How Chapter 11 Is Demolishing Employee Expectations
By Mark Reutter
Sunday, October 23, 2005
The scene in Lower Manhattan was reminiscent of teenagers rushing to
the front of a concert stage, only this time it was middle-aged
lawyers and Wall Street bankers who pushed elbow to elbow into a
federal courtroom no bigger than a gas station mini-mart.
The throng of pinstripe suits forced court aides to call in workers to
pry open windows for ventilation, allowing U.S. Bankruptcy Judge
Robert D. Drain to proceed with the Oct. 11 opening-day hearing
regarding the "petition for relief" by Michigan auto parts maker
Delphi Corp. under Chapter 11 of federal bankruptcy laws.
Once shunned by respectable companies and ignored by Wall Street,
federal bankruptcy court has become the venue of choice for
sophisticated financiers and corporate managers seeking to pull apart
labor contracts and roll back health and welfare programs at troubled
About 150 major corporations are now in some stage of bankruptcy
reorganization, including four of the nation's leading airlines. As
the prospect of other large enterprises taking a spin down Chapter 11
becomes more widely discussed in business circles ("maybes" on the
list include such iconic names as General Motors and Ford), the
tactics used in bankruptcy courts are shaking the very foundations of
the American workplace.
Whether an assembly-line worker or middle manager, an employee can no
longer assume that promises made earlier -- health benefits or fully
funded pensions -- will be there when he or she retires. The loss of
security arising from Chapter 11 reorganizations has introduced a new
element of anxiety into the lives of baby boomers who are approaching
60, not to mention younger workers just starting out in their careers.
The new bankruptcy law, which took effect last week, will have little
effect on corporate bankruptcies. The legislation, approved by
Congress and signed by President Bush in April, is aimed at curbing
abuses in consumer bankruptcies. It tightens the rules for individual
filings, making it more difficult for consumers to have their credit
card and other debts wiped clean in court.
But except for barring certain bonus payouts, the new law keeps intact
the legal system by which corporations can shed certain employee
obligations, including pension costs that can be shifted to the
Pension Benefit Guaranty Corp. (PBGC), which Congress set up in 1974
to insure defined-benefit corporate pensions.
The PBGC is now struggling with $23.3 billion in net deficits arising
from the termination of pension plans from Chapter 11 bankruptcies in
the steel and airline industries. Delphi's filing shifts the spotlight
onto the pension problems of the auto sector, where a total shortfall
ranges between $45 billion and $50 billion, according to the PBGC's
Why the surge in corporate bankruptcies at a time when the economy is
expanding? The explanation heard most often is two-fold: global
competition and out-of-control labor costs. Competition from low-wage
assembly plants in Mexico and Asia is tightening the screws on
American manufacturers who must pay top-dollar wages to unionized
workers as well as promised pension and health benefits, known as
"legacy costs," to retirees.
"Legacy costs are killing us," says Robert S. "Steve" Miller, who was
named Delphi's chairman and CEO last July. Miller is emblematic of the
shifting nature of bankruptcy law. A self-styled "corporate doctor,"
he has a law degree from Harvard University, a master's degree in
finance from Stanford University and a blunt speaking style that makes
him quotable in the media.
Before taking Delphi into Chapter 11 on Oct. 8, Miller made it known
that unionized employees represented by the United Auto Workers (UAW)
would have to accept either a wage reduction of 62 percent, from an
average of $26 an hour to as little as $10 an hour, or sharp benefit
reductions to retirees. UAW President Ron Gettelfinger denounced the
offer as insulting, but Miller defended it at a news conference. The
CEO couldn't have been more explicit in describing his view of the
modern workplace: "Some people insist that fairness requires that we
slash wages across the board if we cut wages for anyone. Well, I am
sorry. My job is to preserve the value of this enterprise as we
restructure. We have to adjust to market conditions and appropriately
pay for our human capital at each level. There are large disparities
in this country and around the world in what people can expect for
mowing the lawn, versus managing a huge business. It may not be fair,
but it is reality."
The Delphi chief often cites reality -- and the bottom line -- in
answering his critics. "They [have to] understand that I haven't got
any more money," Miller told the Financial Times.
But the reality, to use Miller's word, isn't so simple. Delphi does
have money -- specifically, it has $1.6 billion in cash on hand. Even
more significantly, it secured $2 billion in loans and revolving
credit from Citigroup and J.P. Morgan Chase bank just before it filed
for bankruptcy. Which raises a question that the common explanation
for Chapter 11 filings doesn't answer: If Delphi is so broke, with
unsustainable wage costs and skyrocketing pension obligations, why are
two of the nation's major banks offering to lend it money on excellent
The answer: For the same reason that Bank of America, General Electric
Capital Group, UBS Securities and distressed property, or "vulture,"
capitalists have invested billions of dollars in supposedly tattered
companies entering or exiting Chapter 11 since 2001. Investors can
profit richly from the meltdown of established companies -- at least
in the short run. Chapter 11 protects a company from creditors as
management develops a reorganization plan and restructures its
liabilities in the hope of becoming profitable again. Older companies
may have high legacy costs, but they have long-term customer contracts
and plenty of cash flow.
"The way the code is now structured, the temptation is to make the
workforce pay for management's mistakes, rather than taking all of the
stakeholders into account and re-building the company together," says
Harley Shaiken, a professor at the University of California at
Berkeley who specializes in labor issues. Chapter 11 calls on
management to bargain with unions in good faith to reduce costs, but
also permits management to petition the court to void labor contracts
and substitute whatever terms it chooses. Properly stage-managed and
set in motion, the restructuring process can steamroll the union, peel
away retiree benefits and dump pension obligations onto the PBGC.
That's exactly what happened during Miller's 19-month tenure as chief
executive of Bethlehem Steel. Some 95,000 retirees and dependents lost
their health-care plan in 2003 when the bankruptcy judge sold the
company's assets to International Steel Group, a company controlled by
billionaire financier Wilbur L. Ross.
Meanwhile, the PBGC was left with the responsibility of paying $4.3
billion in underfunded Bethlehem pensions over the next 30 or so
years. Because of the less generous terms of PBGC's pension formula,
some steelworkers lost 50 percent of their expected pensions as well
as their health benefits.
Earlier this year, Ross sold International Steel to London-based
Mittal Steel Co., picking up $267 million in profit on the sale.
Ross's investment fund has since amassed $4.5 billion, some of which
he plans to use to make acquisitions in the auto parts industry, he
said recently. One of his possible targets? Delphi. He has made it
clear, in recent interviews, that he is carefully watching the company
and its Chapter 11 reorganization.
So what others see as an ailing business, Ross sees as an opportunity.
Economists often talk about "moral hazard" and "free rider" systems
that create incentives for governments or common citizens to behave
imprudently and follow short-term strategies that can cause long-range
problems. Bankruptcy law can encourage such behavior.
Established by Congress in 1898 as a part of the U.S. district court
system, early bankruptcy courts were auction houses where
court-appointed referees settled claims among squabbling creditors.
Little interest was shown in keeping a company on legal life support
until the Great Depression when, faced by an unprecedented number of
business failures, the Chandler Act of 1938 created Chapter 11
bankruptcies to allow managers to try restructuring instead of simply
liquidating the assets.
The present system dates to the 1978 Bankruptcy Act, which made it
easier for a business to file for protection and gave management broad
rights to set forth a reorganization plan under the supervision of a
bankruptcy judge. The act changed the economic ground rules. Before
1978, few law firms bothered having a bankruptcy department;
afterward, nearly every "white-shoe" firm opened up thriving
bankruptcy and restructuring practices.
Bankers were not far behind. Rather than fighting with management over
existing assets, they began to underwrite management's reorganization
plans through "debtor in possession" loans and revolving credit. This
gave them priority claim on company assets if reorganization didn't
work (something not offered to employees, who are in the heap of
unsecured creditors), and offered lavish rewards to managers who cut
This helps explains an aspect of the Delphi filing that has puzzled
observers: CEO Miller's petition to the court to award up to $87
million in bonuses to senior managers, who also would share 10 percent
of the equity in the reorganized company.
Logic would suggest that a dynamic corporate doctor would want to
amputate, not remunerate, the people who helped get the company in
trouble in the first place. Bonuses and equity, however, "incentivize"
managers, to use Wall Street lingo, to remain at the company and meet
the downsizing targets set by Miller.
It's one of those disembodied tactics of modern business life in which
there is no apparent crime -- only victims, such as retirees who lose
their benefits, and Middle American towns that lose a part of their
tax base when the local Delphi plant is padlocked.
Aside from the question of social equity, is Chapter 11 an effective
cure for a sick company? There is little evidence that
court-supervised reorganization produces a superior company. In fact,
quite a few companies that come out of bankruptcy make a return trip,
and there is growing evidence that the process diverts capital away
from needed investments into the pockets of the restructurers.
"Moral hazard" warns us against letting poorly run companies undercut
the practices of strong companies. It would be a pity, says Shaiken,
to encourage responsible companies to follow in the Chapter 11
footsteps of weak ones, rending the social and economic fabric of
years of comparative labor peace.
You don't have to be UAW's Ron Gettelfinger to be bothered by the
contrast between the winners and losers of recent Chapter 11
reorganizations. The enrichment of managers and financiers who
parachute into troubled industries is unacceptable if taken from the
benefits promised to workers who served their employers loyally in
return for a measure of security in their golden years.
Author's e-mail :
Mark Reutter is an Illinois-based journalist and the author of "Making
Steel: Sparrows Point and the Rise and Ruin of American Industrial
Might" (University of Illinois Press). He writes about business issues
at his Web site, Makingsteel.com.