Sixth Circuit Broadly Interprets Section 959(b) to Cover State Pension Plans

The majority on a Sixth Circuit panel broadly interpreted 28 U.S.C. § 959(b) as allowing states to regulate the activities of chapter 11 debtors in areas far beyond public health and safety.

Sections 1113 and 1114 of the Bankruptcy Code allow debtors to modify or terminate union contracts and retiree health benefits. In the case before the Sixth Circuit, the debtor was not contributing to a retirement plan under a union contract. Rather, state law mandated participation in a state employees’ retirement program.

Because the state law did not permit withdrawal from the retirement program, the appeals court concluded that the debtor was obliged by Section 959(b) to continue making contributions during the course of the chapter 11 case. In other words, the Sixth Circuit found a loophole where Section 1113 does not afford relief while the case is in progress.

The Second Trip to the Circuit

We wrote about the very same appeal 23 months ago. See Kentucky Employees Retirement System v. Seven Counties Services Inc., 901 F.3d 718 (6th Cir. Aug. 24, 2018). To read the ABI report, click here.

Two years ago, the Sixth Circuit court left a question open that resulted in the new opinion on July 20, where the panel was again split 2/1.

The debtor is a nonprofit organization that is the primary provider of mental health services for the state in seven Kentucky counties. Until 1996 when the debtor was formed, the services were provided by the state’s Department of Mental Health. To ensure that workers would not lose their state pensions, the governor issued an executive order allowing the debtor to join the state pension system. New hires, like legacy employees, were all covered by the state pension system.

Required contributions to the state pension system grew dramatically over the years. The state provided 95% of the debtor’s revenue, but the debtor could not provide mental health services while continuing to contribute to the state pension system. So, the debtor filed a chapter 11 petition to reject its relationship with the pension system as an executory contract because there was no statutory mechanism to withdraw.

The state pension system contended that the debtor is a governmental unit and therefore ineligible for chapter 11. Alternatively, the pension system sought a declaration that the relationship with the pension system is a statutory obligation that cannot be rejected like an executory contract.

The bankruptcy court and the district court sided with the debtor on both issues. The pension system appealed to the Sixth Circuit and lost two years ago. The majority held that the debtor was not a governmental unit and was therefore eligible for chapter 11.

However, the retirement system had also appealed the finding in bankruptcy court that the relationship with the debtor was contractual, allowing rejection as an executory contract under Section 365. In the appeal two years ago, the retirement system argued that the relationship was a statutory mandate that the debtor could not reject in view of Section 959(b).

The two-judge majority certified a question asking the Kentucky Supreme Court to decide whether the debtor’s participation in the retirement system is “based on a contractual or statutory obligation” under state law.

Last year, the Kentucky high court answered the certified question, saying that the relationship between the debtor and the state retirement system was based on a “statutory obligation.” In re Kentucky Employees Retirement System, 580 S.W. 530 (Ky. Aug. 29, 2019).

Implications of a ‘Statutory Obligation’

The answer from the Kentucky Supreme Court left the Sixth Circuit with the task of deciding “whether 28 U.S.C. § 959(b) required [the debtor] to continue, throughout the pendency of the proceedings, to fulfill its statutory obligation to contribute to” the state retirement system.

The majority opinion was written again by Circuit Judge Jane B. Stranch, joined by Chief Judge R. Guy Cole, Jr. Judge Cole was a bankruptcy judge in Ohio from 1987 to 1993.

Section 959(b) provides that a “debtor in possession . . . shall manage and operate the property . . . according to the valid laws of the State in which such property is situated . . . .”

Judge Stanch admitted that Section 959(b) has not been extended beyond “the realm of laws enforcing a state’s police power to protect the health and safety of its citizens,” and the retirement system cited no case “in which § 959(b) has been invoked to require payments into a pension system.”

Judge Stranch explained the lack of precedent limiting the ability of companies in chapter 11 to modify or terminate pension obligations. Citing 29 U.S.C. § 1341(c)(2)(B)(ii)(IV), she said that bankruptcy courts may approve “the termination of a single-employer plan during Chapter 11 reorganization.” [Judge Stranch also might have cited Section 1113 of the Bankruptcy Code.] She added that pension obligations “are typically not based on state law statutory obligations, though such is the circumstance here.”

Despite the lack of precedent supporting the state’s argument, Judge Stranch said that Section 959(b) “does not specify that it applies only to state laws enforcing police powers.” Rather, she said, the idea that the “text applies more broadly than solely to health and safety laws finds some support in cases from other circuits.”

Judge Stranch cited the Fifth, Ninth and Eleventh Circuits for holding that a debtor must pay fines for mining violations and must pay statutorily imposed interest on sales taxes that were not remitted on time.

“Applying § 959(b)’s plain language (and considering its application by other circuits),” Judge Stranch held that the debtor “was required to manage its property according to the valid state laws and make contributions during the pendency of the bankruptcy proceeding.”

The State’s Remedy

The state contended that the debtor was obligated to pay more than $30 million in contributions that were not made. In that regard, Judge Stranch alluded to the debtor’s statement that it could not both provide mental health services for Kentucky citizens and make contributions to the retirement program.

On remand to the bankruptcy court, Judge Stranch said “that an informal resolution may be appropriate at this stage.” The state, she said, “has an interest in avoiding a result that leaves approximately 33,000 Kentucky citizens without safety-net mental health services.”

In other words, the bankruptcy court may be obliged to liquidate the debtor if there is no compromise.

The Dissent

Circuit Judge David M. McKeague again dissented. As he did two years ago, he argued that the debtor is a governmental unit not eligible for chapter 11 relief.

Judge McKeague explained at length how the Kentucky court’s answer to the certified question provided ammunition for the argument that the debtor is a governmental unit that couldn’t be in chapter 11.

What Does the Decision Mean?

The Sixth Circuit’s holding is broad. There is no language limiting the holding to the peculiar facts of the case.

Does the decision mean that a state could adopt laws barring companies from modifying union contracts or retiree health benefits under Sections 1113 and 1114? Would a bar under state law conflict with the Supremacy and Bankruptcy Clauses of the Constitution?

Will other courts interpret the Sixth Circuit opinion as being applicable only to participation in state retirement funds, or only to debtors performing a governmental function, or to cases where almost all of the revenue is from the state?

Either or both sides may file a petition for rehearing en banc. On rehearing, the debtor could make arguments under the Supremacy Clause, the Bankruptcy Clause and the canons of statutory interpretation. After all, Sections 365, 1113 and 1114 are far more specific than the few general words in Section 959(b). Congress even gave debtors the ability to obtain interim relief from union contracts under Section 1113(e).

Congress carefully balanced the rights of unions, workers, creditors and debtors in crafting those provisions. Nothing of the sort was involved in the adoption of Section 959(b). On the other hand, if the obligation was not part of an executory contract, what provision of the Bankruptcy Code would permit the debtor to escape its statutory obligation?

And should a state court be deciding whether an obligation arises from an executory contract? Isn’t the definition of an executory contract a question of state law? Is it possible that a statutory obligation could also be seen as an executory contract under the Bankruptcy Code?