that
event, retirees would be entitled to continuation coverage under the employer’s
ongoing plan. But COBRA works in conjunction with ERISA and the Bankruptcy
Code; it does not require an employer to fund independent health insurance for
retirees or to maintain the plan on behalf of current employees notwithstanding other
permissible termination provisions of ERISA or the Code.
Employee Participation in Bankruptcy Proceedings
Employee representation on creditor committees. Viewed broadly,
a chapter 11 reorganization contemplates a negotiated settlement of claims by the
debtor with its creditors under the supervision of the court and within the strictures
of the Code. Creditors actively participate in the development of a reorganization
plan, and ultimately vote to accept or reject it. Employees may have a limited voice
or a more active role in reorganization negotiations.
Rules of bankruptcy practice expressly grant a labor union, an employees’
association, or a representative of employees a right to address the court “to be heard

24 (...continued)
[http://www.dol.gov/dol/pwba/public/pubs/COBRA/cobra99.pdf] and CRS Report
RL30626, Health Insurance Continuation Coverage under COBRA, by Heidi Yacker.
25 29 U.S.C. § 1163.
26 64 Federal Register 5165 (Feb. 3, 1999).

on the economic soundness of a plan affecting employees’ interests.”27 The right is
limited, however, because the employee representative does not generally have
standing to appeal any of the bankruptcy court’s rulings.
A more active role in the reorganization planning is reserved to creditor
committees. Shortly after the bankruptcy petition is filed, the U.S. trustee will
appoint an official committee of creditors holding unsecured claims.28 In complex
cases, the court may create additional committees if necessary to ensure adequate
representation of creditors. The unsecured creditors’ committee is generally
comprised of persons willing to serve who hold the seven largest claims of the types
represented by the committee. Among the committee’s powers and duties is the
!to consult with the trustee or debtor concerning the administration
of the case;
!to investigate the acts, conduct, assets, liabilities, and financial
condition of the debtor, the operation of the debtor’s business and
the desirability of the continuing it;
!to participate in the formulation of a plan, to advise those
represented by the committee of any committee determinations
and/or any plan formulated; and
!to generally represent the interests of creditors who are represented.29
Every bankruptcy is intensely fact-specific with specific creditor claims
dictating the composition of the creditor committee(s). When employees are
unsecured creditors, they may be represented on creditor committees.30 If and when
appropriate, the court may allow the creation of official or unofficial committees
composed solely of employee representatives. For example, in the Enron bankruptcy,
the court appointed a committee “for the purpose of investigating the issues relating
to: (1) the continuation of health or other benefits for former employees of the
Debtors; (2) the investigation of claims uniquely held by employees, as such, against
the Debtors; (3) the treatment of employees' claims under any plan(s) of
reorganization or liquidation; (4) possible Warn Act violations by the Debtors in
discharging employees; (5) possible violation by the Debtors of state labor laws and
certain provisions of ERISA; and (6) dissemination of non-confidential information

27 Fed. Rules of Bankr. Procedure, Rule 2018.
28 11 U.S.C. § 1102.
29 11 U.S.C. § 1103.
30 See, e.g., In re Altair Airlines, Inc., 727 F.2d 88 (3rd Cir. 1984)(Pilots’ association, which
was the exclusive bargaining agent for pilots holding claims for unpaid wages which
amounted to the second largest unsecured claim against the debtor, was entitled to
appointment to the unsecured creditors’ committee.); In re Salant Corp., 53 B.R. 158
(Bankr.S.D.N.Y. 1985)(When the creditor committee was made up of seventeen members,
including one representative of managerial employees, the court was willing to grant a
union’s motion to add an additional three members to represent non-managerial employees.)

relating to items (1) through (5) hereof to employees[.]”31 Unofficial committees
comprised of self-selected members may be free of the fiduciary responsibilities
required of an official committee.
Section 1114 expressly provides for the appointment of committees of retired
employees when a debtor seeks to modify or terminate retiree benefits. The U.S.
Trustee appoints members to act as “authorized representatives” for retirees.
Ordinarily, retirees whose benefits are covered by collective bargaining agreements
are represented by the labor organization. Recognizing that there can be internal
conflicts between the interests of active employees and retirees covered by a CBA
and their interests in the bankruptcy case, the labor organization may elect not to
serve as authorized representative. In that case, a committee may be comprised of
other retirees found by the court to be appropriate.
Employee litigation-based claims against an employer. The
bankruptcies of Enron and other companies, such as Polaroid, Global Crossing, and
WorldCom, raised new concerns about corporate responsibility for harm employees
experience as a result of illegal stock manipulation and other forms of corporate
malfeasance. For example, employees’ defined contribution pension funds, when
comprised of their employer’s stock, can be devastated by employer
mismanagement. Discussed below is the process a bankruptcy court may use to
consider a civil claim for damages that has not been reduced to judgment prior to the
bankruptcy filing.
History teaches that the U.S. Bankruptcy Code is not an efficient vehicle to
protect the funding and management of employment benefits.32 By the time an
employer is in bankruptcy, if the system has already failed, it is generally too late to
impose new management, auditing, fiduciary, or funding safeguards to restore
benefits. Other laws, such as ERISA, the Tax Code, and COBRA, address these
employment benefit programs prospectively. Nevertheless, employees who are
victims of wrongdoing may wonder if they can assert those claims in the bankruptcy
and increase their distributive share of the debtor’s assets.
It is frequently said that a debtor in bankruptcy “cannot be sued.” While it is
correct that bankruptcy’s automatic stay stops the continuation of a judicial process
to collect a money judgment,33 it does not mean that a debtor corporation is immune
from claims that have not yet been reduced to judgment. If employees want to sue

31 In re Enron, Amended Appointment of Employment-Related Issues Committee,
(Bankr.S.D.N.Y. 2002), at 2002 Extra LEXIS 537.
32 After the LTV Corp. filed under chapter 11 in 1986, the debtor and the PBGC engaged
in a great deal of litigation concerning payment of arrearages as a result of underfunding of
the debtor’s pension plans. Although the PBGC was initially unsuccessful in asserting
administrative and unsecured priority claims for underfunding arrearages, it ultimately
succeeded in ordering restoration of the terminated plans. See In re Chateaugay Corp., 115
B.R. 760 (Bankr.S.D.N.Y. 1990), order vacated and withdrawn, 17 Employee Benefits Cas.

1102 (S.D.N.Y. 1993). See also PBGC v. LTV Corp., 496 U.S. 633 (1990).

33 11 U.S.C. § 362.

their employer/debtor, they may still have a “claim” in bankruptcy, even if it has not
been reduced to judgment.34
When a claim that must be established through a lawsuit is stayed, the
bankruptcy court is permitted to estimate “any contingent or unliquidated claim, the
fixing or liquidation of which, as the case may be, would unduly delay the
administration of the case[.]”35 The court may also estimate any right to payment
“arising from a right to an equitable remedy for breach of performance.”36 This
occurs pursuant to the bankruptcy court’s mandate to allow or disallow claims
against the estate. Estimating claims for the purpose of confirming a plan under
chapter 11 is expressly cited as a core proceeding within a bankruptcy court’s
Hence, the chapter 11 filing triggers a series of decisions by the court evaluating
the stayed litigation. Do the best interests of the parties and the bankruptcy estate
require the estimation of outstanding claims or should they be reduced to a sum
certain, i.e., fixed by litigation authorized by the court? Agreeing on appropriate
methodology to estimate a claim is in itself a complicated issue.
The courts have discretion to consider the most appropriate manner to handle
an unliquidated, contingent claim – whether it should be estimated or whether the
stay should be lifted. The goal of the bankruptcy process is to fix an amount, i.e.,
assign a value for a claim in order to expedite reorganization; to determine whether
reorganization itself is feasible; and, to assist the parties in fashioning a plan. It is
also necessary to create a yardstick to enable the court to apply the “best interests of
the creditor” test for a chapter 11 debtor. The court cannot confirm a chapter 11
reorganization plan unless creditors will receive more under the plan than if the
debtor were liquidated.38
And, of course, creditors are constrained by practical strategic considerations.
Litigation is an expensive proposition and it may not be worthwhile in the face of a
looming prospect of the debtor’s having inadequate assets to satisfy the claim.
Simply put, does the potential distribution warrant the costs of litigation? Some

34 A “claim” in bankruptcy is defined broadly at 11 U.S.C. § 101(5) to mean “(A) right to
payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed,
contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or
unsecured; or (B) right to an equitable remedy for breach of performance if such breach
gives rise to a right to payment, whether or not such right to an equitable remedy is reduced
to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or
35 11 U.S.C. § 502(c)(1). See In the Matter of Interco Incorp., 137 B.R. 993 (Bankr.E.D.
Mo. 1992)(Claims of a multiemployer pension fund against a debtor may be estimated).
36 Id.
37 28 U.S.C. § 157(b)(2)(B). A bankruptcy court may not, however, liquidate or estimate
personal injury tort or wrongful death claims.
38 11 U.S.C. § 1129(a)(7).

portion or all of the creditors’ damages may be discharged in the bankruptcy and any
recovery will be reduced by distributions among all unsecured creditors.
Employees whose pensions have suffered under the fiduciary mismanagement
of corporate debtors face many difficult decisions. Claims against their employers
may be based on many legal theories grounded in many different laws. Claims may
be directed at different parties within and without bankruptcy and this may also
affect decisions regarding litigation. The bankruptcy process, however, does allow
claims that have not been finalized to be considered. And, as in all bankruptcies, the
outcome is dependent upon the unique situation of each debtor and its creditors.
The Enron bankruptcy is a case study. Numerous suits have been filed against
the debtor by or on behalf of employees, and although few went to trial, several
settlements have been announced. In December of 2001, a federal district court
consolidated all of the ERISA claims brought in the Southern District of Texas under
the caption, Tittle v. Enron Corp.39 In June of 2005, the court approved a proposed
settlement between former Enron employees and insurers for numerous pension plan
fiduciaries that would give a judgment reduction credit of $85 million, representing
the policy limits on two fiduciary liability policies.40 Basically, in return for releasing
defendants from further claims for indemnity or contribution arising from ERISA-
based claims, the plaintiffs will collect insurance proceeds. The district court judge
is quoted as explaining:
Without question this settlement is driven by the need to preserve for the plaintiff
class the insurance policy proceeds, which otherwise are likely to be consumed
by litigation defense costs. This factor works to justify a settlement for less than
what Plaintiffs might obtain if they continued to prosecute their claims through41
trial, only to find that the actual recovery has gone up in smoke[.]
In another proceeding, the U.S. Dept. of Labor announced an agreement that would
give participants in an Enron retirement plan a general unsecured bankruptcy claim
of $356.25 million.42 The announcement notes that the final distribution that plan
participants receive will depend upon the total amount of assets available. Earlier in
the bankruptcy, the PBGC announced an agreement it reached with Enron requiring
it to place $321 million in escrow to fund a standard termination of its defined benefit
pension plan.43

39 For background on the litigation, see CRS Report RL31282, Tittle v. Enron Corp. and
Fiduciary Duties under ERISA by Jon Shimabukuro.
40 Court Approves Partial Settlement in Enron Fiduciary Breach Litigation, 17 BNA
BANKR. L. REPTR. 488 (June 2, 2005).
41 Id.
42 Labor Department Announces Agreement Giving Enron Participants Unsecured Claim,

17 BNA BANKR. L. REPTR. 611 (July 14, 2005).

43 Enron Agrees to Pay $321 Million To Preserve Plans’ Defined Benefits, 16 BNA BANKR.
L. REPTR. 817 (Sept. 16, 2004).

A major bankruptcy may involve a great deal of litigation, much of which is
designed to assess and/or settle claims both against and on behalf of the debtor. Just
discussed are examples of employee and federal agency claims against Enron.
Likewise, suits brought by Enron against others have been settled.44 Claims settled
in Enron’s favor bring assets into the bankruptcy estate for ultimate distribution to
creditors. Thus, the bankruptcy process does, to some extent, encompass procedures
for addressing debtor wrongdoing. There are strong incentives for creditors and the
debtor to attempt to evaluate and settle civil claims in order to reorganize.
Managerial Compensation in Bankruptcy
The substantial amounts that many attorneys and professionals earn as fees for
work performed in a major bankruptcy case has been, and continues for many to be
a subject of widespread interest. So too, more recently, has the amount of executive
compensation earned by debtor’s management on the eve of or in the course of the
bankruptcy. In many cases, debtor companies retain “turn around” experts or bring
in new executives to guide the company through the restructuring and bankruptcy
process. Executive compensation, like other employee benefits, comes in many
forms and is contract specific. Although a trustee is always appointed in chapter 7,
chapter 11 is premised on the supposition that a reorganization is most likely to be
successful and creditors and the public are most likely to benefit from continued
operation of the business by existing management.45 Under chapter 11, management
may be removed “for cause, including fraud, dishonesty, incompetence, or gross
In the ordinary course of a bankruptcy, certain claims are “disallowed. This
means that even though a creditor may have a perfectly legal claim, bankruptcy law
declines to permit, or allow it – generally for the purpose of maximizing the debtor’s
estate for distribution to all creditors. One example of such are claims by an
employee whose employment contract is terminated for damages that exceed more
than one year’s compensation under the contract.47
Like all bankruptcy claims, the disposition of executive compensation may
depend upon when it was earned and/or paid, that is, before or after the bankruptcy
filing. Postpetition payments are generally subject to court approval, and prepetition
payments, to a more limited extent, may be subject to avoidance. Generally, the

44 See JPMorgan Chase Settles With Enron; Will Pay $350 Million in Bankruptcy Case, 17
BNA BANKR. L. REPTR. 742 (August 25, 2005).
45 H.Rept. 95-595, 95th Cong., 1st Sess. 233 (1977), comprising part of the legislative history
of the 1978 bankruptcy law. “Moreover, the need for reorganization of a public company
today often results from simple business reverses, not from any fraud, dishonesty, or gross
mismanagement of the part of the debtor’s management.”
46 11 U.S.C. § 1104. Pursuant to amendment by the BAPCPA, the U.S. Trustee shall seek
appointment of a trustee if “there are reasonable grounds to suspect that current members
of the governing body of the debtor...participated in fraud, dishonesty, or criminal conduct
in the management of the debtor or the debtor’s public financial reporting.” § 1104(e).
47 11 U.S.C. § 502(b)(7).

debtor must assume the employment contract, that is reaffirm it after the bankruptcy
filing, in order for an executive to lay claim to payments thereunder as an
administrative priority.48
Nevertheless, retention bonuses and similar compensation for executives are
commonly sought and approved by the courts.49 But they may be challenged by
parties to the bankruptcy proceeding and denied in whole or part. In a pre-BAPCPA
decision in the U.S. Airways bankruptcy, the court considered proposed severance
and retention plans for its officer and non-officer managerial employees.50 The
proposed plan, called a Key Employee Retention Plan or KERP, affected executives
and over 1,800 management employees and was formulated in contemplation of a
merger of the debtor with another airline. The motion to approve the plan was
supported by the Official Committee of Unsecured Creditors, which had negotiated
a number of changes to the original proposal, and was opposed by the U.S. Trustee
and by the unions representing the debtor’s pilots, flight attendants, mechanics, and
reservation agents. Explaining its rationale, the court observed:
The Bankruptcy Code does not specifically address so-called Key Employee
Retention Plans, or KERPs, whether adopted before the filing of a bankruptcy
petition or after. It is common, however, for bankruptcy courts to approve the
adoption of post-petition KERPs, or the assumption of pre-petition KERPs, if the
debtor has used “proper business judgment” in adopting the plan, and the plan
is “fair and reasonable.” In re Aerovox, Inc., 269 B.R. 74, 80
(Bankr.D.Mass.2001). Nevertheless KERPs have something of a shady
reputation. All too often they have been used to lavishly reward– at the expense
of the creditor body– the very executives whose bad decisions or lack of
foresight were responsible for the debtor’s financial plight. But even where
external circumstances rather than the executives are to blame, there is something
inherently unseemly in the effort to insulate the executives from the financial
risks all other stakeholders face in the bankruptcy process. Congressional
concern over KERP excesses is clearly reflected in changes to the Bankruptcy
Code that will become effective for cases filed after October 17, 2005.
Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub.L. No.

109-8, § 331, 119 Stat. 23, 102-03 (April 20, 2005). Those changes will severely

48 See, e.g., In re FBI Distribution Corp., 330 F.3d 36 (1st Cir. 2003)(Executive who was
terminated by chapter 11 debtor after rendering postpetition services was not entitled to
administrative priority claim for employment and retention benefits under prepetition
employment agreement that was rejected by the debtor. The executive was entitled to the
reasonable value of her postpetition services that benefitted the estate.).
49 See, e.g., In re Pacific Gas and Electric Co., 2001 WL 34133840 (Bankr.N.D.Ca.
2001)(Court approves management retention program supported by Official Committee of
Unsecured Creditors over objections of U.S. Trustee.); In re American West Airlines, Inc.,
171 B.R. 674 (Bankr.D. Ariz. 1994)(Court approves “success” bonus for chief executive
officer and others who successfully downsized airline and settled substantial administrative
claims despite seven hundred letters to the court from rank and file employees objecting to
management bonuses. The court found that the executives had accomplished a “major feat”
and were essential to the reorganization process.); In re Interco Incorp., 128 B.R. 229
(Bankr.E.D.Mo. 1991)(Court approves performance-based executive retention program to
ensure that critical executives remained with debtors throughout reorganization.).
50 In re U.S. Airways, 329 B.R. 793 (Bankr.E.D.Va. 2005).

limit both the circumstances under which severance and retention payments may
be made to insiders as well as the amount of such payments, which will be
limited to 10 times the average amount of severance or retention payments for51
non-management employees during the same calendar year.
In support of their objections, the U.S. Trustee and the unions argued that the
plan was overly broad and would undercut employee morale by sparing management
from financial sacrifices that the unionized workforce had to bear.
First, the court considered whether the debtor made a threshold showing that it
used sound business judgment in adopting the plan. It concluded that “[t]here can
be little doubt, based on the evidence, that the plan is in response to a serious
retention problem,” because there were 340 unfilled open positions. The court
ultimately approved a modified KERP that applied to management employees below
the officer level upon approval, but deferred applicability to senior level officers until
plan confirmation.
Of the objections to the program, surely the most compelling, from a purely
human point of view, is that it represents a betrayal of the principle of “shared
sacrifice” that was championed by the company in the litigation and negotiations
that resulted in over $900 million of wage and other concessions by its unionized
workforce. While management employees took some pay cuts and benefit
reductions, the plain truth is that those cuts were significantly less than the cuts
experienced by the non-management employees. It is hardly any wonder,
therefore, that the rank and file employees have reacted to the proposal with
considerable outrage, as evidenced, for example, by the petition that was
admitted at the hearing signed by 2,209 members of the Communications
Workers of America denouncing the proposed severance plan and urging this
court not to approve it.
The court is certainly sensitive to what one witness described as the “uproar in
the workplace” after the company announced it would seek approval of the
severance plan. At the same time, the court cannot ignore the fact that the
landscape has significantly changed. At the time the labor concessions were
negotiated, the company was headed along a particular path, that of
transformation. Now it is headed on a different path, that of merger. Under a
transformation plan, employees--whether management or rank and file--were
equally likely to keep their jobs (if the company successfully emerged from
chapter 11 as a viable airline) or to lose them (if the company had to liquidate).
Under the proposed merger, by contrast, few of the unionized employees are
likely to face the loss of their jobs, since there is little overlap in the route
structure of the two airlines. However, somewhere between one-third and
one-half of the management employees are expected ultimately to lose their jobs.
The problem the company faces is that those management employees will be
needed up until the day their employment is terminated, perhaps two years from
now. If they leave too soon, the merger itself (and with it, the jobs of the rank
and file employees) will be threatened.
The argument that the program is too broad and that any retention benefits
should be narrowly targeted to “critical” or “key” employees likewise misses the

51 Id. at 797-798.

mark. The evidence at the hearing convincingly established that the headquarters
organization cannot afford further attrition without effectively eliminating its
ability to carry the company through the merger. Put another way, once a football
team has been reduced to 11 players, every one of them is “critical,” since you52
cannot field a team with fewer.
Although postpetition retention and severance payments are substantially
modified by the BAPCPA, the foregoing illustrates how a bankruptcy court attempts
to balance economic and non-economic competing interests and claims in the
reorganization process.
The court has less control over prepetition payments, although they can be
avoided in some circumstances, such as when they are found to be fraudulent, as
discussed above in the Enron bankruptcy. Nevertheless, there is an inherent tension
in the policy decision to allow existing management to steer a prospective debtor
through reorganization when self-policing is also an issue. The implicit conflict of
interest that can arise between a chapter 11 debtor company, its management and its
creditors is acknowledged by the courts. A U.S. Court of Appeals considered
whether a bankruptcy court can authorize a creditors’ committee to sue derivatively
on behalf of the trustee to recover alleged fraudulent conveyances made by
management.53 It concluded that a court-approved derivative suit for the benefit of
the debtor’s estate was permissible under the Bankruptcy Code.
As a component of its analysis, the court observed that avoiding a fraudulent
conveyance could be a particularly “vexing” problem in a chapter 11 context:
This situation immediately gives rise to the proverbial problem of the fox
guarding the henhouse. If no trustee is appointed, the debtor--really, the debtor's
management--bears a fiduciary duty to avoid fraudulent transfers that it itself
made. One suspects that if managers can devise any opportunity to avoid
bringing a claim that would amount to reputational self-immolation, they will
seize it. For that reason, courts and commentators have acknowledged that the
debtor-in-possession “often acts under the influence of conflicts of interest.”
These conflicts of interest can arise even in situations where there is no concern
that a debtor’s management is trying to save its own skin. For example, a debtor
may be unwilling to pursue claims against individuals or businesses, such as
critical suppliers, with whom it has an ongoing relationship that it fears
damaging. Finally, even if a bankrupt debtor is willing to bring an avoidance
action, it might be too financially weakened to advocate vigorously for itself. In
any of these situations, the real losers are the unsecured creditors whose interests54
avoidance actions are designed to protect.
In conclusion, although the Bankruptcy Code presumes that a debtor company’s
management is best qualified to lead the debtor through the reorganization process,
there are equitable and statutory mechanisms to address intentional wrongdoing and

52 Id.at 799-800.
53 Official Committee of Unsecured Creditors of Cybergenics Corp. v. Chinery, 330 F.3d

548 (3d Cir.), cert. denied, 540 U.S. 1001, 1002 (2003).

54 Id. at 573. (Citations omitted).

less damaging departures from sound business judgment. And, while there is
substantial flexibility in the reorganization process and employees are provided some
level of protection, there is no question that the reorganization process is used
strategically by business debtors to shed what are perceived to be onerous employee
benefit programs.