Let's begin with the nutshell background:
- Patriot Coal was created and spun off from Peabody Energy, the world's largest private coal mining company, in 2007.
- Peabody stuffed the Patriot shell with all sorts of legacy obligations and under-performing assets. Specifically, the assets Patriot assumed carried with them well over a billion dollars worth of health care commitments to retired coal miners.
- A good portion of Patriot's corporate leadership transitioned into their positions from Peabody.
- The mines that formed Patriot's core are spread across Appalachia and they 1) don't produce high quality coal, and, 2) are difficult (and expensive) to mine.
In sum, many suspect that Patriot was a fraud from the beginning. It was never meant to succeed as an independent enterprise. Instead, it was a way for Peabody Energy to escape 1) expensive promises they had made to their labor force; and, 2) environmental liabilities and clean-up costs associated with their Appalachian mines.
This makes sense when one looks at the assets Peabody didn't spin off - their huge Powder River Basin (PRB) operations. There (in Wyoming) the coal is close to the surface and easy to mine. These operations require fewer miners. PRB coal has low sulfur content, making it easier to sell. The mines haven't been operating as long, so there are few (if any) legacy labor expenses (pensions/retiree health care costs). For all of these reasons (and others), Peabody's western assets are profitable. None of them were spun off into Patriot.
About six months after Patriot was spun off, they expanded by purchasing a second round of toxic assets (mines with large retirement obligations) from Arch Coal.
Ultimately, Patriot failed. They entered bankruptcy proceedings in July, 2012.
With that, thousands of retired miners saw their promised pensions and health care benefits imperiled. Remember, these benefits were bargained for - the miners accepted lower salaries and horrid working conditions in exchange for the promise of a secure retirement.
In addition to the retirees, unionized miners currently working under a collective bargaining agreement (CBA) suspected they wouldn't be able to count on the promises in their contracts.
As it turns out, the miners and retirees were correct to be worried. Last week, Chief United States Bankruptcy Judge Kathy A. Surratt-States ruled that Patriot's reorganization plan - a plan that radically diminishes the value of retiree benefits and current union contracts - was acceptable.
That much is fairly well-known, but the Judge's fact-finding and overall tone of the Judge's order deserve a bit more attention. In short, the union got clobbered.
The Judge begins her order with a short discussion of the suffering sure to result if she were to rule in Patriot's favor:
this Court has received over 900 letters from interested parties, all of which have been read by the Court and placed on the record as correspondence. Many of these letters discuss the imminence of bankruptcy cases for retired coal miners and their families should Debtors be permitted to modify the Collective Bargaining Agreements (hereinafter “CBA” or “CBAs”) and the Retiree Benefits. Many discuss the horrendous conditions of the coal mines when those individuals first began to work, and how hard it was to achieve the promises made pursuant to both the previous and the current CBAs. Some discuss how physically, mentally and emotionally grueling being a coal miner was, many of whom worked as coal miners for over 30 years – a sacrifice made with due consideration of the promised health care from cradle to grave. The Court has received numerous medication lists, lists of various coal mining-related diagnoses and personal accounts of the years of hard work, and, all the reasons why these sacrifices were worth it for the promise of health care for life and an earned pension. One retiree in particular informed the Court that when he first began working, he was given two weeks vacation which was taken when instructed by his superior, and when he retired over 30 years later, he had two weeks vacation which was taken when instructed by his superior. Many coal miners talk of six (6) and seven (7) day work-weeks, of over 12 hours a day. Some letters discuss various injuries sustained while working in coal mines, limbs of self and relatives lost, and the lives lost of relatives and friends. None of these letters, or their comments have been lost on this Court. And, as counsel for the UMWA so eloquently stated, many current and retired coal miners do not have cost spreading abilities, because, for many, cost spreading “means cutting your pills in half. Cost spreading abilities for retirees means making a choice today over medicine or food. And, if you are a diabetic it means making a very difficult choice indeed. Cost spreading abilities for workers means that they either give up their seniority and go out and face the vicissitudes of the modern day unemployment situation, or accept massive wage cuts...”
After making sure everyone knows she has a firm grasp on the weight of the decision before her, she moves on to say:
The Court’s evaluation however must begin with this threshold question: What does the Bankruptcy Code and stare decisis [precedent] require?
With those words, the machine began grinding up the miners. But not right away.
I've already mentioned in passing that the benefits at issue were the result of bargaining. Well, Judge Surratt-States devoted the next 12 pages of her opinion to reviewing the history of these bargaining episodes. Since 1947, a series of strikes, Presidential and Congressional interventions, and collective bargaining agreements resulted in a patchwork of programs designed to ensure miner's retirement and health security. The history is dense, but it's very, very, clear that years of suffering precipitated the strikes and subsequent labor agreements.
Judge Surratt-States next turns to the genesis of Patriot and its debts:
Prior to the spin-off, Peabody’s retiree health care liabilities were $855.8 million dollars. Following the spin-off, Peabody’s health care liabilities were reduced by $617 million dollars.Also, some management at Peabody was involved with the creation of Debtor Patriot Coal Corporation, many of whom became executive members or me members of Debtor Patriot Coal Corporation’s Board of Directors. These individuals are generally no longer employed at Peabody or Debtor Patriot Coal Corporation. [They took their cash and dashed. ed.]
...
Effective December 31, 2005, Arch sold 100% of the stock of three Arch subsidiaries, Hobet Mining, Apogee Coal Company and Catenary Coal Company,and the associated mining operations and coal reserves of those subsidiaries, to Magnum Coal Company (hereinafter “Magnum”). All of these mining operations are located in Central Appalachia. This transaction allowed Arch to assign to Magnum only 12.3% of its assets but also, 96.7% of Arch’s retiree health
care liabilities.
...
The acquisition of Magnum became effective on July 23, 2008 and caused Debtor Patriot Coal Corporation to assume Magnum’s liabilities for health care benefits to current and former employees of Magnum and other entities associated with Arch. As such, over 90% of the health care beneficiaries who now receive post-retirement benefits from Debtors were former employees or dependents of former employees of Peabody, Arch or their subsidiaries, and never worked one day for [Patriot].
...
There is little dispute that today, Debtors must shoulder well over $1.6 billion in health care obligations for its UMWA retirees, and that the number of retirees that Debtors supports outnumber Debtors’ roster of current employees at least fivefold.
That's worth repeating: $1.6 billion in health care obligations to retired miners, 90% of whom never worked a single day for Patriot... and... they outnumber actual Patriot employees by at least 5 to 1.
This was not an accident.
But wait... the retirement obligations don't fully capture Patriot's difficulties:
Additionally, [Patriot] inherited below-cost coal contracts from both Peabody and Arch whereby the cost to [Patriot] to excavate and prepare the coal exceeds the price at which Debtors must sell the coal. Consequently, the cost to [Patriot] to service some of these below-market coal contracts has contributed to the deterioration of [Patriot's] finances.
The next thirty pages of the opinion review the dispute, the testimony and the law having to do with the specifics of bankruptcy and each party's obligations. My takeaway was that the Judge found Patriot's witnesses much more credible than those put forward by the unions. Here's an example of the general tone, but understand that the treatment of witnesses remained consistent (depending on which side they represented) throughout:
Also presented to the Court was the testimony of Mr. Seth Schwartz (hereinafter “Mr. Schwartz”) in support of, and Mr. Srinivas Akunuri (hereinafter “Mr. Akunuri”) in opposition to the 1113/114 Motion. Mr. Schwartz is the President of Energy Ventures Analysis, Inc., and he specializes in analysis of energy markets including analysis and projections of coal supply, demand and market prices, management of coal procurement activities which includes negotiation of coal supply and transportation contracts, evaluation of coal mine operations and production costs such as labor costs and mine productivity, and the purchase and sale of coal properties. Mr. Schwartz echoed the testimony of others regarding the effect of low natural gas prices on the price of coal. Consequently, Mr. Schwartz testified that coal companies must be malleable and have a flexible structure to adjust to the market demands. Mr. Schwartz also testified to other factors that affect coal prices and the overall productivity of a mine such as the geological conditions of the mines, the method of shipment (by rail, truck or barge), the federal reclamation fees associated with the mine, state workers compensation, severance taxes and special reclamation taxes. Nevertheless, Mr. Schwartz testified that he has advised Debtors on the price of coal, and had to reduce his initial July 2012 estimates due to: excess coal production capacity in most U.S. coal basins which will reduce profit margins, reduced rates of cost inflation, lower international market prices for both thermal and metallurgical coals, increased retirements of existing U.S. coal-fired power plants due to Environmental Protection Agency regulations and the outlook for long-term U.S. natural gas prices. As such, Mr. Schwartz believes that the prices reflected in Debtors’ October 2012 Business Plan are in effect on target or slightly optimistic in regards to the prices that will realistically be achieved due to the above. Mr. Schwartz admits that analyzing future coal prices is not exact, and in fact the coal market has changed considerably in the past few months, nevertheless it is the long-term future market that is the relevant predictor (the expected value at a point in time in the future), not the spot price (the current price that a commodity can be bought and sold in a particular place including the price one can pay today for coal to be delivered in the future), and Mr. Schwartz believes Debtors’ October 2012 Business Plan is aligned with future coal prices.
Mr. Schwartz also testified that the productivity at Debtors’ mines, both union and non-union alike, was comparable when factors such as the age of equipment, geological conditions, account for whether the mine was a surface, longwall or continuous mining operation, and the like. For example, with surface mines, the amount of rock that must be removed to expose the coal is important. For underground mines, the coal height and the percentage of saleable coal that is mined is important, which is often a matter of the MMBTU and the sulphur content of the coal – both of which gravely affect pricing in that the lower the sulphur content and the higher the MMBTU of the coal, the higher the market price. Moreover, other factors that are not easily controllable affect the bottom line of a mine such as the cost of fuel, power, taxes and royalties. Nevertheless, Mr. Schwartz believes Debtors’ UMWA-represented mines are more expensive due to the corresponding labor obligations. Based on these factors, Mr. Schwartz testified that certain coal mined from certain mines must be sold at a minimum price, otherwise, it may be a better business decision to idle or close the mine.
The UMWA countered many of Mr. Schwartz’s conclusions with the testimony of Mr. Akunuri, a Valuation Principal in the Houston office of PwC [PricewaterhouseCoopers LLC, the accounting firm advising the union]. Mr. Akunuri performs valuation analyses on oil & gas and mining companies. Mr. Akunuri is not a coal expert, however he has valued coal companies in his career. Mr. Akunuri holds a Bachelor of Commerce Degree from Osmania University, a Master of Commerce Degree from the University of Delhi and a Master of Business Administration Degree from Tulane University. Mr. Akunuri testified that the price of natural gas will increase such that it will become more favorable for electricity producers to increase use of thermal coal because coal will become more economical. Therefore, coal prices are not permanently depressed. Mr. Akunuri however admits that he is unfamiliar with many of the drivers that affect both coal and natural gas prices. For example, Mr. Akunuri was unsure why coal prices typically fall in the summer and rise in the winter while natural gas prices rise in the summer but fall in the winter. Mr. Akunuri also admits that some points of his analysis were incorrect because he assumed the wrong MMBTU content of some coal he attempted to project future prices for and he failed to account for certain differences in federal black lung taxes for coal mined at surface versus underground mines. Mr. Akunuri maintains however that even if those mistakes were corrected, the end result would remain that from an economics perspective, the price of coal will recover as the price of natural gas also increases.
Over and over again, the Judge's narrative painted the union's advisers and experts in a way that made them seem flawed, bungling and incompetent. I may have missed a stray comment somewhere along the way, but I didn't notice a single instance of a Patriot witness suffering similar insult.
But the machine is just warming up.
Before we get to the good stuff though, I need to explain some of the legalese. I'll do that as needed.
The first issue has to do with the negotiation process the Debtor (Patriot) goes through with the people they owe (in this case, the union). The process of bankruptcy encourages collaboration between debtor and debt-holder. Rather than have a court impose its judgment, it's better if the two parties can come to an arrangement. Bankruptcy law establishes a set of procedures and rules to help that process along. At the outset, the debtor makes a proposal and is required to provide all the information the debt-holder could reasonably need to adequately judge the proposal.
In this case the union objects to the proposal offered by Patriot on several grounds. One of those grounds is that Patriot wasn't responsive to the unions' requests for relevant information.
Here are a few things the judge had to say about that:
Based on the representations made to this Court, particularly during the redirect of Mr. Mandarino, it is clear that in the UMWA’s view, Debtors should be required to provide a business model where all of these factors could be manipulated by PwC. This is completely unrealistic and well beyond the requirements of the statute.
...
As such, it appears that the UMWA unreasonably expects that the capabilities of the highly proprietary, highly regarded Hyperion system, which should be highly internally regulated by Debtors such that it would be inappropriate to give the UMWA access, should nonetheless have been reproduced in an Excel spreadsheet that the UMWA could manipulate at its leisure. This is entirely untenable and well beyond what is required of the Bankruptcy Code.
The next legal issue the judge considered was whether or not the specifics (as a whole) of Patriot's proposal are "necessary" for the company to survive and emerge from bankruptcy. Since the union has objected to the proposal, the court has to decide if it's fair to impose. If the proposal hurts the unions more than it should, it should be denied.
Here's the judge weighing in on one contested point:
Mr. Akunuri propounds the theory that while the price of natural gas is low today, particularly spot prices, in the near future, the price of natural gas will increase to a point that it will be more economical for energy producers to rely on coal as a primary source of steam production and therefore, Debtors’ potential revenues will be higher than Debtors predict based on Mr. Akunuri’s sensitivity analysis. The evidence before the Court does not support this oversimplistic conclusion. There were demonstrably numerous flaws in Mr. Akunuri’s sensitivity analysis and overall conclusions...
the Court concludes that the speculation required for Mr. Akunuri’s conclusions is well beyond what this Court will accept as a basis to challenge Debtors’ well supported forecasts... Moreover, it borders on absurd to assume that energy companies can change from coal to natural gas on a whim. Millions of dollars in corporate infrastructure would be required for such changes. In any event, Mr. Akunuri does not profess to be an expert in coal pricing or coal price forecasts, which is the precise skill set required for many of the conclusions Mr. Akunuri made. Mr. Akunuri is an expert in his own right, which is the valuation of oil & gas and mining companies, a completely different animal from the matter at hand.
Here's another blast at the union:
This Court cannot make heads nor tails of where the UMWA believes these additional savings could reasonably come. It appears that at times, the UMWA has merely made arbitrary reductions to Debtors’ October 2012 Business Plan and then determined through self-consultation that those additional savings are “achievable.” It goes without saying that proffers of this nature are insufficient for this Court to accept.
And I thought this was interesting:
So too, the UMWA suggests that certain stock options awards be removed from Debtors’ compensation structure. It is however not certain that any stock options will be offered by the reorganized Debtors because that determination is yet to be made by the board of directors for the reorganized Debtors which is yet to be established. In any event, offering stock options, even if the recipient elects to exercise those options, will not reduce Debtors’ available cash. This argument is therefore a non-starter. Furthermore, this Court has already concluded in a separate matter that Debtors’ compensation structure of its executive and managerial staff must be within the range of its competitors, otherwise, Debtors will suffer attrition which will ultimately impede Debtors’ ability to emerge from bankruptcy and compete. Skilled human labor is a necessity – as is appropriately compensating that skilled human labor for the application of their intellect. As such, the Court concludes that by a preponderance of the evidence, the savings represented in Debtors’ October
2012 Business Plan are needed for Debtors to go forward.
[...]
It is not necessary that the debtor show that managers and non-union employees will have their salaries and benefits cut to the same degree as the union workers’ benefits, rather, “a debtor can rely on proof that managers and non-union employees are assuming increased responsibilities as a result of staff reductions without receiving commensurate salary increases; this is surely a sacrifice for these individuals.” [cite omitted]
So management are the only folks with income security? The next time unions decide to negotiate, they would do well to remember this.
There's another section of the opinion I'd like to go over soon, but for now I'm just wondering if the Judge has had any prior relationships with the energy industry, and coal in particular. It should go without saying that coal and energy corporations have a long, long record of dishonest and unethical behavior. Such a circumstance - the Patriot spin-off - backdrops this bankruptcy litigation.
Yet here we are. The Judge credits every scintilla of Patriot testimony and simultaneously runs the union experts through a meat grinder of exacting scrutiny.
And this matters in a big way too: The union has already noted its intention to appeal. But it's going to be an uphill climb. The trial judge is the fact-finder, and this opinion furnishes the facts for the record that will be examined on appeal. It seems written with exactly this in mind; I'm not sure if Judge Surratt-States' opinion could be any more one-sided.
I'm not sure what the solution is, but one thing labor should take away from this is that there are no promises that can't be broken. In the future, labor should be less willing to compromise their salary demands. Instead, labor might do better by demanding up-front cash and using it to self-insure their members.
I may more to say about Judge Surratt-States treatment of UMAW; this isn't the first controversial ruling she's delivered in this bankruptcy proceeding.