Distress Termination of Pension Plans in Chapter 11
An Overview of ERISA and the PBGC
ERISA, as amended, was enacted to provide protection to participants in pension benefit plans.2 The primary purpose of ERISA was to ensure that employees and their beneficiaries would not be deprived of expected retirement benefits by the termination of pension plans before sufficient funds have been accumulated in the plans.3 Congress sought to ensure that "if a worker has been promised a defined pension benefit upon retirementÑand if he has fulfilled whatever conditions are required to obtain a vested benefitÑhe actually will receive it."4
To accomplish this purpose, Congress established a mandatory government insurance program for pension plans under Title IV of ERISA that is administered and enforced by the PBGC.5 The PBGC is a government agency within the Department of Labor established to provide timely and uninterrupted payment of pension benefits to participants and beneficiaries.6 The PBGC has expansive corporate and governmental powers, including the ability to sue and be sued in its own name and be represented by its own counsel in any court, state or federal;7 enter into contracts, execute instruments and incur liabilities when necessary to exercise its powers;8 and issue subpoenas in the conduct of its investigations.9 The PBGC insurance program is funded by employers that maintain ongoing pension plans through the payment of annual premiums.10 The insurance program is also financed by a statutory liability imposed on employers who terminate underfunded pension plans.11
The plan termination insurance program only covers defined-benefit pension plans.12 Title IV does not cover "defined contribution plans."13 A defined-benefit plan is one that promises to pay employees, upon retirement, a fixed benefit under a formula that takes into account factors such as final salary and years of service with the employer.14 Defined-benefit plans have a pool of assets that is used to pay each participant's benefits.15 There are two types of defined-benefit plans: single-employer plans and multi-employer plans.16 A single-employer plan is a plan that has only one contributing sponsor.17 Multi-employer plans are plans that have more than one contributing sponsor.18 Multi-employer plans are not discussed in this article because such plans are less commonly encountered.
ERISA's Provision Permitting the Distress Termination of a Single-Employer Pension Plan
Section 1341 of ERISA sets out the sole means for the voluntary termination of a single-employer defined-benefit pension plan.19 Such a plan may be terminated only in a standard termination under §1341(b) or a distress termination under §1341(c).20 The pertinent language of §1341 of ERISA provides:
(a)(1) Exclusive means of plan termination. Except in the case of a termination for which proceedings are otherwise instituted by the [PBGC] as provided in [29 U.S.C.A.§1342], a single-employer plan may be terminated only in a standard termination under subsection (b) or a distress termination under subsection (c).21
A standard termination is a termination initiated by the employer with a plan that has sufficient assets to cover all the obligations to the plan participants.22 A standard termination does not implicate the PBGC's insurance function.23
A distress termination, in contrast, is a termination initiated by an employer with an underfunded defined benefit pension plan that can demonstrate to the PBGC that it is in financial distress.24 Following a distress termination of an underfunded defined-benefit pension plan, the PBGC is obligated to pensioners for their benefits. The PBGC is responsible for paying "guaranteed benefits," which are the nonforfeitable basic pension benefits promised by the pension plan.25 The guaranteed benefits are subject to limitations26 such as a maximum dollar amount.27
Procedures for Commencing a Distress Termination of a Single-Employer Pension Plan
To initiate a distress termination, the plan administrator must first give the plan participants and the PBGC written notice at least 60 days in advance of termination.28 After notice is given, the plan administrator must provide the PBGC with the information set forth in §1341(c)(2), which includes information such as the amount of the current value of the plan assets and the actuarial present value of the benefit liabilities of the plan.29 The distress termination process will not proceed to completion until such information is provided to the PBGC.30
The PBGC will permit a distress termination in a chapter 11 case if the bankruptcy court determines that, unless the pension plan is terminated, the employer will be unable to pay all its debts pursuant to a reorganization plan and will be unable to continue in business outside the chapter 11 reorganization proceeding and approves the termination.31 The PBGC must also determine that each member of the debtor's "control" group has satisfied this condition or one of the other conditions set forth in §1341(c)(2)(B). This means that the PBGC will look to see whether (1) the members of the debtor's control group are in a liquidation proceeding or (2) termination is required either to enable the payment of debts while staying in business or to avoid unreasonably burdensome pension costs caused by a declining workforce.32 As a practical matter, any entity seeking a distress termination may also need all members of its control group to seek bankruptcy protection.33
The adequacy of the debtor's disclosures, the ultimate sufficiency of the distress showing, and the qualification of any "controlled group" members are a collective matter for the PBGC to consider as it makes a final determination of the debtor's right to a distress termination.34 The PBGC will be bound, however, by the ruling in the bankruptcy case that unless the pension plan is terminated, a debtor will be unable to pay all its debts under a reorganization plan and will be unable to continue in business outside of chapter 11.35
The Standard Applied under §1341 of ERISA for a Distress Termination of a Pension Plan
The standard applied by courts in a "distress termination" for an entity undergoing a reorganization in bankruptcy is set out in ERISA at §1341(c)(2) (B)(ii)(IV). This standard requires the bankruptcy court to determine that:
[U]nless the plan is terminated, such person will be unable to pay all its debts pursuant to a plan of reorganization and will be unable to continue in business outside the chapter 11 reorganization process...36
Under this standard, the bankruptcy court must go beyond evaluating the currently proposed reorganization plan to determine whether the pension plan is unaffordable under any feasible reorganization plan.37 In In re Resol Manufacturing Co. Inc., the court found that the appropriate standard of review is that "but for" the termination of the pension plan, the debtor "will not be able to pay its debts when due and will not be able to continue in business."38 There are very few cases applying the distress-termination standard.39
The court in In re Wire Rope Corp. of America Inc. applied the distress termination standard and approved termination because the debtor was unable to obtain the financing needed to obtain confirmation of a reorganization plan and because it was not likely that the debtor would be able to continue in business with the pension plans outside of bankruptcy.40 The debtor's chief restruturing officer circulated the debtor's preliminary draft of a reorganization plan to approximately 59 parties.41 In that case, only three parties expressed an interest in financing the debtor, and each indicated that any financing would be conditioned on the termination of the pension plans.42
In In re US Airways Group Inc., the court similarly approved termination even where only one realistic reorganization plan had been proposed.43 In that case, the chapter 11 plan was dependent on exit financing and a substantial capital contribution.44 The exit financing was in turn dependent on the debtor's ability to meet profitability levels reflected in the debtor's seven-year business plan.45 The court noted that no other source of exit financing had been identified and there was no apparent way the debtor would be able to emerge from chapter 11 and avoid liquidation.46 For these reasons, the court concluded that conditions imposed by potential investors and lenders effectively required termination of the pension plan.47
Most recently, the court in In re Aloha Airgroup Inc. approved the termination of defined-benefit pension plans after summarily finding that the "evidence overwhelmingly established that neither of the debtors [could] continue in business, let alone successfully reorganize themselves, without a substantial new investment...."48 In that case, the debtors conducted an extensive and diligent search for investors.49 The only investor to make a complete and serious proposal conditioned its investment on termination of the pension plans.50 The court held that the debtors proved, by clear and convincing evidence, that unless each of the pension plans was terminated, both of the debtors would be unable to pay all of their debts pursuant to a reorganization plan and would be unable to continue in business outside the chapter 11 reorganization process.51
In contrast, the court in In re Philip Services Corp. applied §1341 and did not approve termination despite the fact that the lender of long-term debt had conditioned the loan on the termination of the pension plans.52 In applying this standard, the court stated: [I]n determining whether a pension plan must be terminated as a distress termination, the bankruptcy judge should consider the provisions of a proposed chapter 11 plan (if one has been proposed at the time of the decision) but that the bankruptcy judge must also look to existential financial reality and try to judge whether the plan provisions are necessary or whether they are merely desired by the entities that would benefit from the termination.53
In that case, the court found that the debtor failed to prove that termination was necessary to confirm a reorganization plan.54 The court also noted that merely proposing a particular plan that would result in the pension plans being unaffordable was not sufficient.55
Finally, it should also be noted that a bankruptcy court will inquire into whether the debtor has exhausted all other less-drastic measures that would enable the debtor to pay its debts under a reorganization plan and continue in business outside chapter 11.56 These measures include the elimination of some but not all pension plans, evidence of the exploration of funding waivers, a freeze on future accrual of benefits, and the implementation of other cost savings or discretionary spending in the debtors' business plan that can be used to fund the pension plan.57
As this discussion makes clear, a debtor faces an onerous legal standard if it seeks to terminate a single-employer defined-benefit pension plan. The debtor will essentially need to prove that it faces liquidation if the pension plans are not terminated.
The Consequences of a Distress Termination
When a pension plan is terminated under the distress-termination provisions, the debtor is relieved of the statutory obligations arising from ERISA (e.g., minimum funding contributions).58 In a distress termination where the plan assets are sufficient for benefit liabilities59 or guaranteed benefits,60 the plan administrator liquidates the plan and distributes the plan's assets in a similar manner as that for a standard termination by liquidating the plan and distributing the plan assets to the plan participants in a prescribed order.61
In a distress termination where the plan assets are insufficient to fund future benefits, the PBGC generally becomes responsible for taking whatever actions are necessary to terminate the plan.62 The PBGC liquidates the plan and allocates the proceeds among participants and beneficiaries in a prescribed order.63 The PBGC uses the plan's assets to cover what it can of the benefit obligations.64 The PBGC then must add its own funds under a complex formula that generally results in the pensioners receiving substantially less than the promised benefits.65
The Claims Resulting from the Distress Termination
When an underfunded, single-employer pension plan undergoes a distress termination, the employer becomes liable to the PBGC for the benefits that the PBGC will pay out.66 The PBGC has two significant claims against bankrupt sponsors of pension plans.67 These include the so-called "plan asset insufficiency" claim.68 "This claim arises on the termination of a covered pension plan, and it amounts to the difference between the value of the plan assets at the time of termination and the value of the plan's vested obligations to its participants."69 This claim will also include the pre-petition unpaid funding contributions that were required before the commencement of the bankruptcy case. The existence and amount of the PBGC's claim is to be determined under ERISA law.70 The claim will be a general unsecured claim to the extent the "plan asset insufficiency" claim is based on pension benefits accrued by employees as the result of pre-petition labor.71
The PBGC's second claim in bankruptcy is for unpaid, post-petition funding contributions. Until a plan is terminated, the employer must continue to meet the statutory minimum funding payments mandated by ERISA.72 These unpaid funding contributions are accorded administrative priority under the Bankruptcy Code to the extent these expenses are costs ordinarily incident to the operation of a business.73 In such a situation, the PBGC is usually one of the largest creditors in the bankruptcy case.
The PBGC's Authority to Commence an Involuntary Distress Termination
The PBGC has the authority to institute the involuntary termination of a pension plan as an alternative to waiting for the debtor to complete the distress termination process of §1341(c). Pursuant to §1342, the PBGC may, but is not required to, terminate a plan when it determines "the plan will be unable to pay benefits when due"74 or where the possible long-run loss to the PBGC with respect to the plan may "increase unreasonably if the plan is not terminated."75 The PBGC must institute termination proceedings whenever it determines that a plan does not have assets available to pay benefits currently due.76 The most recent example of an involuntary termination occurred when the PBGC moved to take responsibility for the pension plans of United Airlines to protect the interest of the plan participants and to avoid any unreasonable deterioration of the plan's financial condition or any unreasonable increase in the PBGC's liability.
ERISA sets forth the procedural framework for terminating a pension plan in a chapter 11 case. The distress termination of a pension plan is no easy feat: To accomplish a distress termination, a debtor will have to overcome substantial procedural hurdles as well as an onerous legal standard. If the debtor is able to satisfy the distress criterion under ERISA, then the PBGC will, liquidate the plan and allocate the proceeds among participants and beneficiaries. The distributions made by the PBGC will generally result in the pensioners receiving substantially less than the promised benefits under the pension plan. n
Editor's Note: See this month's Legislative Highlights (p. 8) for a new law establishing an employer-paid termination premium.
1 It should be noted that there may be other methods by which a debtor can relieve itself of its obligations arising from a pension plan. See Morse, Daniel J., "Does ERISA's Provision Governing the Termination of a Pension Plan Preclude the Rejection of a Pension Plan Agreement in a Chapter 11 Case?," Norton Annual Survey of Bankruptcy Law (2005 ed.) (concluding that the rejection provisions of the Bankruptcy Code operate to relieve a debtor of all obligations arising from a pension plan because "termination" under ERISA is a distinct concept from that of "rejection" under the Bankruptcy Code).
2 See Keating, Daniel "Chapter 11's New Ten-Ton Monster: The PBGC and Bankruptcy," 77 Minn. L. Rev. 803, 806 (1993) (hereafter "Keating").
3 See Pension Ben. Guar. Corp. v. R.A. Gray & Co., 467 U.S. 717, 720 (1984); see, also, Nachman Corp. v. Pension Ben. Guaranty Corp., 446 U.S. 359, 361-62 (1980).
4 See Id. (citing Nachman, 446 U.S. at 375).
5 See Keating, 77 Minn. L. Rev. at 806.
6 See 29 U.S.C. §1302 (West 2005).
7 See 29 U.S.C. §1302(b)(1) (West 2005).
8 See 29 U.S.C. §1302(b)(8) (West 2005).
9 See 29 U.S.C. §1303(a)-(c) (West 2005).
10 See 29 U.S.C. §§1306 and 1307 (West 2005).
11 See 29 U.S.C. §1362(b) (West 2005). ERISA provides that the PBGC may recover its claim not only against the terminating employer, but also against members of that employer's "controlled group." See 29 U.S.C. §§1301(a)(14)(A), 1362(a) (West 2005). The "controlled group" includes all entities under "common control" as determined under regulations issued pursuant to the Internal Revenue Code. See 26 U.S.C. §§414(b)-(c), 1563(a) (West 2005) (providing that corporations under "common control" generally consist of those corporations affiliated through overlapping 80 percent ownership).
12 See Dow, Dennis R. and Moedritzer, Mark, "ERISA-Related Claims in Bankruptcy," 3 J. Bankr. L. & Prac. 76, 77 (1993); see, also, 29 U.S.C. §1321(a) (West 2005).
13 See Keating, 77 Minn. L. Rev. at 806 ("Title IV of ERISA covers most defined benefit plans that private employers provide, but not defined contribution plans"). Defined contribution plans are generally governed by the Tax Code. See IRS Reg. §§1.401-6 and 1.411(d)-2 (West 2005).
14 See 29 U.S.C. §1321(a), (b)(1), and (c)(1) (West 2005).
15 See 29 U.S.C. §1002(35) (West 2005); see, also, Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 439 (1999).
16 See Keating, 77 Minn. L. Rev. at n. 9.
17 See 29 U.S.C. §1301(a)(15) (West 2005).
18 See 29 U.S.C. §1301(a)(3) (West 2005).
19 See 29 U.S.C. §1341(a) (West 2005).
20 See 29 U.S.C. §1341(a)(1) (West 2005).
21 See 29 U.S.C. §1341(a)(1) (emphasis added) (West 2005).
22 See Keating, 77 Minn. L. Rev. at 808; see, also, 29 U.S.C. §1341(b) (West 2005).
23 Keating, 77 Minn. L. Rev. at 808. This article focuses solely on the distress termination provisions relating to single-employer pension plans.
24 See Keating, 77 Minn. L. Rev. at 808; see, also, 29 U.S.C. §1341(c) (West 2005).
25 29 U.S.C. §1322(a).
26 29 U.S.C. §1322(b).
27 29 U.S.C. §1322(b)(3).
28 29 U.S.C. §1341(c) (West 2005); 29 C.F.R. §4041.43(a)(1) (West 2005).
29 29 U.S.C. §1341(c)(2)(A) (West 2005).
30 See, e.g., In re Ameripol Synpol Corp., 2004 WL 3073143 (Bankr. D. Del. 2004). The PBGC contended that the debtor had not provided it with the information required by 29 U.S.C. §1341(c) because the debtor had not provided sufficient financial information regarding the control group members and certain other actuarial information.
31 See 29 U.S.C. §1341(c)(2)(B)(ii) (West 2005).
32 See 29 U.S.C. §1341(c)(2)(B).
33 29 U.S.C. §1341(c)(2)(B).
34 See In re Sewell Mfg. Co., Inc., 195 B.R. 180, 185 (Bankr. N.D. Ga. 1996).
35 29 C.F.R. §4041.41(d)(l)(iv) (West 2005).
36 See 29 U.S.C. §1341(c)(2)(B)(ii)(IV) (emphasis added).
37 In re Resol Mfg. Co., Inc., 110 B.R. 858, 862 (Bankr. N.D. Ill. 1990); see, also, In re US Airways Group, Inc., 296 B.R. 734, 743-44 (Bankr. E.D. Va. 2003) (citing In re Wire Rope Corp. of America, Inc., 287 B.R. 771, 777-78 (Bankr. W.D. Mo. 2002)).
38 In re Resol Mfg. Co., 110 B.R at 862.
39 In re Wire Rope Corp., 287 B.R. at 777 ("There is virtually no case law involving the application of the distress termination provisions of §1341").
40 See Id. at 778.
41 See Id.
42 See Id.
43 In re US Airways Group, Inc., 296 B.R. 734, 745 (Bankr. E.D. Va. 2003).
44 See Id.
45 See Id.
46 See Id.
47 See Id.
48 In re Aloha Airgroup, Inc., 2005 WL 3487724 at *2 (Bankr. D. Hawaii 2005).
49 See Id.
50 See Id.
51 See Id.
52 In re Philip Servs. Corp., 310 B.R. 802 (Bankr. S.D. Tex. 2004).
53 See Id. at 808.
54 See Id.
55 See Id.
56 See, e.g., In re US Airways, 296 B.R. at 744-46; In re Philip Services Corp., 310 B.R. 802; In re Wire Rope, 287 B.R. at 777-80.
57 See Id.
58 See Matter of Esco Mfg., Co., 33 F.3d 509, 514 (5th Cir. 1994), opinion withdrawn and superseded on reh'g., 50 F.3d 315 (5th Cir. 1995) ("the plan sponsor's annual contributions to the plan continue to accrue under 29 U.S.C.A. §1082 until the plan is terminated pursuant to Title IV"); see, also, In re White Motor Corp., 42 B.R. 693, 704 (N.D. Ohio 1984).
59 See Rubin, Irwin N., "Title IV of ERISA: Employee Pension Benefit Plans," 574 PLI/Tax 253, 263 (2003) ("in any case where plan assets are sufficient for benefit liabilities, the termination can proceed like a standard termination and assets shall be distributed in accordance with [§1344] of ERISA") (hereafter "Rubin"); see, also, 29 U.S.C.A. §1341(c)(3)(B)(i).
60 See Rubin, 574 PLI/Tax at 263 ("if the PBGC determines that the plan has sufficient assets to provide at least all guaranteed benefits, the PBGC will issue a distribution notice. In that case, the plan administrator must...make a distribution of plan assets no earlier then the 61st day, and no later than the 180th day...following completion of issuance of the notices of benefit distribution....") (citing 29 U.S.C. §1341 (c)(3)(B)(ii)) (emphasis added); see, also, 29 U.S.C. §1341(c)(3)(B)(ii).
61 See 29 U.S.C. §1341(b)(2)(D); see, also, 29 U.S.C.A. §1341(b)(3).
62 See 3 Compensation and Benefits §41:117 (2005).
63 See 2 Emp. Coord. Benefits, §29:129 (2005); see, also, 29 U.S.C. §1342 (a).
64 See Pension Ben. Guar. Corp. v. LTV Corp., 496 U.S. 633, 637-38 (1990).
65 See Id.
66 See 29 U.S.C. §1362.
67 See Keating, 77 Minn. L. Rev. at 814.
68 See Id.
69 See Id.
70 See In re U.S. Airways, 303 B.R. 784.
71 See In re Bayly Corp., 163 F.3d 1205, 1210-11 (10th Cir. 1998); see, also, In re Chateaugay Corp., 130 B.R. 690 (S.D. N.Y. 1991), opinion withdrawn and vacated, 1993 WL 388809 (S.D.N.Y. 1993).
72 See 29 U.S.C. §1082 (West 2005).
73 See 11 U.S.C. §503(b)(1)(A); see, also, In re Sunarhauserman, Inc., 126 F.3d 811, 819 (6th Cir. 1997) (holding that the normal cost component, to the extent it consisted of benefits earned after the debtors entered bankruptcy, was a liability that arose post-petition and was therefore entitled to administrative priority).
74 29 U.S.C. §1342(a)(2).
75 29 U.S.C. §1342(a)(4).
76 29 U.S.C. §1342(a).