Pension Protection Act New FASB Rule May Put Secured Lenders at Greater Risk of PBGC Liens
The Pension Benefit Guaranty Corporation (PBGC) is the U.S. government corporation that insures benefits for workers and retirees covered by defined benefit pension plans (plans). When a plan is terminated, the PBGC is able to take over the plan's assets, but is also responsible, subject to limitations, for insuring payment of the plan's obligations to beneficiaries.
According to the Congressional Budget Office, from its inception in 1974 through 2004, the PBGC assumed responsibility for about 3,500 underfunded plans, representing an obligation to provide benefits to approximately 500,000 current retirees and another 550,000 plan participants not yet retired.1 For single-employer plans, the PBGC's "accumulated deficit" as of Sept. 30, 2004, totaled $23.3 billion and, at the end of fiscal year 2004, total underfunding of all PBGC insured plans was estimated to exceed $450 billion.2 As a result, the PBGC's accumulated deficit was projected to grow dramatically over the next 10 years. Moreover, high-profile plan terminations at companies such as Bethlehem Steel, LTV, US Airways, United Airlines and Delta Airlines, as well as extensive speculation about the ability of other large employers to meet plan-funding requirements, have focused attention on the PBGC's serious underfunding problem.
This growing problem has energized legislative action, including (1) the Deficit Reduction Act of 2005, which increased premiums paid to the PBGC, indexed those premiums for wage inflation, authorized supplemental premiums for non-terminated but underfunded plans, and imposed new premiums on plan termination;3 and (2) the Pension Protection Act of 2006, which will soon require, among other things, most sponsors of underfunded plans to make "catch-up" payments over seven years.4
The underfunding problem also appears to have resulted in an increasing assertiveness by the PBGC in insolvencies and potential insolvencies to maximize the PBGC's recoveries or contain its losses. This assertiveness poses substantial risks for secured lenders because, under some circumstances, the PBGC has the ability to assert lien rights that may prime otherwise valid senior liens. The PBGC's ability to assert lien rights is not new, but both the Pension Protection Act and the Financial Accounting Standards Board's (FASB) recently-issued statement regarding standards for accounting for plans5 will magnify the risk faced by secured lenders of PBGC priming liens.
FASB Statement No. 158 will begin to take effect on Dec. 15, 2006, and be fully effective by the end of 2008. The "catch-up" provisions of the Pension Protection Act will begin a three-year phase-in beginning in 2008. For many secured lenders, the new rules will enhance the risks posed by the PBGC and will result in a need to formalize new and more extensive monitoring processes for their borrowers that either sponsor plans or are part of controlled groups that do. This article will conclude with some basic recommendations for a monitoring regimen.
Overview of PBGC's Lien Rights
The PBGC is able to take advantage of two different statutory lien schemes, both of which have the potential to prime consensual liens granted to a secured lender. The provisions are 26 U.S.C. §412(n)6 and 29 U.S.C. §1368. The principal difference between the two is that §412 enables the PBGC to assert lien rights when a plan sponsor fails to make mandatory contributions to a plan, while §1368 generally enables the PBGC to assert lien rights upon plan termination. Both liens, however, have the status of liens for "taxes due and owing the United States." 26 U.S.C. §412(n)(4)(C); 29 U.S.C. §1368(c)(2). Moreover, both types of liens can be asserted not only against property of the specific plan sponsor, but against any entity within its "controlled group." Section 412 states as much directly, 29 U.S.C. §412(n)(1), and §1368(a) creates a lien against the property of "any person liable to the [PBGC] under §1362, 1363 or 1364," which generally includes all persons in the "controlled group." See, e.g., 29 U.S.C. §1362(a).
The two provisions are not identical. Section 412, for example, requires that unpaid mandatory contributions to a plan exceed $1 million before a lien arises, 26 U.S.C. §412(n)(1), while §1368 provides that the lien "may not be in an amount in excess of 30 percent of the collective net worth of all persons" liable under §1362(a). 29 U.S.C. §1368(a).7 The rules governing priority of the various liens, however, are drawn from the same source. Sections 1368(c), (d) and (e) provide for rules governing the liens under §1368, and §412 provides that "rules similar to the rules of subsections (c), (d) and (e) of [§1368] shall apply with respect to a lien imposed by subsection (a) and the amount with respect to such lien." 29 U.S.C. §412(n)(4)(C). Section 1368(c), in turn, references 26 U.S.C. §6323 (as in effect on April 7, 1986) for the rules governing priority of the PBGC's liens.
In general, the PBGC's liens are treated like judgment liens that arise "as of the time notice of such lien is filed." 29 U.S.C. §1368(c)(3). They are "not...valid against any purchaser, holder of a security interest, mechanic's lienor or judgment lien creditor until notice thereof...has been filed." 29 U.S.C. §6323(a).8 Thus the PBGC's lien rights will not interfere with the priority of properly perfected liens securing obligations that predate the filing of notice of the PBGC's liens. However, as with judgment liens under the Uniform Commercial Code (UCC), see UCC §9-323, it becomes more problematic to preserve a secured lenders' lien priority where revolving advances are being made.
PBGC liens arising under §412 and §1368 can prime a secured lenders' liens securing advances made after filing/ perfection of the PBGC's liens. Specifically, 29 U.S.C. §6323(d) provides that:
Even though notice of [a PBGC] lien has been filed, such lien shall not be valid with respect to a security interest which came into existence after [the PBGC] lien filing by reason of disbursements made before the 46th day after the date of [the PBGC] lien filing, or (if earlier) before the person making such disbursements had actual notice or knowledge of [the PBGC] lien filing, but only if such security interest—(1) is in property (A) subject, at the time of [the PBGC] lien filing, to the [PBGC's] lien, and (B) covered by the terms of a written agreement entered into before [the PBGC] lien filing and (2) is protected under local law against a judgment lien arising, as of the time of [the PBGC] lien filing, out of an unsecured obligation.
Thus the statute can be construed to grant a grace period to secured lenders making revolving loans that extends to the earlier of (1) 45 days after the PBGC files notice of its lien or (2) the date of "actual notice or knowledge" of the filing of the PBGC's lien. In general, it should not be difficult to meet the requirements for the application of this grace period. There is no conflict if the two liens do not attach to the same property, and secured revolving loan transactions are ordinarily subject to written agreements. The applicable version of UCC §9-323(b) will generally provide the requisite local law protection. Nonetheless, liens securing advances made 46 or more days after the filing of a PBGC lien are clearly at risk of diminished priority, and the priority of liens securing earlier advances may be at risk of the PBGC contending that the lender had "actual notice or knowledge" of the PBGC's liens.
Cumulatively, these new realities suggest the need for more rigorous monitoring by secured lenders of plans sponsored by their revolving loan borrowers, or members of their revolving loan borrower's controlled group. Awareness of the circumstances and risks, and prompt action when problems arise, is the key.
Impact of the Pension Protection Act
The Pension Protection Act of 2006 requires, in most cases, that sponsors of underfunded plans will have to begin by 2008 to make "catch-up" payments amortized over a period of seven years to remedy plan underfunding. Pension Protection Act §112(a)(1) and (c). These "catch-up" payments are termed "shortfall amortization charges" and are one component of the "minimum required contributions" required of plan sponsors. Moreover, the §412 lien provision, as modified by the Pension Protection Act, makes clear that the lien granted thereby extends to these shortfall amortization charges. Pension Protection Act §112(k)(1).
In combination, the accelerated "catch-up" payment requirement and the modification of §412 may enhance secured lenders' priming lien risk for at least two reasons. First, while the $1,000,000 underpayment threshold for a §412 lien to arise is preserved under the Pension Protection Act, the fact that the mandatory payments include the "catch-up" payments means that when a §412 lien arises from failure to make required contributions to an underfunded plan, the lien will be likely to secure an even larger claim (and therefore have the potential to prime a secured lender's liens by a larger amount). Moreover, for smaller plans whose sponsors find themselves in the position of needing to defer a mandatory contribution, the very fact that what could be a significantly larger catch-up payment is required may increase the mandatory contribution enough to push more delinquencies over the $1 million threshold, thus resulting in a lien where none would have arisen prior to the Pension Protection Act.
"Actual Notice or Knowledge" and FASB Statement No. 158
Of course, the primary threat to a secured lender is less in the amount of the PBGC's lien than in its priority. In that regard, as noted, §6323 provides something of a grace period even for revolving loans disbursed after the PBGC files notice of a lien. But that grace period may be construed to extend only until the earlier of (1) 45 days after the PBGC files notice of its lien or (2) the date of "actual notice or knowledge" of the filing of the PBGC's lien. This grace period offers less protection than it first appears. The reason is that §6323(i) of the Internal Revenue Code defines "actual notice or knowledge" of a PBGC lien filing as arising:
from the time such fact is brought to the attention of the individual conducting such transaction, and in any event from the time such fact would have been brought to such individual's attention if the organization had exercised due diligence.
This definition of "actual notice or knowledge" does not really appear to require actual notice or knowledge. On its face, it appears to permit "actual notice or knowledge" of a PBGC lien filing to be imputed as of the time actual knowledge would have been acquired by an organization exercising due diligence. Because of this loose definition, additional financial statement disclosure by borrowers regarding plan funding status enhances the risk of the PBGC contending that a secured lender had "actual notice or knowledge" at an earlier date. And as discussed below, FASB Statement No. 158 will require more detailed, accurate and timely information about plan funding status to be disclosed.
FASB Statement No. 158 begins to take effect after Dec. 15, 2006, for public companies, and after June 15, 2007, for nonpublic companies. All of its new reporting requirements will be in effect after Dec. 15, 2008. According to FASB Statement No. 158, it was issued to address problems with prior standards that frequently resulted in either misleading, incomplete or inaccurate representations of plan funding status in financial statements. The FASB also noted that prior standards, while requiring some footnote disclosure, (a) "did not require an employer to report in its statement of financial position the over funded or underfunded status of a [plan]," (b) "did not require an employer to recognize completely in earnings...the financial effects of certain events affecting the [P]lan's funded status" and (c) "allowed an employer to recognize in its statement of financial position an asset or liability arising from a [plan], which almost always differed from the [P]lan's overfunded or underfunded status."
Among other things, when fully implemented, FASB Statement No. 158 will now require the following changes in financial statements:
• Overfunded or underfunded plans will result in the recognition of an asset or liability, respectively, on the sponsor's balance sheet;9
• In most cases, the disclosure of the current and noncurrent portion of the liability for underfunded plans will be required;10 and
• Overfunded or underfunded status will be required to be measured as of the date of a plan sponsor's fiscal year end, and reported in interim periods on an adjusted basis to account for additional accrued benefits, plan contributions and benefit payments made.11
The result should be, and is intended to be, more accurate, comprehensible and up-to-date disclosures in financial statements of information regarding plan status and, as secured lenders generally receive financial statements from their borrowers, an enhanced risk of the PBGC claiming "actual notice or knowledge" of the existence (or at least of the circumstances that might give rise to) a PBGC lien at an earlier date.
Recommendations for Secured Lenders
Cumulatively, these new realities suggest the need for more rigorous monitoring by secured lenders of plans sponsored by their revolving loan borrowers, or members of their revolving loan borrower's controlled group. Awareness of the circumstances and risks, and prompt action when problems arise, is the key. At a minimum, this should include:
• requiring borrowers to disclose whether they sponsor a plan or plans;
• evaluating the borrower's ownership structure to determine whether non-borrowers who may sponsor plans are in a borrower's controlled group;
• requiring borrowers or control group members who sponsor plans, or their actuaries, to timely provide schedules of required plan contributions and prompt proof that required contributions are made; and
• prompt remedial action with respect to any borrower that is unable to meet its plan contribution obligations, or that has a controlled group member in such circumstances.
Moreover, because §6323, unlike the UCC, requires PBGC liens to be filed in the state in which the plan sponsor or its controlled group member's assets are located, in many distressed circumstances, a careful and attentive secured lender will need to be aware of the state by state filing rules and will want to conduct regular searches in multiple locations.
1 Congressional Budget Office, The Risk Exposure of the Pension Benefit Guaranty Corporation (Sept. 2005).
3 See Pub. L. No. 109-71, §8101, effective Feb. 8, 2006, and codified at 29 U.S.C. §1306. Perhaps in part as a result, the PBGC has recently reported that as of Sept. 30, 2006, the accumulated deficit was $18.1 billion.
4 See Pub. Law No. 109-280 (the "Pension Protection Act") at §§101-102.
5 Statement of Financial Accounting Standards No. 158, Employers' Accounting for Defined Benefit Pension and Other Post-retirement plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R) ("FASB Statement No. 158").
6 This provision was modified to conform to the new terms of the Pension Protection Act. See Pension Protection Act §112(k). Citations are to the pre-amendment codification except where material modifications have been made.
7 There is an argument that the 30 percent limit applies to §412 liens as well, but the PBGC disputes this position.
8 29 U.S.C. §1368(c)(4) mandates that filings be made "in the same manner as under §6323(f) and (g) of Title 26." 26 U.S.C. §6323(f) and (g), in turn, generally require that filings be made in the offices designated by the state law of the state in which the property subject to the lien is situated, unless no such provision is made in state law, in which case filings are to be in the "office of the clerk of the U.S. district court for the judicial district in which the property subject to the lien is situated...."
9 FASB Statement No. 158 ¶4(a).
10 Id. ¶4(b).
11 Id. ¶¶5-6.