The hotel industry has suffered significantly since the outset of the COVID-19 pandemic. Occupancy rates for hotels in urban areas in August 2020 were down to 38% compared to 89% in August 2019.[1] Many hotels, particularly those in New York, were forced to furlough staff in response to local requirements and economic pressures. One such hotel, the Herald Hotel, doing business as a Hilton Curio (Hotel), filed for bankruptcy protection in late September.[2] Employee issues are at the forefront of the hotel’s bankruptcy, particularly relating to the hotel’s collective bargaining agreement (CBA), which the debtor called “one of the major impediments to [its] profitability.”[3]
The debtor asserts that the CBA was historically onerous but had also resulted in a significant obligation for severance (approximately $3.5 million) based on an industry-wide arbitration decision. Accordingly, potential modification of the CBA under § 1113 of the Bankruptcy Code was one of the objectives of the bankruptcy. This same issue is likely to present itself in other similar hotel industry bankruptcies. As such, a review of § 1113 is merited.
Section 1113 Overview
The Bankruptcy Code vests a debtor in possession or trustee (debtor) with the power to reject or modify a CBA. However, unlike with other executory contracts that can generally be rejected at will, the debtor must satisfy the standards set forth by § 1113, which are demanding, before obtaining such relief.
In sum, § 1113 requires that, prior to requesting rejection of a CBA, the debtor make a proposal, based on complete and reliable information, to employees that provides for alterations “that are 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.”[4] There is a split of authority regarding what “necessary to permit the reorganization” means; the Third Circuit has found that it means “essential” to prevent liquidation, while the Second Circuit has taken a less stringent approach.[5] Section 1113 also calls for a certain level of transparency between debtors and employee representatives by requiring that the debtor provide employee representatives access to the information necessary to assess the proposal. Moreover, the rule strives to foster out-of-court consensus-building by placing an obligation on the parties to “confer in good faith in attempting to reach mutually satisfactory modifications of such agreement.”[6]
If the employee representative and debtor cannot come to terms, § 1113 provides for an expedited hearing process[7] to determine whether rejection or modification[8] is appropriate. The court shall approve an application for modification only if it finds that “(1) the trustee has, prior to the hearing, made a proposal that fulfills the [above-mentioned] requirements...; (2) the authorized representative of the employees has refused to accept such proposal without good cause; and (3) the balance of the equities clearly favors rejection of such agreement.”[9] Notably, the debtor has the burden of proof — a preponderance of the evidence — as to each of these elements.[10]
Determining whether a proposal meets the standard for rejection under § 1113 is more of an art than a science. A court may determine that the employee representative’s rejection of the debtor’s proposal was without “good cause” in a variety of circumstances, including if the debtor has negotiated in good faith and adopted adequate cost-saving measures pre-bankruptcy without receiving any concessions from the union.[11] Furthermore, in balancing the equities, courts may assess several considerations, including, but not limited to, “the likelihood and consequences of liquidation if rejection is not permitted”; “the likely reduction in the value of creditors’ claims if the [CBA] remains in force”; “the likelihood and consequences of a strike if the [CBA] is voided”; “the possibility and likely effect of any employee claims for breach of contract if rejection is approved”; “the cost-spreading abilities of the various parties, taking into account the number of employees covered by the [CBA] and how various employees’ wages and benefits compare to those of others in the industry”; and “the good or bad faith of the parties in dealing with the debtor’s financial dilemma.”[12]
Conclusion
As demonstrated by the recently filed chapter 11 proceedings of the Herald Hotel, use of this mechanism will likely become more prevalent in the wake of the COVID-19 pandemic. So far, the debtor in Herald Hotel has not filed a motion to reject or modify the relevant CBA, so that is something to keep an eye on. Notably, however, even in the absence of a formal motion, the § 1113 construct could encourage concessions outside of an adversarial process. For example, the debtors in In re Libbey Glass Inc.[13] commenced proceedings in June in the U.S. Bankruptcy Court for the District of Delaware. The Libbey debtors asked the court to allow them to reject certain CBAs and cut employee wages by 10%.[14] Although the court has yet to rule on the motion, the relevant unions recently voted overwhelmingly in favor of accepting modified contracts, which included a temporary wage reduction and other concessions that are expected to give the debtors breathing room to reorganize.[15]
[1] See State of the Hotel Industry Analysis: COVID-19 Six Months Later, AHLA, at 7 (Aug. 31, 2020) (available at https://www.ahla.com/sites/default/files/State%20of%20the%20Industry.pdf).
[2] In re Herald Hotel Associates L.P., Case No. 20-12266 (Bankr. S.D.N.Y.) (SCC).
[3] Id., Docket No. 4, ¶ 21.
[4] 11 U.S.C. § 1113(b)(1)(A). Similarly, § 1114 allows a debtor to modify retiree benefits and is virtually identical to the § 1113 framework — with some notable exceptions, such as that it applies to union and non-union employees alike. See 11 U.S.C. § 1114; see also In re Horizon Natural Resources Co., 316 B.R. 268, 280-81 (Bankr. E.D. Ky. 2004).
[5] Compare Wheeling-Pittsburgh Steel Corp. v. United Steelworkers of Am., 791 F.2d 1074, 1088 (3d Cir. 1986), with Truck Drivers Local 807 v. Carey Transp. Inc., 816 F.2d 82, 89 (2d Cir. 1987).
[6] 11 U.S.C. § 1113(b)(2).
[7] 11 U.S.C. § 1113(d).
[8] “[I]f essential to the continuation of the debtor’s business, or in order to avoid irreparable damage to the estate,” the court may “authorize the trustee to implement interim changes in the terms, conditions, wages, benefits, or work rules provided by a [CBA].” § 1113(e).
[9] 11 U.S.C. § 1113(c).
[10] See In re AMR Corp., 477 B.R. 384, 406 (Bankr. S.D.N.Y. 2012); but see In re Trump Entm’t Resorts Inc., 519 B.R. 76, 89-90 (Bankr. D. Del. 2014) (explaining that once debtor establishes it provided employee representative with relevant and necessary information and proposal was refused, burden of proof shifts to employee representative as to those elements), aff’d, 810 F.3d 161 (3d Cir. 2016).
[11] See In re Royal Composing Room Inc., 848 F.2d 345, 349 (2d Cir. 1988).
[12] Truck Drivers Local 807, 816 F.2d at 93.
[13] In re Libbey Glass Inc., Case No. 20-11439 (Bankr. D. Del.) (LSS).
[14] See id. Docket No. 353.
[15] See Unions Ratify Four-Year Agreements with Libbey Glass, available at https://www.prnewswire.com/news-releases/unions-ratify-four-year-agreem… (Sept. 25, 2020).