Patriot Coal settles claims with Peabody, eyes Chapter 11 exit

(Corrects first bullet and 5th paragraph to reflect that Peabody's contribution will fund healthcare only, not healthcare and pensions)

* Peabody to provide $310 mln to fund health benefits

* Peabody to provide $140 mln in liquidity funding to Patriot

* Knighthead Capital to infuse $250 mln of new capital in Patriot

* Patriot also reaches settlement with Arch Coal

* Patriot expects to emerge out of bankruptcy by year end

Oct 10 (Reuters) - Patriot Coal Corp said it has resolved certain legal claims against Peabody Energy Corp in exchange for key funding, which would help the company emerge out of chapter 11 bankruptcy by the end of the year.

The two companies have been fighting over funding of health benefits for about 3,100 retirees that Peabody agreed to continue covering after it spun off the now-bankrupt Patriot Coal in October 2007.

Peabody had said it had no obligation to fund health and pension benefits for Patriot retirees affected by the company's insolvency, arguing that new labor deals between Patriot and the United Mine Workers of America (UMWA) effectively relieved Peabody of any funding obligations.

However, Peabody continued to fund healthcare benefits for retirees during Patriot's bankruptcy proceedings, said Peabody's Chief Legal Officer Alexander Schoch.

In an amended reorganization plan filed with a bankruptcy court on Wednesday, Patriot said Peabody has agreed to provide $310 million, payable over four years through 2017, to fund health benefits and settle all Patriot and UMWA claims.

Peabody will also provide about $140 million to Patriot in the form of letters of credit.

As per the settlement, Peabody's existing contractual commitment to fund healthcare benefits for a certain group of Patriot retirees would terminate on Dec. 31.

After this date, all healthcare benefits would be funded by the newly established Voluntary Employee Beneficiary Association (VEBA).

In a settlement with Arch Coal Inc, Patriot will receive $5 million in cash and a release of a $16 million letter of credit posted in Arch's name. Arch Coal had spun off a unit that was later acquired by Patriot.

UMWA had claimed that Peabody and Arch deliberately shunted their obligations onto Patriot in an effort to avoid having to pay the full amount.

The settlements with Peabody and Arch Coal will be presented to the bankruptcy court for approval at the Nov. 6 hearing.

Patriot Coal also said it will receive $250 million in new capital through a rights offering backstopped by Knighthead Capital Management.

"As a result of the transaction with Knighthead and the company's settlement with Peabody, the VEBA is expected to receive more than $400 million in cash over the next four years. These agreements resolve all matters with the UMWA," Patriot Coal said in a statement.

The case is in re Patriot Coal Corp et al, U.S. Bankruptcy Court, Eastern District of Missouri, No. 12-51502. (Reporting by Sakthi Prasad in Bangalore; Editing by Supriya Kurane)