Recent news articles discussing actions by the Pension
Benefit Guaranty Corporation (PBGC) in large bankruptcies, such as US Airways
and United Airlines, have made turnaround professionals more cognizant of
defined benefit pension plans in bankruptcy cases. Two frequently asked
- How will the pension plan impact the outcome of the
- How will PBGC decide what role to play in the case?
provides some tools for turnaround professionals in dealing with defined benefit
pension plans and the PBGC.
The first contact
in a case generally is made by the debtor.
Employee Retirement Income Security Act (ERISA) requires that a plan
administrator or contributing sponsor — usually the company in both cases —
notify the PBGC, the federal insurer of defined benefit pension plan, within 30
days of a bankruptcy filing.
requirements include the submission of certain information, including a copy of
the bankruptcy petition, the bar date if it is known, a discussion of the
debtor’s controlled group,
and a list of pension
plans in the controlled group, along with each actuarial valuation
At times, a
debtor and its advisors are so busy with the initial activities of the
bankruptcy that they are unprepared to provide the required information to the
PBGC. In those cases, it is best to submit the Form 10, along with as much
information as is available, rather than to wait and submit a complete report
In response to its notification, a debtor probably will
receive a letter or telephone call from the PBGC asking whether the plan sponsor
intends to continue or terminate one or more pension plans in the restructuring.
Additionally, the PBGC is likely to ask for a schedule of required pension
payments, called minimum funding payments, for each plan for the next 12 months.
particularly those that want their pension plans to survive the bankruptcy,
treat funding the plans as ordinary course expenses and make all scheduled
pension payments. Others take the opposite view and withhold payment. The PBGC
or the U.S. Department of Labor may ask a Bankruptcy Court to compel a debtor to
make these scheduled payments.
generally have agreed to do so, they also have limited the size of required
payments. Minimum funding payments consist of the cost of benefits earned,
called normal cost; an interest expense component; and an amortization of
previous periods’ liabilities. Courts have directed debtors to contribute just
the normal cost component (accrued post-petition), which is usually the smallest
of the items.
Under ERISA, all
controlled group members are jointly and severally liable for minimum funding
payments and termination liability. If a debtor has one or more controlled group
members that are not in bankruptcy, those entities must make the pension plan
whole with respect to minimum funding payments or face the non-bankrupt
consequences. In other words, a Bankruptcy Court can direct a debtor to
contribute a specific amount of money to its plans, but it cannot direct
controlled group members fail to satisfy minimum funding contributions in a
timely manner and the missed payments to any one plan aggregate at least $1
million, the PBGC will file Internal Revenue Code Section 412(n) liens against
all assets of all non-debtor controlled group members for the amount of the
To head off such a move,
pension advisors frequently recommend that all controlled group members file for
bankruptcy protection if minimum funding payments are scheduled and are not
likely to be made.
Another area subject to significant confusion involves the
funded status of a pension plan — that is, the difference between a plan’s
assets and liabilities. Often financial and legal advisors, as well as company
officials, find pension accounting confusing because of the different
methodologies used for calculating the funded status of a pension plan for
reporting (GAAP) purposes, companies follow guidance from the Financial
Accounting Standards Board (FASB). The GAAP formula is used to book a pension
liability — or an asset, if the plan is overfunded — on a company’s balance
sheet and assumes an ongoing pension plan. The plan sponsor can select the
interest rate used to discount the liabilities,
along with assumed mortality rates, salary increases, return on plan assets, and
other variables, provided each assumption is reasonable.
the PBGC’s valuation approach assumes the plan is terminated — that no
additional benefits are earned by participants. While at first blush it might
seem that the PBGC’s methodology would yield a smaller liability since
additional benefits will not be earned, that is not the case. Primarily this is
because of the interaction between the interest rates and mortality assumptions
regulations require the PBGC to use. The interest rates the PBGC uses to
discount liabilities are generally below the rates plan sponsors use for GAAP
purposes, which results in a larger liability.
regulations also specify expected early retirement ages and mortality
assumptions for plan participants. However, these may differ from the
assumptions used by the plan sponsor for financial reporting purposes, causing
differences between the liabilities calculated by the plan sponsor and those
computed by the PBGC.
Finally, the PBGC
grosses up liabilities with an expense load factor. Because the plan is deemed
to terminate, no additional contributions are assumed and no additional interest
income or capital gains are included in the assets under the PBGC’s approach.
This is because the PBGC becomes the trustee of the pension plan once it is
plan’s funded basis from a GAAP methodology to a PBGC termination basis can turn
a slightly underfunded plan or even an overfunded plan into a significantly
underfunded plan in the eyes of the PBGC. While Bankruptcy Courts do not agree
on the appropriate methodology to use in determining funding status, turnaround
professionals should recognize that PBGC will participate in a bankruptcy based
on its findings. Furthermore, trying to convince the PBGC that its methodology
is not appropriate is a waste of time. A judge, however, may be more receptive
to that argument.
underfunding is expected to be significant, the PBGC likely will request
appointment to the unsecured creditors’ committee. Seeking such an appointment
does not indicate that the PBGC believes that a plan termination is likely; in
fact, it is usually too early in the case for any determination to be made.
while a plan remains ongoing, the PBGC has a contingent, as opposed to a mature,
Nonetheless, applicable law permits the PBGC
to sit on an unsecured creditors committee on the basis of its contingent
Having the PBGC represented on a committee
can be helpful, particularly if the other creditors are new to the bankruptcy
process. PBGC officials have extensive experience as a full member and an ex
officio member of committees and bring a level of sophistication and knowledge
to the table.
What if the
underfunding is expected to be large but the PBGC doesn’t request a seat on the
unsecured creditors’ committee? One cannot necessarily glean a strategy from
this. The PBGC’s workload often restricts the number of committees it can staff.
Participating on a committee is time-consuming, requiring travel, long meetings,
and reviewing significant amounts of information. The PBGC tries to participate
actively on committees rather than serving in name only, so it sometimes has no
personnel available to staff a committee.
Even if the PBGC
isn’t represented on a committee, turnaround professionals should expect the
agency to be active with respect to pension issues and other matters that may
impact the pension situation during a bankruptcy case. For example, as mentioned
earlier, each controlled group member is jointly and severally liable for
pension termination liability. A motion for substantive consolidation, if
granted, could dramatically reduce the PBGC’s recoveries, so the agency would
oppose such a motion vigorously.
At minimum, the
PBGC will file claims in a case, even if a plan is wildly overfunded. It also
will do so even if a plan sponsor intends for the plan to survive the
bankruptcy. The PBGC files claims for unpaid premiums, unpaid minimum funding
missed pre- and post-petition, and total pension underfunding.
PBGC files its claims with the liability amounts noted. At other times it
initially files unliquidated claims. A turnaround professional shouldn’t read
too much into the difference. Often it is just a matter of workload — an actuary
may not have had a chance to compute the underfunding prior to the bar
A plan can be terminated in a reorganization case in two
ways — through a distress termination, which is initiated by the plan sponsor,
or an involuntary termination, which is initiated by the PBGC.
To terminate a
plan in a distress manner in a bankruptcy, a plan sponsor must make a financial
affordability demonstration so that “the bankruptcy court (or such other
appropriate court) determines that, unless the plan is terminated, [the debtor]
will be unable to pay all its debts pursuant to a plan of reorganization and
will be unable to continue in business outside the [C]hapter 11 reorganization
process and approves the termination.”
distress criteria, the PBGC first requires that each plan be tested separately.
Aggregating plans as one unit is unacceptable.
example, a sponsor of multiple plans may have one large underfunded plan that
meets the termination test, but a second small underfunded plan that may be
affordable and therefore will not be terminated.
controlled group member entity must meet at least one of the four distress
termination criteria, but it need not meet the same criteria as another control
group member. The PBGC views each controlled group member on a stand-alone basis
— profitable subsidiaries cannot be netted against negative entities to reach a
net negative. If a healthy controlled group member can support the plan and make
minimum funding payments, the PBGC will expect that entity do
Third, a plan
cannot be terminated in violation of a collective bargaining agreement (CBA). A
debtor may need to initiate a Bankruptcy Code Section 1113 action to reject a
CBA first before pursuing a distress termination. This restriction does not
apply to the PBGC’s involuntary termination actions.
Finally, the PBGC
believes that Bankruptcy Courts have jurisdiction only over those controlled
group members that are debtors. In other words, its position is that each
non-debtor controlled group member must satisfy at least one of the distress
criteria to the PBGC’s — not a court’s — satisfaction. In Chapter 11
reorganizations, the key is the Bankruptcy Court’s determination that a debtor
cannot reorganize without the termination of a plan.
The PBGC also can
terminate an underfunded plan over objections of a plan sponsor who wants the
plan to remain ongoing. There are several possible reasons the PBGC purposely
would incur additional liabilities by pursuing an involuntary termination. The
agency may believe a debtor plan sponsor eventually will file a distress
termination application, while making only normal cost contributions to the plan
and paying out significant benefits in the meantime.
As a result, the plan’s funded status would
deteriorate. To prevent that, the PBGC may move to terminate the plan to
preserve the remaining plan assets and limit the liabilities.
The PBGC also may
pursue an involuntarily termination if it believes an action today may increase
the risk that plan termination will be required later, resulting in the agency’s
future recoveries being less than they would be today. This is known as the
“long-run loss” theory.
In the bankruptcy
context, the PBGC may apply this theory if, for example, a plan of
reorganization provides for existing unsecured creditors — but not the ongoing
underfunded pension plan — to receive security interests in the reorganized
company. If the plan were to terminate post-emergence under such a scenario,
there would be few or no unencumbered assets for the PBGC to receive in a
To prevent such
an outcome, the PBGC might initiate a termination action prior to plan
confirmation. In reality, however, the PBGC’s goal in employing this tactic
might be to force the parties to renegotiate the deal. If so, the PBGC would
simply dismiss its termination action once it was satisfied of its treatment
vis-à-vis similarly situated creditors, and the plan, now protected, would
previously has moved to terminate one or more pension plans when a debtor has
agreed to sell a subsidiary (controlled group) and place the proceeds at the
holding company level. Because a pension plan claim is joint and several to each
controlled group member, the PBGC may believe its recovery will suffer from the
movement of value from one controlled group member to another, even though no
value has left the estate. In such cases, the PBGC and debtors have agreed to
place the proceeds in escrow and allow the sales to go forward. In this way, the
PBGC’s creditor position can be preserved for a later
Assuming that a
plan will be terminated in a bankruptcy and that the PBGC has mature claims for
which it will seek recoveries in the plan of reorganization, two variables must
be addressed — the amount of the agency’s claim and the amount of its
For a turnaround
professional to manage this process efficiently and effectively, it may make
sense at times to focus on minimizing the amount of the PBGC’s claims. At other
times, it may be more productive to concentrate on the agency’s recoveries. At
still others, a turnaround professional may need to address both claims and
earlier, there is disagreement among courts on the appropriate methodology for
measuring pension liabilities. The 6th U.S. Circuit Court of Appeals, for
example, has adopted the “prudent investor” rate as the appropriate interest
rate to use in discounting pension liabilities. This is a rate at which a
reasonably prudent investor would invest in the current situation, and it
implies a risk-adjusted rate. This rate can be significantly higher than the
PBGC’s statutory rate, creating a substantially lower liability and lower (or
no) underfunding amounts. Conversely, the judge in the US Airways case in the
U.S. Bankruptcy Court for the Eastern District of Virginia affirmed the PBGC’s
methodology as appropriate.
If a successful
argument can be made that the prudent interest rate is the appropriate theory to
apply, the estate and creditors will benefit from a ruling that the higher rate
must be used in the pension calculations. As a result, a claims estimation
hearing may be critical to a bankruptcy case, depending on the
At times it can
be more productive to ignore the size of the PBGC’s claims and concentrate
instead on the recovery amounts. In cases in which the PBGC’s claim overwhelms
those of all other creditors, a straight priority code recovery analysis would
give the agency significantly all the value, which may not be acceptable to
other creditors. In these situations, the PBGC in the past has shown a
willingness to put some of its recovery back into the pot for other creditors as
a compromise to achieve confirmation.
Skipping a claims
fight and negotiating a recovery arrangement with the PBGC can lead to a quicker
result for everyone. This can be accomplished by putting the PBGC’s unsecured
claim in a separate class. Usually the PBGC requests that its claim be valued
according to its regulations. This is a non-economic issue for the estate and
other creditors because the recovery amount will not be based on this
PBGC has preferred to have its claim recognized in full and receive a lower
percentage recovery than other unsecured creditors rather than have its claim
banged up in a prudent investor rate fight and show a higher recovery percentage
later. In other words, the PBGC tends to focus on the economics of the deal.
This is sometimes overlooked by turnaround professionals. However, the PBGC does
consider how any compromise may affect future situations, and it is reluctant to
enter into a negotiated arrangement that may set a negative
When negotiating with the PBGC, turnaround professionals
should recognize that the PBGC staff has significant reorganization experience.
A party in a bankruptcy case should negotiate in good faith, treating the PBGC
as it would other creditors. If a debtor loses credibility with the PBGC, it is
difficult to regain it.
The PBGC should
not be expected to incur the lion’s share of the economic compromise in a
bankruptcy case. Rather, the agency analyzes how other creditors are treated to
ensure that they “share the pain.” Also, the PBGC considers how a compromise
will affect not just the case at hand, but future cases as well. As a
governmental entity, the PBGC must interpret how policy may be
should expect the process to take time. It may be weeks before a meeting can be
scheduled. The PBGC staff will need time to analyze the facts and prepare
briefings, counterproposals, and other positions.
companies have annual reporting requirements to PBGC under ERISA Section
See ERISA Section
4043, post-event notices of reportable events. The notice is to be submitted on
a PBGC Form 10.
There are two general
types of controlled groups: parent-subsidiary and brother-sister. A
parent-subsidiary controlled group exists when a parent owns directly or
indirectly at least 80 percent of a subsidiary. A brother-sister controlled
group exists when the same five or fewer shareholders own at least 80 percent or
more of companies.
ERISA requires that
PBGC be given notice of missed minimum funding payments within 10 days of the
due date. The notice is to be submitted on a PBGC Form 200.
requires that the interest rate reflect current rates at which the liabilities
could be “settled.” The Securities and Exchange Commission has indicated that
this rate should not be higher than the yield on a portfolio of bonds rated AA
or higher whose cash flows match the predicted schedule of benefit
The claim belongs to
the pension plan and is enforced by the plan’s fiduciary. In the United Airlines
case, the PBGC and U.S. Department of Labor insisted on an independent fiduciary
to enforce the plan’s claim for minimum funding. Increasingly, bankrupt
companies are appointing independent fiduciaries.
Protection Act of 1994 (RPA) (under separate bankruptcy reform) allowed PBGC to
sit on creditors’ committees. Prior to RPA, many trustees were uncomfortable
appointing a governmental agency or a creditor with a contingent claim to a
creditors’ committee, so PBGC usually participated as an ex officio
There are four
distress termination criteria (see ERISA Section 4041(c)). The second test,
discussed in the this article, is applicable for debtors that are
The concept is being
tested in the Kaiser Aluminum and Falcon Products cases, in which the judges
permitted the distress test on an aggregate basis.
guarantee covers basic pension benefits only, and the agency limits the amount
of pension benefits participants can receive. For plans terminating in 2006, the
maximum annual benefit PBGC will pay a plan participant retiring at age 65 is
$47,659. Additionally, PBGC does not pay lump sum benefits in excess of