CHAPTER 5, B. Bankrupt with a Pension Plan? Here's What to Expect

• Jurisdiction: United States

B. Bankrupt with a Pension Plan? Here's What to Expect

ABI Journal

July 2019

Katie Burgess Kohn

Groom Law Group, Chartered

Washington, D.C.

Monique Bair DiSabatino

Saul Ewing Arnstein & Lehr LLP

Wilmington, Del.

Almost by definition, a company entering bankruptcy faces a host of challenges, including those that arise when a debtor offers or participates in a defined-benefits plan. In that scenario, the debtor must address a number of unique regulatory and legal issues.

Private-sector defined-benefit pension plans are governed by the Employee Retirement Income Security Act of 1974 (ERISA) and are insured by the Pension Benefit Guaranty Corp. (PBGC). ERISA provides specific rules and requirements that govern changes to pension benefits and plan terminations. Moreover, even when a company is not intending to change or eliminate its pension plan, additional compliance issues often arise in bankruptcy that might be challenging for debtors to navigate.

Defined-Benefit Plans and the PBGC

A defined-benefit pension plan is a tax-qualified, single-employer¹ retirement plan that is sponsored by a private-sector employer and governed by ERISA.² A pension plan typically provides benefits to participants and beneficiaries based on factors such as length of service and salary.³ Pension assets are held by — and benefits are paid from — a tax-qualified trust operated exclusively for the benefit of the plan participants and beneficiaries.⁴

The PBGC guarantees pension plan benefits, collects premiums from plan sponsors (i.e., employers), monitors ongoing pension plans and their sponsors, and becomes trustee of plans that have terminated with insufficient assets to pay benefits.⁵ Furthermore, when the PBGC acts as a trustee, it pays benefits to the plan's participants and beneficiaries up to certain statutory maximums.⁶

Are Plan Assets Property of the Estate?

A question that frequently arises when a company files for bankruptcy is whether the pension plan's assets are subject to the claims of creditors. Section 541(c)(2) of the Bankruptcy Code excludes trusts from the bankruptcy estate, including pension trusts, that restrict the transfer of the debtor's beneficial interest if such restriction is enforceable under "applicable nonbankruptcy law."⁷ "Applicable nonbankruptcy law" includes ERISA and the Internal Revenue Code (IRC), each of which prohibit pension benefits from being assigned or alienated.⁸

Although a debtor's interest in plan trust assets is generally not property of the estate, exceptions exist where courts have permitted parties to reach the assets.⁹ These instances include where (1) transfers to the trust were made with fraudulent intent or were otherwise determined to be fraudulent conveyances;¹⁰ (2) transfers to the trust were made after the petition date such that the property was property of the estate as of the date of the filing;¹¹ (3) the pension plan was administered in violation of the IRC;¹² and (4) the pension plan was not operated in a manner consistent with ERISA.¹³

PBGC Bankruptcy Claims

In nearly every bankruptcy of a plan sponsor, the PBGC files three claims. When filing these claims, the PBGC takes the position that each member of the sponsor's controlled group is jointly and severally liable.¹⁴ For this reason, the PBGC typically objects to any attempts to substantively consolidate debtor-controlled group members.¹⁵

Unfunded Benefit Liabilities

The unfunded benefit liabilities (UBL) represent the shortfall in plan assets compared to benefit liabilities.¹⁶ The PBGC's UBL claim, which is contingent upon plan termination,¹⁷ is typically much larger than the actual underfunding of a plan, as calculated by the sponsor. The PBGC calculates the UBL using assumptions prescribed under its regulations that are intended to approximate the cost to purchase annuities.¹⁸ More conservative assumptions generally produce higher liabilities. Furthermore, the PBGC typically seeks priority status for UBL claims accruing after the petition date.

Due and Unpaid Employer Contributions

When a plan is terminated and the PBGC is appointed trustee of the plan, the PBGC will assert a claim on the plan's behalf for any missed contributions.¹⁹ The PBGC typically seeks priority status for unpaid contributions that came due 180 days prior to the bankruptcy pursuant to § 507(a)(5) of the Bankruptcy Code. The PBGC has also claimed administrative-expense status for unpaid contributions coming due after the petition date, although this position has been rejected by the Tenth Circuit.²⁰

PBGC Premiums

The PBGC will assert claims for any due and unpaid variable-rate or flat-rate premiums owed by an employer under the plan terms, as well as premiums that come due in the event of a plan termination.²¹ The PBGC has argued, and the Second Circuit has agreed, that in a chapter 11 reorganization, termination premiums do not arise until after the reorganization plan has been confirmed. Therefore, these claims are not bankruptcy claims but rather obligations of the reorganized debtor.²²

Plan Termination or Freeze

ERISA limits a sponsor's ability to reduce its pension liabilities. Specifically, sponsors can typically only reduce benefits prospectively, since ERISA generally prohibits sponsors from reducing accrued benefits.²³ Moreover, if a sponsor wants...