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Third Circuit Allows Withdrawal Liability Claim to Receive Administrative Priority Status in Chapter 11 Bankruptcy

December 2, 2011

In one of the more significant bankruptcy and employee benefits decisions issued this year, the U.S. Court of Appeals for the Third Circuit held that withdrawal liability could qualify as an administrative expense in Chapter 11 bankruptcy and therefore receive priority over claims of general unsecured creditors.

In In re Marcal Paper Mills, Inc., 650 F.3d 311, 2011 U.S. App. LEXIS 12109 (3d Cir. N.J. June 16, 2011), the Third Circuit prohibited an employer from using the bankruptcy process to avoid certain pension obligations to its Teamster truck drivers. The Marcal Paper Mills case provides an example of the complex interplay between bankruptcy laws, labor laws and employee benefits laws. This article explains what withdrawal liability is, how it applies to Chapter 11 bankruptcy, and how the Court reached its ruling in Marcal.

Withdrawal Liability
Many employers provide pension benefits to their employees by participating in a “multiemployer defined benefit pension plan.” Under such plans, employers make ongoing contributions and, upon retirement, employees receive a set monthly amount for life, with the amount typically based upon the employee’s wages and length of service.  

The amount of pension benefits that an employee receives is also based upon the pension plan’s expected resources. These resources include the expected future contributions of employers and the expected income to be earned on plan investments.  

Originally, under the Employee Retirement Income Security Act, employers participating in these plans were permitted to eventually withdraw from participation and thereby escape their obligations to provide subsequent benefits. And, because the promised benefits to employees is often funded over many years, if the withdrawing employer had not made sufficient contributions to the plan to fund its fair share of the cost, the plan was crippled.

Withdrawal liability was created by the Multiemployer Pension Plan Amendments Act to alleviate this problem. It ensures that employers cannot avoid their obligation to help fund a pension plan by simply withdrawing.

Withdrawal liability is essentially an exit fee requiring an employer that is withdrawing from participation to pay its share of the plan’s costs, which have not been paid through previous contributions or investment returns.

The plan trustee determines the amount of the withdrawal liability, notifies the withdrawing employer and collects it from the employer.

Chapter 11 Bankruptcy
When a business files for Chapter 11 bankruptcy, it immediately receives the benefit of the “automatic stay,” which generally prohibits creditors from trying to collect debts from the business.

Instead, each creditor is instructed to submit a “proof of claim” with the Bankruptcy Court. Each claim is then reviewed and if accepted, the creditor is then placed in one of several categories including: secured, priority or general unsecured.  

Eventually, the business’s debt obligations are restructured, and creditors are repaid based on the availability of funds and in accordance with a hierarchy created by the bankruptcy laws. Generally, secured and priority debts are paid back before general unsecured debts.

The bankruptcy laws allow “administrative expenses” to receive priority status within the hierarchy of debts. To be treated as an administrative expense, a debt must generally have arisen from a transaction with the business that:
1)    occurred after the bankruptcy case was filed,
2)    was beneficial to the business, and
3)    was actual and necessary.

Facts of Marcal
Marcal Paper Mills, Inc. (“Marcal”), was a company that manufactured paper products and operated a fleet of trucks to distribute its products. Its truck drivers had entered into a collective bargaining agreement with Marcal, which required Marcal to participate in a multiemployer defined benefit pension plan.

Marcal eventually filed for Chapter 11 bankruptcy. However, the company continued to operate and continued to employ its truck drivers. It also continued to contribute to its truck drivers’ pension fund, and the truck drivers continued to accrue pension credits.

Eventually, Marcal sold its assets to another company, Marcal Paper Mills, LLC, (“Marcal LLC”), which ceased to employ the truck drivers and stopped contributing to the truck drivers’ pension fund.  

Once the pension fund contributions stopped, the pension fund assessed withdrawal liability to Marcal and submitted a proof of claim in the Chapter 11 bankruptcy case.

Third Circuit’s Ruling in Marcal
The Third Circuit ruled that the portion of Marcal’s withdrawal liability that was attributable to the work performed by the truck drivers after the bankruptcy petition was filed constituted an administrative expense and was therefore entitled to priority under the Bankruptcy Code.

The Court noted that the truck drivers were required to perform work post-petition in order to keep Marcal in operation, which unquestionably conferred a benefit to the company. Pursuant to the collective bargaining agreement, Marcal promised to provide pension benefits in exchange for that post-petition work. The portion of the withdrawal liability that corresponded to the post-petition work was owed in fulfillment of the promise Marcal LLC assumed as part of its purchase of Marcal’s assets to provide pension benefits in consideration for that necessary post-petition work.

The Court rejected counter-arguments, including that the amount of withdrawal liability attributable to post-petition work cannot be calculated. Instead, the Court cited several cases in which such calculations had been made.

Finally, the Court rejected a Sixth Circuit ruling from a similar case, which had held that a withdrawal liability claim was not entitled to administrative priority.

For more information on bankruptcy and employee benefit issues, feel free contact an attorney in Willig, Williams and Davidson’s Bankruptcy or Employee Benefits groups.

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