By Douglas E. Deutsch

The US coal industry is being forced by competition from natural gas and renewable energy to “right size.” At least part of the right sizing will be done through the bankruptcy process.

An example is the bankruptcy filing by Patriot Coal, the 12th largest coal producer in the United States, in May. It was the second bankruptcy filing for the company in three years. Walter Energy and Alpha Natural Resources filed for bankruptcy protection in July and August. They are the 10th and 4th largest US coal producers. Other bankruptcy filings by coal companies are expected.

This article explores the common themes and issues that will be addressed in future coal bankruptcy cases, focusing on what a bankruptcy filing can accomplish for a coal producer, and what it is not likely to accomplish. Every coal case will have to work through a minefield of employee retiree and environmental issues.

Coal Industry Challenges

Natural gas and oil output are up significantly in the United States due to fracking. This has led to a fall in coal prices. Coal accounts for roughly 39% of US electric generating capacity. Coal plant retirements are expected to accelerate due not only to competition from natural gas and renewable energy, but also to tougher environmental regulation of mercury and carbon dioxide emissions from fossil fuel power plants. When utilities are considering options for replacement plants, cheaper and cleaner gas is almost always the preferred option. Updating plants with expensive scrubbing equipment to clean coal emissions is not cost effective and thus is almost never done. The result is a shrinking market for thermal coal.

Of course, not all coal is used to produce electricity. Metallurgical coal is used in the steel industry. However, there is not good news on that side of the coal equation either. The global steel market has softened, leading to a reduction in demand for metallurgical coal also.

Demand problems are not the only issues the coal industry is facing. Substantial legacy liabilities continue to be a major cost. Employee and retiree obligations have been huge issues for coal producers for decades. Environmental regulations have also added additional costs to coal production. Meanwhile, private litigants have brought a number of actions against coal companies that have also raised the cost of operating coal mines.

Employee Issues

Many coal companies have inadequately funded plans for retired miners. The burden of paying retirement obligations out of operating cash flow is a major burden on current operations. Federal mandates and rules specific to the coal industry are a source of additional costs. Bankruptcy may be the only option for a coal producer that must reduce employee and retiree costs to stay in business.

In a bankruptcy case, debtors are typically allowed to reject unfavorable contracts. The collective bargaining agreement between a coal producer and a union is a contract for this purpose. However, the US bankruptcy code does not treat a collective bargaining agreement as a typical contract that can be easily rejected. Such agreements are protected from outright rejection by a required negotiation process intended to provide collective bargaining agreements with special bankruptcy protections. A similar process is required for modifications to retiree benefits.

Collective bargaining agreements establish the work terms between an employer and its employees. They usually include provisions on base pay, overtime, vacation, health and retiree benefits and similar benefits, as well as work rules.

Section 1113 of the US bankruptcy code permits a bankrupt company to reject a collective bargaining agreement if certain requirements are first satisfied. These requirements include that the company must provide the union information about the company, make a formal proposal to the union to modify the collective bargaining agreement, and meet in good faith with the union in an attempt to negotiate the changes. The collective bargaining agreement can be set aside if the union then rejects the proposed changes and the bankruptcy court ultimately finds that the changes are “necessary” for a reorganization.

Determining whether a proposed modification is “necessary to permit the reorganization of the debtor” has been subject to debate. Courts in the third circuit, which includes federal courts in Delaware, have found that “necessary” means essential to prevent liquidation of a company in the short term. In contrast, courts in the second circuit, which includes federal courts in New York, believe that “necessary” requires only that the modifications will increase the likelihood of a successful reorganization. Other interpretations also exist in other parts of the country. The result is that coal producers may have the option of selecting among venues, one of which may be more receptive to finding for the coal company than other venues.

Retiree benefits are governed by section 1114 of the bankruptcy code. As section 1114 is generally modeled on section 1113, the same criteria are used in each. That leads to the same debate as to what “necessary” means. The main difference between sections 1113 and 1114 is that, while a collective bargaining agreement can only be rejected under section 1113 (leaving the employer and the union to renegotiate employment terms), non-consensual modifications to retiree benefits can be approved under section 1114.

Special Coal Benefit Issues

In addition to addressing the substantial employee and retiree issues common in mature industries like steel and airlines, coal producers must also address a series of rules and regulations that add substantial costs to a coal producer restructuring. These fall under three headings: the Coal Act, black lung benefits and Pension Benefit Guaranty Corporation rules.

The Coal Act was passed by Congress in 1992. It was intended to address the looming insolvency of certain trusts that were paying coal industry retiree health care costs and also to address so-called “orphan” retirees. “Orphan” retirees are those who were promised medical benefits by a coal producer no longer in business.

The Coal Act requires most coal producers to make contributions based on, in part, the number of beneficiaries assigned to them by the Social Security Administration, as well as a percentage of orphan beneficiaries who worked for other, defunct coal companies.

Courts have found that Coal Act obligations can be modified by a company in a chapter 11 bankruptcy if the requirements of section 1114 are followed. Several courts have also found that coal companies can sell their assets free and clear of Coal Act obligations under section 363(f) of the bankruptcy code. However, it is also clear that Coal Act obligations that arise after a bankruptcy filing are to be treated as “administrative expenses” and entitled to priority treatment under the bankruptcy code, meaning they are paid ahead of any recovery by unsecured creditors.

The Black Lung Act of 1973 provides benefits to coal miners who are affected by black lung disease. The Act allows such a miner to file a claim with the US Department of Labor. The department then investigates the claim and holds the appropriate coal producer responsible for the black lung disease. If that coal producer files for bankruptcy, then a trust fund pays the required monthly benefits and medical costs and then seeks reimbursement from the coal producer. The Act provides that the trust can file a lien against that producer in a bankruptcy case, thus creating a claim with the same high priority as a tax claim. Moreover, if that claim is not paid, then the coal producer’s officers can also be held personally liable for the obligation. The result is that these claims are usually paid in full by the coal company.

The Pension Benefit Guaranty Corporation is a federal agency that steps in to pay (typically reduced) pension benefits owed to employees where the employer has gone out of business or is otherwise unable to satisfy its pension obligations. If a defined benefit pension plan is terminated during a bankruptcy, then a special rule enacted in 2006 to provide the PBGC an additional source of funding will come into play. Under this rule, the employer is obligated to pay the PBGC $1,250 per affected individual for a period of three years. That obligation cannot be discharged in bankruptcy.

Environmental Issues

Coal companies can also have legacy liabilities tied to environmental claims.

Some might argue that addressing those claims was long overdue as there has been a history of substantial damage to health and the environment caused by coal mining. Where clean-up costs could not be paid by these producers, the costs have been borne by state and federal governments. This seemingly unfair outcome led to passage of a web of laws designed to shift all costs associated with protecting the environment, remediating property that is affected by mining, and protecting the health of the population, to mining companies. However, there is a price to pay for this change. The new laws necessarily limit the steps that a coal company might otherwise take in a bankruptcy case to maximize the value of the bankruptcy estate and reorganize successfully.

Mining is regulated by a number of statutes, including the Surface Mining Control and Reclamation Act or “SMCRA,” the Clean Air and Clean Water Acts, the Resource Conservation and Recovery Act and the Comprehensive Environmental Response, Compensation and Liability Act also known as Superfund.

SMCRA is one of the most important of these statutes. SMCRA requires environmental protection and reclamation standards to be satisfied during mining activities. It does this through required permitting (for example, SMCRA requires a permit for, among other things, coal prospecting, mine plan development, and mine pit back-filling) and other requirements.

SMCRA requires a coal mine operator to provide a performance bond to the appropriate regulatory authority (either an office within the US Department of the Interior or, where so assumed by a state, a similar state entity) to ensure performance of all permit and regulatory requirements. The bond must be large enough in amount to remediate the coal property. Mining companies are allowed to self-bond their liabilities in a number of states. But self-bonding may create additional problems for coal companies in financial distress. Self-bonding normally requires a mining company to maintain certain financial benchmarks, such as a specific rating agency grade. A finding that a coal company is no longer qualified to self-bond is most likely to occur at the most difficult of times. For example, after reading in the press about financial difficulties being experienced by Alpha Natural Resources this spring, Wyoming concluded that Alpha could no longer satisfy the state’s self-bonding requirements. While Alpha challenged Wyoming’s decision, a new potential $400 million bonding obligation was essentially imposed by the state at a time when it was impossible for Alpha to afford it. This was a primary reason that Alpha filed for bankruptcy in August.

SMCRA also requires coal operators to pay reclamation fees into trust funds for unfunded remediation costs. These funds are supposed to be used to restore land and water resources degraded by poor mining practices, thus protecting public health and safety. These fees are due quarterly and are based on the number of tons of coal mined. Different rates are charged for surface mining and underground mining. In bankruptcy cases, courts have found that fees payable under SMCRA are “excise taxes” that cannot be discharged.

Coal regulators have an additional and powerful weapon if an individual (as an agent) fails to operate the mine in an appropriate fashion: a regulator can bring a civil action directly against that individual. For example, failure to remediate property as promised has led to financial liability for the individual agent who acknowledged representing a company, including with respect to promises to remediate.

Permit-blocking, a form of industry “blacklisting,” is another substantial deterrent to individuals who are coal experts and would like to continue to work in the coal industry. If a SMCRA violation exists and has not been abated, and perhaps cannot be abated because the company has insufficient funds, the president of the company may very well not be able to work for another mine in the future. In this scenario, the mine official is placed in a difficult situation. On the one hand, environmental law requires the mine official – who could be a liquidating trustee – to remediate a property and the possible downside for not doing so is the loss of a person’s ability to obtain coal industry employment in the future. On the other hand, bankruptcy law requires the mine official to maximize value of the company’s assets (including by minimizing costs). It is difficult to prove that a trustee has not complied with the bankruptcy mandate. Thus, and unsurprisingly, the typical outcome in such cases is that SMCRA fees and remediation obligations are paid in bankruptcy cases.

Officers of mining companies entering into bankruptcy have strong incentives to ensure that remediation and other environmental obligations are paid in full, even if such obligations might legally be subject to compromise in bankruptcy. Nothing in the US bankruptcy code abrogates an owner or operator’s obligation to continue operating the property while the company is in bankruptcy in compliance with environmental laws. Environmental obligations that arise after the bankruptcy filing must be paid as “administrative expenses” ahead of payments to creditors. The US Supreme Court has made clear that bankrupt companies cannot simply abandon their hazardous properties in a bankruptcy case in contravention of statutes designed to protect public health or safety.

Postscript

One of the main reasons that Patriot, a coal company, filed for bankruptcy in 2012 was to address its employee and retiree obligations. Following the required proposal and negotiation process, Patriot filed a motion to reject its collective bargaining agreement to terminate certain retiree benefits. In a 102-page opinion, the bankruptcy court found that Patriot’s requests were necessary for reorganization and granted the motion. That decision was appealed to a federal district court. Meanwhile, the union and Patriot continued to negotiate. Ultimately, Patriot and the union agreed to modify the existing collective bargaining agreement and address certain retiree benefit issues. Patriot claimed that the result of the settlement was approximately $130 million in cost savings for each of the next four years. Nevertheless, the result was not as hoped.

In May 2015, Patriot filed for bankruptcy again. In first-day filings, Patriot blamed low coal prices, increased regulation costs, and legacy liabilities. Patriot said that after its emergence from bankruptcy in 2012, it was still obligated to contribute to the miners’ pension plan and to make payments under the Coal Act and the Black Lung Act, each of which it said were unrelieved by the prior bankruptcy. It also said it has substantial environmental liabilities. This highlights what appears as a clear problem in coal cases: employee and retiree benefits and environmental obligations are difficult to modify, even after a bankruptcy filing.

The next coal bankruptcy filings will confirm whether this remains true, even in the most difficult of industry environments.

by Douglas E. Deutsch, in New York