Practical Results of Rejecting, Terminating Pension Plans Are Significant

(TMA International Headquarters)

Editor’s Note: The full version of this article first appeared in the 2005 edition of the Annual Survey of Bankruptcy Law, published by Thomson/West, which holds the copyright. This article has been abbreviated and reproduced with the permission of the copyright holder. ___________________________________________________________

The Employee Retirement Income Security Act of 1974 (ERISA), as amended, was adopted to protect participants in pension benefit plans. [1] Title IV of ERISA establishes a mandatory government insurance program for pension plans that is administered and enforced by the Pension Benefit Guaranty Corporation (PBGC).

The plan termination insurance program covers only defined benefit pension plans. [2] A defined benefit plan 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. Each participant’s benefits are paid from a pool of assets.

There are two types of defined benefit plans: single-employer plans and multi-employer plans. [3] This article discusses the distress termination of a single-employer defined benefit pension plan.

Section 1341 of ERISA sets out the means for the voluntary termination of a pension plan. Section 1341(a)(1) of ERISA provides:

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. Section 1342], a single-employer plan may be terminated only in a standard termination under subsection (b) or a distress termination under subsection (c). [4]

A standard termination is initiated by an employer whose pension plan has sufficient assets to cover all obligations to the plan participants. [5] A standard termination does not implicate the PBGC’s insurance function. [6]

A distress termination, in contrast, is initiated by an employer that has an underfunded pension plan and can demonstrate to the PBGC that it is in financial distress. [7] Essentially, the employer must show that it faces liquidation if the pension plan is not terminated. [8] A distress termination under Section 1341 of ERISA in a Chapter 11 case relieves the debtor of the contractual obligations arising from the pension plan agreement (PPA) and the statutory obligations imposed by ERISA. A distress termination implicates the PBGC’s insurance function because a claim by the PBGC results for accrued but unpaid funding contributions.

The issue raised by these circumstances is whether the distress termination provision of Section 1341 of ERISA precludes the debtor from rejecting the PPA under the U.S. Bankruptcy Code. The rejection of a PPA under the Bankruptcy Code also would relieve the debtor of the contractual obligations arising from the PPA and the statutory obligations imposed by ERISA. Only two courts have addressed the issue of whether a debtor can reject a PPA as an executory contract, and they reached contrary results. [9]

Different Courts, Different Decisions

In In re Philip Services, the debtor moved for a finding of distress and alternatively sought to reject pension plans as executory contracts under Bankruptcy Code Section 365. [10] The PBGC opposed the rejection of the pension plans as executory contracts and asserted that the court should not permit the debtor “to use ‘rejection’ as a tool to terminate the Pension Plans.” [11]

The court denied Philip’s motion for a finding of distress under 29 U.S.C. Section 1341(c)(2)(B). The court further concluded that ERISA’s distress termination provisions occupied the field and that a pension plan could not be rejected as an executory contract:

The Court concludes that rejection of a pension plan as an executory contract is not permissible if the requirements of distress termination are not met. First, notwithstanding the legislative history, ERISA provides a considered and comprehensive set of rules and procedures to deal with the problem of underfunded single-employer pension plans. The statute was enacted to overrule jurisprudence that Congress viewed as inappropriate, and the language of the statute states that it is exclusive. The statute starts with the statement that the ERISA termination provisions are the “Exclusive means of plan termination…” (footnote omitted) “Exclusive” means “exclusive”…there are no other means. The statute also states: “…a single-employer plan may be terminated only in a standard termination...or a distress termination under...this section.” (footnote omitted). The words “only” occur in uncommon frequence [sic] in this statute. If one interprets the clear words of the statute instead of the vague legislative history, the answer seems clear.…

Therefore, the Court concludes that a Debtor may not “reject” a pension plan as an executory contract. The specific (“exclusive”) statute trumps the vague (“general”) statute when there is no demonstrated conflict.… [ 12]

However, the court in In re Bastian Co., Inc. (Bastion I) held that pension plans may be rejected as executory contracts. [13] The court stated:

The language of Section 365 is quite simple. “...the trustee, subject to the court’s approval, may assume or reject any executory contract or unexpired lease of the debtor.” 11 U.S.C.A. Section 365(a) (emphasis added). If this court holds that the pension plan is an executory contract, not only is ERISA not the exclusive procedure for terminating a pension plan, but instead the language of Section 365 prevents a debtor-in-possession or trustee from terminating (i.e. rejecting) or assuming a pension plan without first requesting Bankruptcy Court approval pursuant to 11 U.S.C.A. Section 365.

The fact that a pension plan is rejectable under U.S.C.A. Section 365 notwithstanding termination procedures in ERISA does not mean that ERISA is inapplicable to pension plans of employers in bankruptcy. Only the ERISA provisions which conflict with 11 U.S.C.A. Section 365 are affected. Therefore, ERISA is not the exclusive means to terminate a pension plan and Section 365 of Title 11 applies to pension plans of employers in bankruptcy. [14]

Ultimately, the court in Bastion I approved the rejection of the “pension plan” under Section 365 of the Bankruptcy Code and thereby permitted the debtor to “terminate” its pension plans. [15]

Although Philip Services and Bastian I reached different results as to whether a debtor may reject a PPA as an executory contract, both courts conflate the concepts of rejection of a PPA with the termination of a pension plan. Specifically, the courts seem to be of the opinion that rejection will extinguish the pension plan (i.e., the pension trust holding plan assets) in a manner similar to that of termination under ERISA.

This is not the case, however, because these concepts are distinguishable and should be viewed as independent remedies. The notion that a distress termination under Section 1341 of ERISA and rejection under the Bankruptcy Code are distinct concepts is predicated on the analysis of the relevant statutes and the congressional history of the exclusivity provision, which follows in this article.

More Than Semantics

The general provision governing the rejection of an executory contract is found in Section 365 of the Bankruptcy Code. This provision is used to reject a PPA when there is a self-standing pension plan — one not incorporated into a collective bargaining agreement (CBA). A special provision for rejection under Bankruptcy Code Section 1113 pertains to a PPA appended to a CBA. When a debtor rejects a PPA under Section 365 or a CBA incorporating a pension plan under Section 1113, the estate is freed from its obligations to perform under the PPA, such as promises to maintain a pension plan for a period of years or to make minimum funding contributions required under ERISA. [16]

At first glance, any distinction that might exist between rejection of a PPA under the Bankruptcy Code and termination of a pension plan under ERISA appears to be merely a matter of semantics, as both relieve the debtor of its pension obligations. However, rejection can be distinguished from termination on the basis that rejection does not extinguish or bring an end to the pension plan (i.e., the pension trust holding plan assets). Unlike termination, the pension plan survives rejection because it is a distinct legal entity separate and apart from the contract. [17]

The primary effect of this difference is that the PBGC will wind up the affairs of a pension plan when it undergoes a distress termination and the assets are insufficient to fund future benefits, whereas the effect of rejecting the PPA is to leave the pension plan unaffected and the plan assets and liabilities under the control of the plan administrator. The notion that rejection under the Bankruptcy Code and termination under ERISA should be viewed as alternative remedies is also supported by the legislative history of the Section 1341 of ERISA.

The Single Employer Pension Plan Amendment Act (SEPPAA) provided in Section 1341(a) that the exclusive means to terminate a pension plan was either in a standard termination under Section 1341(b) or a distress termination under Section 1341(c). [18] SEPPAA was enacted in 1986, shortly after the decision in Bastian I, w hich permitted the debtor to reject its PPA as an executory contract under the Bankruptcy Code. The House Committee on Education and Labor included language stating that Bastion I was decided incorrectly:

[T]he Committee intends that ERISA provide the sole and exclusive means under which a qualified pension plan may be terminated. The Committee therefore believes that…In re Bastion [sic] Company, Inc., (No. 83-2107, Jan. 16, 1985), which held that ERISA does not impair other Federal law, and therefore, a pension plan can be rejected as an executory contract, was incorrectly decided. [19]

However, it is the Conference Committee Report for SEPPAA that should be afforded the most weight. Next to the statute itself, the conference report is the most significant evidence of congressional intent behind enactment of the statute. [20] The SEPPAA Conference Committee Report made clear that the legislation does not make any substantive changes in the bankruptcy laws. Significantly, the Conference Committee Report explained: “The distress termination criteria are not intended to make any substantive changes in the bankruptcy laws. The conferees take no position on when or whether a pension plan is an executory contract.” [21]

Comments from various senators also make clear that SEPPAA was not intended to make any changes in the bankruptcy laws. For example, the late Sen. Strom Thurmond stated: “[T]o the extent a pension plan is an executory contract, it is covered by the voidance provisions of section 365 of the Bankruptcy Code. …The conferees wisely chose to stay neutral and simply maintain current law regarding these issues.…." [ 22]

This legislative history is persuasive support for the conclusion that Section 1341 of ERISA should not preclude the rejection of a PPA under the Bankruptcy Code.

Implications of Rejection

The ability to distinguish the rejection of a PPA under the Bankruptcy Code from the termination of a pension plan under ERISA may be highly significant as a practical matter. First, if a debtor rejects a PPA, it may be able to relieve itself of all obligations attributable to the pension plan earlier and more easily. For instance, if the debtor rejects the PPA under Section 365 of the Bankruptcy Code, the debtor can relieve itself of its pension obligations by satisfying the “business judgment test,” [23] which is a legal standard less onerous than that for a distress termination under Section 1341 of ERISA.

Under Section 1341, the standard applied by courts in a “distress termination” for an entity undergoing reorganization in bankruptcy essentially requires the debtor to show that it faces liquidation if the pension plans are not terminated. [24] Further, in a distress termination the Bankruptcy Court also inquires into whether the debtor has exhausted all other less drastic measures that would enable it to pay its debts under a plan of reorganization and continue in business outside Chapter 11. [25] The Bankruptcy Court looks for evidence that a debtor explored funding waivers, elimination of some but not all pension plans, or a freeze on future accrual of benefits. [26]

As for rejection of a PPA that is appended to a CBA, the standard for rejecting a CBA under Section 1113 of the Bankruptcy Code is just as demanding as that for terminating the pension plan under Section 1341 of ERISA. [27] However, absent from Bankruptcy Code Section 1113 are the inherent procedural delays present in Section1341 of ERISA. [28] For example, the PBGC does not allow a distress termination if it determines that any member of the debtor’s controlled group has not satisfied one of the distress tests set forth in Section 1341(c)(2)(B).

Second, if it rejects the PPA under Section 365 or 1113 of the Bankruptcy Code, the debtor can halt the buildup of unpaid post-petition funding contributions that are accorded administrative priority early in the case and prevent these expenses from consuming the estate.

Third, the debtor gains significant leverage in any negotiations with the PBGC regarding the amounts of its claims as a result of its ability to potentially force the agency to commence an involuntary termination. Section 1342(a) of ERISA requires the PBGC to institute termination proceedings whenever it determines that a plan does not have assets available to pay benefits that are currently due. [29] This provision may be implicated if the debtor rejects a PPA because after rejection the pension plan remains in existence but fails to receive any more contributions from the debtor. The administration expenses will consume the plan assets to the point that the plan may soon not have assets available to pay benefits that are due.

Finally, rejection of the PPA will not trigger the liability of the nondebtor members of the control group, unlike termination of a pension plan under ERISA. When a plan sponsor terminates a pension plan in a distress termination, the PBGC has claims that it may collect not only from a plan sponsor, but also from members of its “control group.” If the debtor rejects a PPA under the Bankruptcy Code, however, there has not been a termination of the Pension Plan that triggers the liability of the nondebtor members of the control group. Thus, all members of a control group would not need to seek bankruptcy protection.

Alternative Remedies

The exclusivity provision of Section 1341 of ERISA should not preclude rejection of the PPA under the Bankruptcy Code. The rejection of a PPA under the Bankruptcy Code and the distress termination of a pension plan under Section 1341 of ERISA are alternative remedies available to a debtor. This conclusion is predicated not only on an analysis of the relevant statutes, but also on the congressional history of the exclusivity provision of Section 1341 of ERISA.
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[1] -See Daniel Keating, Chapter 11’s New Ten-Ton Monster: The PBGC and Bankruptcy, 77 Minn. L. Rev. 803, 806 (1993) (hereafter “Keating”).

[2] -See Dennis R. Dow and Mark Moedritzer, ERISA- Related Claims in Bankruptcy, 3 J. Bankr. L. & Prac. 76, 77 (1993); see also 29 U.S.C. Section 1321(a). Title IV does not cover “defined contribution plans.” Keating, 77 Minn. L. Rev. at 806.

[3] -See Keating, 77 Minn. L. Rev. at n. 9.

[4] ‑See 29 U.S.C. Section 1341(a)(1).

[5] ‑See Keating, 77 Minn. L. Rev. at 808; see also 29 U.S.C. Section 1341(b).

[6] ‑Keating, 77 Minn. L. Rev. at 808. This article focuses solely on the distress termination provisions relating to single-employer pension plans. The provisions governing termination of multi-employer plans is beyond the scope of this article.

[7] ‑See Keating, 77 Minn. L. Rev. at 808; see also 29 U.S.C.A. Section 1341(c).

[8] ‑See In re Resol Mfg. Co., Inc., 110 B.R. at 862 (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.”).

[9] ‑See In re Philip Services Corp ., 310 B.R. 802 (Bankr. S.D. Tex. 2004) (prohibiting debtor from rejecting pension plan as an executory contract) and In re Bastian Co., Inc ., 45 B.R. 717 (Bankr. W.D. N.Y. 1985) (permitting debtor to reject the pension plan as an executory contract). Although these courts refer to the ability of the debtor to reject “pension plans” (i.e., the separate legal entity comprised of plan assets), they no doubt were referring to the pension plan agreement (i.e., the documents giving rise to the plan).

[10] ‑See Philip Services Corp., 310 B.R. at 808.

[11] ‑See Objection of the Pension Benefit Guaranty, In re Philip Services Corp., 2003 WL 23967468 (Bankr. S.D. Tex. 2003).

[12] ‑See 310 B.R. at 808-09 (first emphasis in the original) (second emphasis added).

[13] ‑45 B.R. at 719.

[14] ‑  Id. at 719-22 (emphasis added).

[15] ‑ Id. at 722.

[16] ‑See generally In re Family Snacks, Inc., 257 B.R. 884, 905 (B.A.P. 8th Cir. 2001) (“The debtor’s decision to reject (or not to assume) gives rise to a presumption that the debtor has breached or will not perform its obligations.”); see also Michael T. Andrew, Executory Contracts in Bankruptcy: Understanding ‘Rejection’, 59 U.Colo.L.Rev. 848, 931 (1988) (“Rejection is not the power to release, revoke, repudiate, void, avoid, cancel or terminate, or even to breach, contract obligations. Rather, rejection is a bankruptcy estate’s election to decline a contract or lease asset. It is a decision not to assume, not to obligate the estate on the contract or lease as the price of obtaining the continuing benefits of the non-debtor party’s performance. That decision leaves the non-debtor in the same position as all others who have dealt with the debtor, by giving rise to a presumption that the debtor has ‘breached’—i.e., will not perform—its obligations. The debtor’s obligations are unaffected, and provide the basis for a claim.”).

[17] ‑A pension plan is a regulated federal entity and may sue and be sued in its own name. See 29 U.S.C. Section 1132(d). A pension plan also has disclosure and significant reporting requirements. See generally 29 U.S.C. Sections 1021-1030.

[18] ‑ Office & Professional Employees Intern. Union, Local 2 v. F.D.I.C., 962 F.2d 63 (D.C. Cir. 1992).

[19] ‑See H.R. Rep. No. 99-300, at 289 (1985), reprinted in 1986 U.S.C.C.A.N. 756, 940.

[20] ‑See Payne v. Federal Land Bank of Columbia, 916 F.2d 179, 182 (4th Cir. 1990) (“The part of legislative history which is given the most weight is the conference report. ‘Inasmuch as the conference report represents the final statement of terms agreed upon by both houses of Congress, next to the statute itself, it is the most persuasive evidence of the Congressional intent behind the enactment of the statute.’”) (citing Davis v. Lukhard , 788 F.2d 973, 981 (4th Cir. 1986); Murphy v. Arlington Cent. School Dist. Bd. of Educ ., 402 F.3d 332, 196 Ed. Law Rep. 415 (2d Cir. 2005), petition for cert. filed, 74 U.S.L.W. 3026 (U.S. June 27, 2005) (“We also recognize that, while some legislative history is less reliable than others, a conference committee report is generally among the most authoritative.”).

[21] ‑See 131 Cong. Rec. H13252 (daily ed. Dec. 19, 1985) (Conference Report) (emphasis added).

[22] ‑See 131 Cong. Rec. S 18, 207 (daily ed. Dec. 19, 1985) (remarks of Senator Thurmond) (emphasis added); see also 131 Cong. Rec. S 18,209 (daily ed. Dec. 19, 1985) (remarks of Senator Nickles); see also 132 Cong.Rec. S15048-05 (October 3, 1986) (remarks from Congressman Clay).

[23] ‑The predominant test is described as the “business judgment test.” See 2 Norton Bankr. L. & Prac. 2d, 39:16. “This test concerns the impact that continued performance of the contract will have on the estate. Assumption or rejection of the contract will be approved upon a mere showing that the action will benefit the estate.” Id . “This approach essentially relegates the court to a secondary role and validates the sound exercise of discretion by the trustee or the debtor in possession.” Id .

[24] ‑See In re Resol Mfg. Co., Inc., 110 B.R. at 862.

[25] ‑See e.g., In re US Airways Group, Inc., 296 B.R. 734, 744-46 (Bankr. E.D. Va. 2003); In re Philip Services Corp ., 310 B.R. 802 (Bankr. S.D. Tex. 2004); In re Wire Rope Corp. of America, Inc., 287 B.R. 771, 777-80 (Bankr. W.D. Mo. 2002).

[26] ‑See Id .

[27] ‑ In re Resol Mfg. Co., Inc ., 110 B.R. 858 (Bankr. N.D. Ill. 1990); see also 2 Norton Bankr. L. & Prac. 2d, 156:27 (2004) (“[The reorganization distress] test is similar, but not identical, to the analysis that a Bankruptcy Court must undertake under 11 U.S.C.A. Section 1113.”) (citing In re Resol Mfg. Co., Inc. , 110 B.R. 858 (Bankr. N.D. Ill. 1990)).

[28] ‑The PBGC will not consent to the termination of a pension plan unless the plan administrator gives the plan participants and the PBGC written notice at least 60 days in advance of termination. 29 U.S.C. Section 1341(c); 29 C.F.R. Section 4041.43(a). The debtor also must provide the PBGC with certain financial and actuarial information. See 29 U.S.C. Section 1341(c)(2).

[29] ‑See 29 U.S.C. Section 1342(a) (“The corporation shall as soon as practicable institute proceedings under this section to terminate a single-employer plan whenever the corporation determines that the plan does not have assets available to pay benefits which are currently due under the terms of the plan.”).