2012 ANNUAL SPRING INVESTMENT FORUM American College of Investment Counsel Chicago, IL Bankruptcy Trends in Times of Distress: What the Next Administration Should Avoid Friday, April 27, 2012 11:00 a.m. - 12:30 p.m. James E. Spiotto Chapman and Cutler LLP (Moderator) Renee M. Dailey Bracewell & Giuliani LLP Todd J. Dressel Chapman and Cutler LLP
PRESENTATION TO AMERICAN COLLEGE OF INVESTMENT COUNSEL BANKRUPTCY TRENDS IN TIMES OF DISTRESS: WHAT THE NEXT ADMINISTRATION SHOULD AVOID PBGC UPDATE: WHAT COULD HAVE BEEN IN GM AND CHRYSLER AND WHAT MAY BE FOR AMERICAN AIRLINES AND OTHERS? AN ANALYSIS OF PBGC, ERISA & RETIREE HEALTH CARE TRUST ISSUES IN BANKRUPTCY AND IN CONNECTION WITH ASSET SALES IN BANKRUPTCY OR ARTICLE 9 FORECLOSURE Prepared by: James E. Spiotto CHAPMAN AND CUTLER LLP 111 WEST MONROE STREET CHICAGO, ILLINOIS 60603-4080 March, 2012 ACICSF12 - Bankruptcy - PBGC Update
TABLE OF CONTENTS INTRODUCTION...1 EXECUTIVE SUMMARY...2 ANALYSIS...7 I. PBGC ROLE...7 A. Types of Pension Plans...7 1. Defined Contribution Plans: No Future Obligation to Employees...8 2. Defined Benefit Plans: Fixed Future Benefits...8 B. PBGC Revenue...10 II. ANALYSIS OF PBGC LIENS...11 A. The Aggregate Balance of Past-Due Contributions Must Exceed $1 million Before a Lien Arises...11 B. Even if a Lien Arises, PBGC Liens Do Not Prime Perfected Secured Lenders Except for Credit Extended 45 Days After the Lien is Filed...13 C. Potential Control Group Issues...15 III. PENSION PLAN SUCCESSOR LIABILITY...17 A. Employer Provides Notice of a Reportable Event...17 1. Change in contributing sponsor or controlled group...24 2. Loan Defaults As Reportable Events...24 B. Liability in Asset Purchases...25 C. Transactions to Evade Liability and Effect of Corporate Reorganization...31 IV. PLAN TERMINATIONS: ANATOMY OF A PBGC PENSION PLAN TAKEOVER...33 A. Distress Termination...33 B. Involuntary Termination...34 1. Procedure for Termination...34 2. Follow-on Plans...39 C. Limitations on the PBGC Guarantee...41 D. The Pension Protection Act of 2006...43 V. GENERAL ERISA CLAIMS PRIORITY ISSUES...47 A. Priority Status: Unsecured vs. Secured...47 B. Unperfected ERISA Liens Do Not Have Priority Status...47 C. Overview of PBGC Claims in Bankruptcy....48 D. No Tax Priority for PBGC Claims...51 E. No Administrative Expense Priority for PBGC Claim...53 ACICSF12 - Bankruptcy - PBGC Update
F. Portion of PBGC Claims Entitled to Administrative Expense Priority under 11 U.S.C. 503(b)(1)(B) and 507(a)(1) Post-Petition Labor Minimum Funding Contributions Due...55 G. PBGC Liens Must be Perfected...56 H. Multiemployer Pension Plan Amendments Act Issues...57 VI. PERFECTION OF A PBGC LIEN: UNSECURED TREATMENT PREVAILS POST-PETITION...58 VII. STATUTORY DISCOUNT RATE APPROACH ADOPTED IN IN RE US AIRWAYS...60 CONCLUSION...62-2-
INTRODUCTION As the economy hopefully improves, one of the recurring issues for discussion will be who are the winners and who are the losers. In that process, there will be some older legacy companies whose aging workforce, uninspired management and unchanged and treadworn business plans are living off of basic core product ideas or services, which do have value. The challenge for lenders to such a company, especially institutional investors, is how to unlock the promise of that business and its value that the lenders saw and supported for years. This is complicated by the existence of unfunded pension obligations and benefits owed to the workers and the absolute need for a change in management through the sale of the company to a real new management team and new ownership who can do what is necessary to realize and unlock the value of the company. The traditional approach has always been to put the company into a Chapter 11 bankruptcy. GM and Chrysler, with the government s support and aid, changed the dynamics, the expectations and the concerns of institutional investors. American Airlines and future bankruptcies will test different approaches to resolving Pension Benefit Guaranty Corporation ( PBGC ), pension and employer issues that may make all the difference to sophisticated lenders and their recoveries. The question has been framed as how can secured lenders and institutional investors implement a process to quickly and effectively transfer the assets from a company, which is challenged by excessive worker and legacy costs and uninspired management, but which has a product, service or niche position that that has significant value if it can be rescued by a new management team and new ownership. This paper will address the key issues of dealing effectively with the PBGC without inappropriate government influence and problems. Such excessive government involvement will probably drastically reduce the return to the secured lender and the institutional investor and, more likely than not, threaten the future of the ACICSF12 - Bankruptcy - PBGC Update
company and the benefit that the enterprise provides in long term employment services and contributions to our gross national product. EXECUTIVE SUMMARY This memorandum analyzes a debtor company s underfunded pension claims in a corporate bankruptcy and the impact on a potential sale of lenders collateral under Article 9 of the Uniform Commercial Code or a potential sale pursuant to Section 363 of the Bankruptcy Code. It assesses the lenders risks under the Employee Retirement Income Security Act of 1974 ( ERISA ), including the risk of successor liability for prospective asset purchasers or the lenders as credit bidders, as well as the potential of the PBGC to interfere with a sale. It concludes that unless the asset sale is shown to be a sham entered into for purposes of avoiding pension liability, there is little risk of successor liability for a purchaser of the assets or the lenders. Additionally, while the PBGC could theoretically move to terminate the pensions and acquire a lien on a debtor company s unencumbered assets, it is unlikely that they could properly interfere with a sale of assets or otherwise interfere with the rights of secured lenders. Therefore, while the bankruptcy process may afford more clarity and certainty regarding these issues, it does not appear that there is a meaningful risk to lenders in liquidating their collateral in a UCC sale especially if the sale is combined with court approval with notice to all affected parties. Below are answers to key questions that lenders may have in considering how to dispose of collateral in a default or bankruptcy situation. 1. If the pension plan will not be terminated, how will it be treated and why? Any significant loan default, asset sale, or bankruptcy will trigger a reportable event in which a debtor company must give notice to the PBGC. This will trigger the PBGC s involvement. If the debtor company lacks sufficient assets to satisfy its pension obligations, and these obligations (missed payments) exceed $1 million, the PBGC may seek to impose a lien on -2-
the debtor s remaining assets or involuntarily terminate the plan. The PBGC may also seek to impose liability on other entities which it deems to be within the control group of the debtor. (See II and III.A below.) 2. What would be the effect if the PBGC terminates the pension plan? The PBGC must show proper cause to terminate a pension plan. If the termination is contested, the PBGC must petition the U.S. District Court to obtain a termination order. As described below, unless the asset sale is deemed to be a sham, the pension obligations should remain behind with the debtor and not pass through to the lenders or a prospective purchaser. (See IV.B below.) 3. Identify likely arguments of PBGC, plan trustee or retiree representative in UCC or 363 sale scenarios, their strengths/weaknesses and potential to block/delay sale. Before the PBGC may assert a lien, the aggregate unpaid balance of past-due contributions must exceed $1 million. Additionally, unless the lien is perfected (and is superior to the lien of the secured lender), the claims of the PBGC, a plan trustee or retiree representative are unsecured. In a sale of assets pursuant to 363 of the Bankruptcy Code, a debtor would enjoy the protections of the business judgment rule, meaning that any potential objection of unsecured creditors would be overruled. The result would be the same in a UCC sale because the debtor would be consenting to the commercial reasonableness under Section 9-610 of the UCC. General unsecured creditors may also arguably lack standing to object under these circumstances, but a separate suit to challenge the commercial reasonableness is hypothetically possible. However, unless the value of the businesses significantly exceeds what is owed to the lenders, a typical third-party creditor does not have a legitimate economic basis for a post-closing challenge to the sale. State court approval of the sale further diminishes this possibility. (See II.A, II.B, and III.B below.) -3-
4. Potential for successor liability of buyer (including credit bid buyer/lenders) to PBGC or plan trustees in UCC or 363 sale scenarios. A purchaser of assets is typically not liable for the general obligations of the selling company. Additionally, the PBGC has issued opinion letters stating that it will not assert successor liability claims against a purchaser of assets unless the buyer expressly assumes responsibility for the seller s plan. Therefore, the PBGC or a plan trustee could only raise successor liability claims if the transaction is a sham. This requires proof of two hard-to-show elements: (1) that the subjective intent of the sale was to evade pension liability and (2) that there was no objective basis for belief that the buyer had a chance of meeting those obligations. The prospect of successor liability is made more remote in this instance because the sale is to an unrelated third party to remedy a default on a secured loan. (See III.B below.) 5. Compare relative protection against liability under 363 vs. UCC sale -- could state court order address successor liability? As described above, both approaches provide adequate protection. While the automatic stay and the protections of the business judgment rule in a bankruptcy proceeding afford greater comfort than a state court proceeding, some of these issues could be addressed in a form of order that incorporated findings such as that the buyer was expressly not assuming liabilities, that it was an arms-length third-party transaction, and was for the benefit of all creditors. While such an order may not bind claimants who are not party to the proceeding, it would provide additional comfort in a situation with only remote risk. (See III.B below.) 6. Buyer insistence on lender indemnity for same. Any sale of assets would be on an as-is, where-is basis, whether under the UCC or 363 of the Bankruptcy Code. Buyer insistence on an indemnity is inappropriate because of the lack of any meaningful successor liability risks. Further, any potential indemnity should be given by the debtor, not the lenders. -4-
7. Discuss whether and how credit bidding/equity ownership of business increases PBGC/ERISA risks. As described above, the risk of successor liability is remote. Obtaining ownership through a 363 sale or a court-supervised UCC sale further reduce these risks. However, a transaction that results in equity ownership of the debtor company as opposed to an asset purchase would be dangerous and could lead to increased risk of successor liability. (See III below.) 8. Other remedies PBGC/retirees might pursue that could harm lenders. The PBGC could attempt to assert statutory lien rights against the debtor and members of the control group, but this would not have an impact immediately, if at all, on the first-priority perfected security interest of the lenders. Another potential remedy that retirees could seek would be to file an involuntary bankruptcy petition against the debtor. Additionally, these entities could attempt to reduce their claims to judgment in proceedings in state or federal court. (See V below.) 9. What is PBGC s legal liability for payments if plan is terminated? As described below, the PBGC would have an unsecured claim for the entire unfunded balance. While the plan sponsor is responsible for giving notice to the PBGC, PBGC may not receive notice or take action until after the sale has passed. Additionally, the PBGC is liable to the retirees for amounts owed to them up to the statutory cap of $54,000 per year. 10. Would notice of UCC sale go to PBGC/retiree representative? Plan if PBGC/retiree representative objects? The obligation to notify the PBGC is with the plan sponsor under ERISA and is triggered by, among other things, a default or significant asset sale. This is a reportable event and within 30 days after the event their notice should be provided. Additionally, normal UCC notice procedures would be followed, including giving notice by publication. To provide further protection, notice can also be provided to additional parties as appropriate. To the extent that -5-
objections were received in a consensual sale undertaken through a state court, additional strategies could be explored, such as bringing the objectors into the suit and asking the court to declare that their objections are without merit. (See III.A, V, and VI below.) 11. Impact of Section 1114 of the Code and impact of same on court willingness to approve a sale. Nothing in the sale order would seek to directly modify retiree obligations. Additionally, the decision of a bankruptcy court to approve a sale under 363 is typically governed by the business judgment rule. The Court s inquiry focuses on whether the sale is in the best interests of the estate. While retirees, like the PBGC, may object to the sale, such an objection would likely be overruled. Section 1114 provides the procedures and standards for modifying the payment of retiree benefits in a Chapter 11 case. It permits modification of these payments on fair and equitable terms so that the debtor might reorganize. This provision is not operative in Chapter 7 cases, and the case law suggests that a liquidating Chapter 11 debtor should not be compelled to continue paying full retiree benefits on a priority basis under 1114. Either way, this does not appear to be an impediment to a sale. 12. Treatment of PBGC/plan trustee/retiree claims as administrative expenses in bankruptcy. Courts have normally refused to grant the PBGC administrative expense status for its claims relating to pre-petition benefit accruals. The PBGC has attempted to assert that its claims are entitled to priority as tax claims, but has failed in these efforts. Therefore, the only administrative expense claims that the PBGC would likely have are those arising from the portion of the minimum funding contribution attributable to pension benefits actually earned by the debtor company s employees who worked after the commencement of the case. Given that the plans have been frozen and there is no further accruing liabilities, the PBGC likely has no relevant administrative claims. (See V-VII below.) -6-
13. Existence of precedent transactions for UCC sale of business where defined benefit plan liability existed. As described in the PBGC opinion letters discussed below, the PBGC does not pursue successor liability claims against asset purchasers unless the buyer expressly assumes responsibility for the seller s plan. Therefore, unless the transaction is shown to be a sham, liability will not attach. (See III.B below.) ANALYSIS I. PBGC ROLE The Pension Benefit Guaranty Corporation was created by the Employee Retirement Income Security Act of 1974 and acts as a governmental insurance company, guaranteeing a variety of employee benefits in the event a pension plan becomes unfunded or underfunded. 29 U.S.C. 1301-1461 (2000). The intended function of the PBGC is threefold: (1) to encourage the continuation and maintenance of voluntary private pension plans for the benefit of their participants; (2) to provide for the timely and uninterrupted payment of pension benefits to participants and beneficiaries under pension plans; and (3) to maintain insurance premiums established by the corporation. See 29 U.S.C. 1302(a)(1)-(3) (1996). These administrative goals have become increasingly more important as the baby boom generation will soon begin to rely more heavily upon pension plans as a substantial source of retirement income. A. Types of Pension Plans Under ERISA, two categories of pension plans came into existence: defined contribution plans and defined benefit plans. See 29 U.S.C. 1002(34)-(35) (1996). Defined contribution plans vary from defined benefit plans in a myriad of ways. Although both plans are administered as entirely distinct insurance programs by the PBGC, each exhibits unique attributes tailored to meet the needs of its plan participants. -7-
1. Defined Contribution Plans: No Future Obligation to Employees Unlike its defined benefit counterpart, defined contribution plans do not offer predetermined benefits upon retirement. See 29 U.S.C. 1002(34) (1996). Instead, the employer pays pension benefits to the employee in a lump sum which has been determined by the amount contributed by the employee during the course of his or her period of employment and by various returns on investments. See Employee Benefit Research Inst., Fundamentals of Employee Benefit Programs, 7 (5th ed. 1997). Examples of defined contribution plans include 401(k) savings plans, money purchase plans, deferred profit-sharing plans, employee stock ownership plans, thrift plans, and target benefit plans. See Employee Benefit Research Inst., Fundamentals of Employee Benefit Programs, 57 (5th ed. 1997). Such plans do not fall under the ambit of the PBGC because ERISA restricts the plan s funding to the sum of the employee s contributions and returns on investment income. Id. at 76. As a result, the employee can only anticipate pension benefits in the amount of contributions made during his or her term of employment supplemented by money earned from investments. In other words, the PBGC does not offer insurance to defined contribution plans, because there exists no prearranged amount that employees will receive, thus making it impossible for the PBGC to ascertain the exact amount of benefits to be insured. 2. Defined Benefit Plans: Fixed Future Benefits Larger-sized employers tend to prefer defined benefit plans, while nonunionized, service employers -- the fastest growing employment sector -- often initiate defined contribution plans. See Testimony Concerning Employee Retirement Benefits for the Year 2015: U.S. Chamber Proposed Changes to Prepare for Baby Boom Retirements, Before Subcomm. On Aging of the Senate Labor & Human Resource Comm., 104th Cong. (1996), available in 1996 WL 10165021 at *14 (hereinafter EBRI ). Because of their prevalence among larger companies, defined -8-
benefit plans typically cover a greater number of participants than do defined contribution plans. Id. at *14. Although defined contribution plans do not get PBGC coverage, defined benefit plans entail an essential need for federal protection. Upon retirement, participants of defined benefit programs receive a fixed amount of benefits determined by calculating the length of the employee s term of employment in conjunction with the rate of the employee s compensation. See 29 U.S.C. 1002(35) (1996). An employer may utilize a formula based upon an individual s salary and service which, for example, may result in a retirement benefit package of a specified amount per month for every year of the employee s service with the employer. See Communications & Pub. Affairs Dept, Pension Benefit Guar. Corp., Your Pension: Things You Should Know About Your Pension Plan 3 (1996). While returns on defined contribution plans vary in proportion to the relative successes or failures of the investment in which the employer places the employee s contribution, participants of defined benefit programs receive a fixed amount which can easily be insured by the PBGC. See Scott Robertson, Pensions Keeping Steel Uneasy: Defining Benefits an Industry Taboo, 140 AM. METAL MKT. 1 (1996). Moreover, employers sponsoring defined benefit plans are required to fulfill a host of funding requirements to ensure the stability of the plan. Despite the promise of a PBGC guarantee for defined benefit plans, the number of defined benefit plans continues to dwindle as defined contribution plans gain more popularity with employers. See Testimony Concerning Employee Retirement Benefits for the Year 2015: U.S. Chamber Proposed Changes to Prepare for Baby Boom Retirements, Before Subcomm. On Aging of the Senate Labor & Human Resource Comm., 104th Cong. (1996), available in 1996 WL 10165021 at *21. During the fifteen years prior to the enactment of ERISA, the number of newly initiated defined benefit plans dipped to a low of 50.12% in 1960 and climbed to a high of 57.88% in 1972. Id. at *12. By 1983, the number of defined benefit plans dropped to 32.7% of -9-
all new plans formed. Id. at *13. The number of newly created defined benefit programs faltered, particularly during the late 1980s and early 1990s, encountering a precipitous drop between 1987 and 1995. Id. at *14. In 1994, 56% of employers contributed to Section 401(k) plans, 36% to defined benefit plans, 27% to profit sharing plans, and 7% to employee stock ownership plans. Id. at *5. In 1985, there were 112,000 single employer-defined benefit plans insured by the PBGC. By 1996, there were only 53,000 such plans in existence. The demise of defined benefit programs can be attributed to numerous factors, including the restructuring of Internal Revenue Code provisions, increased PBGC insurance premiums, and from an overall escalation in employer costs. See Robertson, Pensions Keeping Steel Uneasy, supra. This trend has generated much concern among employee advocacy groups who contend that individuals with defined contribution plans such as 401(k) plans must decide for themselves how to invest their pension money, whereas defined benefit plans limit financially unsophisticated employees ability to tamper with pension funding. Id. B. PBGC Revenue The PBGC derives its revenue solely from insurance premiums established by Congress, assets generated from pension plans trusteed by the PBGC, and recoveries made from companies formerly responsible for PBGC-trusteed plans. 29 U.S.C. 1306(a)(1) (1996). For plan years beginning in 2009, all single-employer pension plans pay a basic flat-rate premium of $34 per participant per year. Underfunded pension plans pay an additional variable-rate charge of $9 per $1,000 of unfunded vested benefits. The premium for the smaller multiemployer program is $9 per participant per year. The comparable rates for 2010 will be $35 per participant for singleemployer plans and $9 per participant for the multiemployer program. The variable-rate charge for single-employer plans will be the same in 2010 as it is in 2009. A termination premium of -10-
$1,250 per participant per year applies to certain distress and involuntary plan terminations occurring on or after January 1, 2006, payable for three years after the termination. II. ANALYSIS OF PBGC LIENS A. The Aggregate Balance of Past-Due Contributions Must Exceed $1 million Before a Lien Arises When the sponsor of a pension plan fails to make required contributions to the plan, and the aggregate unpaid balance of all current and past due contributions exceeds $1 million, a lien arises under the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 in favor of the plan against all of the assets of the plan s sponsor and the members of the sponsor s controlled group. IRC 412(n)(1); ERISA 302(f)(1), 29 U.S.C. 1082(f)(1). The lien may be perfected and enforced only by the Pension Benefit Guaranty Corp. or at the direction of the PBGC. See IRC 412(n)(5); ERISA 302(f)(5), 29 U.S.C. 1082(f)(5). Liens under IRC 412(n) were created pursuant to the Pension Protection Act of 1987 to provide an early warning to PBGC, the IRS and the plan s participants of possible employer difficulty in meeting its funding obligations, and to ensure that contributions are actually paid to the pension plan. See H. Con. Res. 93, Rep. No. 100-76, at p. 222 (1987). The lien arises as a matter of law when the aggregate unpaid balance of contributions owed exceeds $1 million as of a due date for a required installment or payment. The plan sponsor is required to inform PBGC within ten (10) days of the due date of its failure to make a required installment or payment that causes a lien to arise. See IRC 412(n)(4); ERISA 302(f)(4), 29 U.S.C. 1082(f)(4). If the plan sponsor fails to inform the PBGC, a penalty may be assessed against the plan sponsor in an amount up to $1,100 per day. See ERISA 4071, 29 U.S.C. 1371; 29 C.F.R. 4071.3. The amount of the lien is not the pension plan s accumulated funding deficiency at the time of the missed payment. Instead, the amount of the lien represents the aggregate amount of -11-
all missed contributions, including interest. See IRC 412(n)(3); ERISA 302(f)(3), 29 U.S.C. 1082(f)(3). The lien will accrue interest from the payment due date at the funding standard rate established by the pension plan s enrolled actuary. Unlike PBGC s lien for termination liability under ERISA 4068, no statutory limit exists on the amount of the pension plan s lien under IRC 412. Compare IRC 412(n)(3); ERISA 302(f)(3), 29 U.S.C. 1082(f)(3) with ERISA 4068(a); 29 U.S.C. 1368(a). After the lien arises, if a subsequent quarterly payment is missed, a second lien will arise (assuming the sum of the new missed contribution and the previous missed contributions, plus interest, still exceeds $1 million). This subsequent lien will arise in the amount of the subsequent missed payment. For example, if a lien arose on April 15 in the amount of $1.5 million and a subsequent contribution in the amount of $750,000 is missed on July 15, the pension plan would now possess an initial lien in the amount of $1.5 million, plus interest that accrues on that amount after April 15, and a second lien in the amount of $750,000 plus interest that accrues on that amount after July 15. If the aggregate amount of missed payments, with interest, is reduced to less than $1 million as of the end of the plan year, the pension plan s lien will expire as a matter of law at the end of the plan year. See IRC 412(n)(4)(B); ERISA 3022(f)(4)(B), 29 U.S.C. 1082(f)(4)(B). Because the statute provides for expiration of the lien only at the conclusion of the plan year when the missed contributions, plus interest, are less than $1 million, PBGC does not have the authority to extinguish the lien prior to the end of the plan year. Id. However, PBGC may withdraw the notice and/or subordinate the lien as part of a workout or forbearance agreement. -12-
B. Even if a Lien Arises, PBGC Liens Do Not Prime Perfected Secured Lenders Except for Credit Extended 45 Days After the Lien is Filed Although the pension plan s lien under IRC 412(n) arises as of a specific date, the lien is not effective against other interests until a notice of the lien has been filed in the appropriate recording office. Notice of the lien is required to be filed in a manner similar to the way the Internal Revenue Service files federal tax liens pursuant to IRC 6323. See IRC 412(n)(4)(C); ERISA 302(f)(4)(B), 29 U.S.C. 1082(f)(4)(B) and ERISA 4068(c), 29 U.S.C. 1368(c). Under IRC 6323(f), notice of federal liens against real property and personal property must be filed in the one office within the state designated for the filing of federal tax liens by the laws of the state in which the property subject to the lien is situated. IRC 6323(f)(1)(A). If a state fails to designate one office as the appropriate place, the notice must be filed in the U.S. District Court where the property subject to the lien is situated. IRC 6323(f)(1)(B). In some cases, federal tax liens and PBGC notices of a pension plan s lien are filed in offices different from other liens, such as those under the Uniform Commercial Code ( UCC ). Therefore, a party conducting a public records search for notice of a pension plan s lien must be sure to search the proper index at the proper recording office. For example, a plan sponsor incorporated in Delaware but with its principal executive office in New York will have UCC financing statements recorded with the Secretary of State of Delaware but federal tax liens filed with the New York Department of State. Once notice of the pension plan s lien is filed, the lien will have priority over any credit extended, and any collateral acquired by the borrower after the filing of the notice of the pension plan s lien (subject to certain exceptions noted below). See IRC 6323. However, the pension plan s lien is not superior to a prior perfected security interest. Under the IRC, a security interest is recognized as perfected if it meets the following three conditions: (1) the property must exist; (2) the security interest is protected under state law -13-
against a subsequent judgment lien; and (3) the holder must part with money or money s worth. IRC 6323(h)(1). Thus, assuming these conditions is not met, a lender s security interest will maintain priority over a pension plan s lien. Often a security interest will be perfected simultaneously with the pension plan s lien. For example, a lender will have on file a security interest against future inventory and accounts receivable and PBGC will have filed a subsequent notice of the pension plan s lien against the debtor s personal property. Both the lender s security interest and the pension plan s lien will be perfected upon the debtor s receipt of the inventory and accounts receivable. Under a decision of the U.S. Supreme Court, the federal lien will be superior. See U.S. v. McDermott, 507 U.S. 447, 449-450 (1993) (holding that the filing of notice renders the federal lien first in time for priority purposes). Thus, as a debtor s inventory turns over, subject to certain exceptions, the pension plan s lien will prime a secured creditor s first priority position against such inventory and any accounts receivable arising from the sale of the inventory. However, Section 6323(c) protects the priority of certain security interests for future extensions of credit and after-acquired property. These protections apply to a previously filed security interest against qualified property covered by either a commercial transaction financing agreement, a real property construction financing agreement or an obligatory disbursement agreement, as those terms are defined in the statute. However, these exceptions are limited. For example, the commercial financing exception is limited to credit extended at any time before the earlier of the 46th day after the filing of the pension plan s lien and the time that the creditor received actual notice of the pension plan s lien. See IRC 6323(c)(2). This exception is significantly less generous than the protections afforded a secured creditor as to future advances and after-acquired property under the UCC. See UCC 9-323(b) (protecting all advances made by a lender without knowledge of the lien of a judgment creditor). -14-
IRC 6323(d) also contains a catch-all provision to protect prior perfected security interests. This subsection grants priority to a previously perfected security interest for any disbursements made by a lender within 45 days after the filing of notice of the PBGC lien, if the holder of the security interest did not have actual knowledge of the federal lien. However, any disbursements made to a debtor after the 45-day period or after the lender learns of the federal lien, whichever comes first, will be primed by the federal lien. Thus, all disbursements made to a debtor 45 days after the filing of the notice, unless with respect to qualified property protected under IRC 6323(c), will be primed by the pension plan s lien, regardless of whether the lender had actual knowledge of the lien. A good example of a lien enforced by PBGC priming the lien of a prior perfected security interest occurred recently in In re Plymouth Rubber Company, Inc., Case No. 05-16088 (Bkrtcy. D.Mass. 2005). There, the lender continued to loan money to the debtor under a revolving line of credit based on its claim that it was unaware that PBGC had filed notice of a federal lien against the debtor s personal property eight months earlier. During this eight-month period, the revolving credit line and the debtor s inventory turned over several times. When the lender finally learned of the pension plan s lien, the lender refused to continue to loan money to the debtor and the debtor filed bankruptcy. The lender raised numerous arguments contesting the pension plan s first-priority position against the debtor s personal property, including lack of actual notice. Ultimately, the lender and PBGC resolved the matter by granting PBGC a first-priority position against the debtor s personal property in the amount of $5.2 million. As a result, the lender s position against the debtor s collateral was undersecured by $3.5 million. C. Potential Control Group Issues Termination liability, including PBGC liens, can only arise after a termination date has been set, and only then for members of the plan sponsor s controlled group. Under IRS -15-
regulations, controlled group includes, for example, a parent and its 80-percent owned subsidiaries. 29 U.S.C. 1301(a)(14); 29 C.F.R. 4001.3 ("Persons are under common control if they are members of a controlled group of corporations, as defined in regulations prescribed under Section 414(b) of the Code, or if they are two or more trades or businesses under common control, as defined in regulations prescribed under Section 414(c) of the Code"); 26 U.S.C. 414(b) and (c); Treas. Reg. 1.414(b)-1 and (c)-2. Liens associated with termination liability are limited to 30 percent of the collective net worth of the controlled group. 29 U.S.C. 1368(a). A parent-subsidiary controlled group consists of one or more chains of corporations connected through stock ownership with a common parent where: (1) for each corporation in the chain (other than the parent), stock having at least 80% of the combined voting power or value is owned by one or more of the other corporations in the chain, and (2) the common parent owns at least 80% of the stock (combined voting power or value) of at least one other corporation in the chain. 26 U.S.C. 1563(a)(1). Therefore, all subsidiaries directly or indirectly of which the plan sponsor holds 80% of the voting interest will be viewed as within the "control group" for purposes of termination liability. However, unless it somehow met the 80% ownership test, Harris is not a member of the controlled group. Id. However, certain members of a controlled group are not considered "component members" who can be held liable even if they meet the above tests. Under the Internal Revenue Code provision dealing with "controlled group of corporations," an entity is treated as "excluded" if it is "a foreign corporation subject to tax under section 881 for such taxable year." 26 U.S.C.A. 1563(b)(2)(C). Typically, foreign corporations not engaged in business in the U.S. are not subject to tax and are not component members. Reg. 1.1563-1(b)(2)(ii)(B). Therefore, to the extent that foreign subsidiaries of the plan sponsor are at issue, and they do not engage in business in the -16-
United States, it may be worth exploring further whether these provisions can satisfy the purchaser that the PBGC cannot pursue claims against the foreign subsidiary. III. PENSION PLAN SUCCESSOR LIABILITY A. Employer Provides Notice of a Reportable Event Under ERISA, plan administrators have a duty to file a variety of reports with the Pension Benefit Guaranty Corporation. One such required notice is when certain reportable events occur. Failure to give notice of a reportable event can result in significant fines. Upon notification, the PBGC will decide whether to begin termination proceedings. Reportable events are ones that may indicate plan difficulties, and include the following: (1) Plan amendment decreasing benefits; (2) Decrease in number of active plan participants. A drop of more than 20% in the number of active plan participants between the beginning and the end of the current plan year, or a drop of more than 25% in the number of participants between the beginning of the previous plan year and the end of the current plan year, is a reportable event. This rule applies if the present value of unfunded vested benefits under the plan as reported in the most recently filed annual report equals or exceeds $250,000; (3) Failure to meet minimum funding standards. A reportable event occurs when a pension plan fails to meet ERISA s minimum funding standards or is granted a minimum funding waiver; (4) Inability to pay benefits on time; (5) Distribution by an employee benefit plan to a participant who is a substantial owner ; (6) Merger, consolidation, or transfer of assets or liabilities; (7) Bankruptcy or insolvency of contributing sponsor; -17-
(8) Liquidation or dissolution of contributing sponsor; (9) Transaction involving a change of employer. A reportable event occurs in four kinds of situations with respect to a single-employer plan of a contributing sponsor that has $1 million or more in unfunded nonforfeitable benefits. Three of the situations arise as a result of a transaction involving a transfer of assets or an ownership interest in a contributing sponsor. The fourth kind of situation arises as a result of a transaction involving a transfer by a contributing sponsor of assets or an ownership interest in another trade or business. In that situation, the sponsor and the trade or business are or will no longer be part of the same controlled group; (10) Other events. In addition to designating the above occurrences, ERISA provides that the PBGC may identify as a reportable event any occurrence that it finds to be indicative of a need to terminate a plan. 29 U.S.C.A. 1343(c). In certain circumstances, pursuant to its rulemaking authority, the PBGC has promulgated regulations which waive these reporting requirements under certain circumstances. A chart summarizing the reporting requirements, and any corresponding waiver, is attached below: PBGC REPORTABLE EVENTS CHART Plan administrators and contributing sponsors of single-employer defined benefit plans are required to notify the PBGC of a reportable event not later than 30 days after certain plan or corporate events have occurred. Contributing sponsors of a plan sponsored by any privately-owned entity with an aggregate unfunded vested benefit of more than $50 million and aggregated funded vested benefit percentage of less than 90 percent must give 30 days advance notice of certain reportable events. If applicable criteria are satisfied, the PBGC allows waivers of these requirements or extensions of the filing deadlines. This chart summarizes the events to watch for and available waivers. -18-
REPORTABLE EVENT DESCRIPTION 30-DAY NOTICE (FORM 10) ADVANCE NOTICE (FORM 10-ADVANCE) Minimum funding waiver Application for minimum funding waiver. Not waived. Not waived, but deadline is extended to 10 days after the request for the waiver is submitted. Failure to meet minimum funding standards Failure to meet minimum Waived if: funding standards or to pay amount required as a 1. required installment is condition of a funding paid by the 30th day after waiver. due date; 2. the failure to make a 2009 plan year quarterly contribution is not motivated by financial inability and the plan has fewer than 25 participants for the prior plan year; or 3. the failure to make a 2009 plan year quarterly contribution is not motivated by financial inability, the plan has at least 25 but fewer than 100 participants for the prior plan year, and a simplified notice is filed with PBGC by the time the first missedquarterly reportable event report for the 2009 plan year would otherwise be due. However, if any unpaid installment, when added to prior unpaid balances, exceeds $1 million, Form 200 must be filed within 10 days of the payment s due date, if plan is less than Not required. -19-
REPORTABLE EVENT DESCRIPTION 30-DAY NOTICE (FORM 10) ADVANCE NOTICE (FORM 10-ADVANCE) 100% funded. Inability to pay benefits when due Current inability to pay unless: need to verify eligibility Waived, unless plan covered 100 or fewer lives on each day during prior year. Not required. can t locate administrative delay up to two months Projected inability liquid assets less than 2 X disbursements for quarter Transfer of benefit liabilities Transfer of 3 percent or more of benefit liabilities, within any 12-month period to plan outside controlled group. Waived if: 1. complete transfer of the entire plan to one other plan; Waived if: 1. complete transfer of the entire plan to one other plan; 2. transfer complies with Code sec. 414(l) using reasonable assumptions and, when aggregated with other transfers during the plan year, consumes less than 3 percent of assets; 2. transfer complies with Code sec. 414(l) using reasonable assumptions and, when aggregated with other transfers during the plan year, consumes less than 3 percent of assets; 3. transfer complies with 414(l) using PBGC annuity assumptions; or 4. transfer complies with 414(l) using reasonable assumptions and after the transfer each transferee and transferor plan is fully funded using PBGC annuity 3. transfer involves 500 or fewer participants and complies with 414(l) using PBGC annuity assumptions; or 4. transfer complies with 414(l) using reasonable assumptions and after the transfer each transferee -20-
REPORTABLE EVENT DESCRIPTION 30-DAY NOTICE (FORM 10) ADVANCE NOTICE (FORM 10-ADVANCE) rates. and transferor plan is fully funded using PBGC annuity rates. Distribution to substantial owner Non-death distributions to a substantial owner in excess of $10,000 leaving unfunded nonforfeitable benefits. Waived, if: 1. total distribution does not exceed the defined benefit dollar limit for the year; Not required. 2. plan meets select funding exceptions; or 3. total distribution does not exceed 1 percent of assets at end of either of two preceding plan years. Active participant reduction Number of active plan participants is reduced to less than 80 percent of the total number of active participants as of the beginning of the plan s current plan year, or to less than 75 percent of the total number of active participants as of the beginning of the plan s previous plan year. Waived if: 1. plan has fewer than 100 participants as of the beginning of either the current or the previous plan year; or 2. plan meets select funding exceptions. Not required. Change in contributing sponsor or controlled group Transaction involving a change in sponsor or controlled group. Waived if: 1. departing entity represents a de minimis 10 percent segment of the plan s old controlled group; 2. each departing entity is a foreign entity other than a Waived if: 1. 500 or fewer participants in transferred plan; or 2. de minimis 5 percent segment -21-
REPORTABLE EVENT DESCRIPTION 30-DAY NOTICE (FORM 10) ADVANCE NOTICE (FORM 10-ADVANCE) foreign parent; or 3. plan meets select funding exceptions. Liquidation Liquidation of member of the contributing sponsor s controlled group. Waived if: 1. liquidating entity represents a de minimis 10 percent segment of the plan s controlled group and plan sponsorship continues within controlled group; 2. each departing entity is a foreign entity other than a foreign parent; or 3. plan sponsorship continues within controlled group and the plan meets select funding exceptions. Waived if: 1. de minimis 5 percent segment; and 2. plan sponsorship continues within controlled group Extraordinary dividend on stock redemption Extraordinary dividend Waived if: declared (more than current year and four year 1. person making adjusted gross income) or distribution is a de minimis more than 10 percent of the 5 percent segment of the company s assets plan s controlled group; redeemed. Waived if de minimis 5 percent segment. 2. person making distribution is a foreign entity other than a foreign parent; 3. foreign parent makes distribution solely to other members of the plan s controlled group; or -22-
REPORTABLE EVENT DESCRIPTION 30-DAY NOTICE (FORM 10) ADVANCE NOTICE (FORM 10-ADVANCE) 4. the plan meets select funding exceptions. Loan default Member of plan s controlled group defaults on loan with outstanding balance of $10 million or more without cure within 30 days (10 days for plan s subject to advance notice rule). Waived if: 1. default cured or waived within 30 days, or lender s period if later; 2. debtor is a foreign entity other than a foreign parent; or 3. the plan meets select funding exceptions. Waived if default cured or waived within 10 days, or lender s period if later. Notice deadline extended to 10 days after default or day after receipt of written notice, acceleration of loan, or expiration of cure period in loan agreement, if later. Bankruptcy or similar settlement Bankruptcy, insolvency, or similar settlements of contributing sponsor. Waived if entity is a foreign entity other than a foreign parent. Not waived, but deadline extended to 10 days after date of reportable event. Similarly, the PBGC has promulgated regulations regarding the change in contributing sponsor or controlled group. These regulations indicate that an asset sale or other change in control is a reportable event: (a) Reportable event. A reportable event occurs for a plan when there is a transaction that results, or will result, in one or more persons ceasing to be members of the plan's controlled group. For purposes of this section, the term transaction includes, but is not limited to, a legally binding agreement, whether or not written, to transfer ownership, an actual transfer of ownership, and an actual change in ownership that occurs as a matter of law or through the exercise or lapse of pre-existing rights. A transaction is not reportable if it will result solely in a reorganization involving a mere change in identity, form, or place of organization, however effected. -23-
29 C.F.R. 4043.29. 1. Change in contributing sponsor or controlled group The reportable event entitled change in contributing sponsor or controlled group is often referred to by practitioners as the controlled group breakup reportable event. A controlled group breakup is the classic situation contemplated by this reportable event, e.g., where a subsidiary that is not the contributing sponsor of any plan is sold to another controlled group. But this reportable event also can cover a transaction where a plan is transferred from one controlled group to another as part of an asset sale, with both of the controlled groups remaining absolutely intact. The test for reporting is whether there is a transaction that results, or will result, in one or more persons ceasing to be members of the plan s controlled group. 29 C.F.R. 4043.29(a). From the perspective of the plan all members of the plan s controlled group will cease to be members of its controlled group once the transaction becomes effective. 29 C.F.R. 4043.29(e)(2); Q&A 23 of the 1998 PBGC Enrolled Actuaries Meeting Blue Book (available at http://www.pbgc.gov/docs/1998bluebook.pdf). The reportable event is not the actual controlled group breakup or transfer of plan sponsorship, but rather the transaction as a result of which the controlled group will break up or the plan will be transferred. Thus, reporting is due 30 days after the date of actual or constructive knowledge that there is legally binding agreement, regardless of any later closing or effective date. Q&A 25 of the 1998 PBGC Enrolled Actuaries Meeting Blue Book (available at http://www.pbgc.gov/docs/1998bluebook.pdf). 2. Loan Defaults As Reportable Events Only certain loan defaults are reportable the default must be on a loan with an outstanding balance of $10 million or more, and event hen it is reportable only if: (1) it results from failure to make a payment (unless the payment is made within 30 days), (2) the lender -24-
accelerates the loan for any reason, or (3) the lender issues a written notice of default based on one of several specified reasons. 29 C.F.R. 4043.34(a). And there are waivers where the default is cured, where the debtor is a foreign entity other than a parent, or where the plan meets one of several funding-based tests tied to PBGC premium rules. 29 C.F.R. 4043.34(c). Here, the event occurs when the default occurs not when the 30-day period for making the late payment ends, not when the lender issues a notice of default or accelerates the loan, and not when the cure period ends. 29 C.F.R. 4043.34(d)(1); Q&A 25 of the 1998 PBGC Enrolled Actuaries Meeting Blue Book (available at http://www.pbgc.gov/docs/1998bluebook.pdf). This means that the report is due 30 days after the contributing sponsor or plan administrator knows or has reason to know of the default itself, without regard to any of the subsequent events that may make the default reportable. 1 B. Liability in Asset Purchases It is clear that in a merger context, the termination of a plan subsequent to the time that the sponsoring corporation is merged into or becomes a subsidiary of the buyer will shift the liability to the surviving corporation. 29 U.S.C. 1362; see also PBGC Opinion letter 76-92. However, in a purchase of assets situation, the PBGC will not assert a claim of successor employer liability against a buyer unless the buyer expressly assumes the responsibility for the seller s plan. PBGC Opinion letter 78-10 and 76-111; see also Travis v. Harris Corp., 565 F.2d 443, 446 (7th Cir.1977) ( a corporation that merely purchases for cash the assets of another corporation does not assume the seller corporation's liabilities ). 1 The PBGC provides an extension until one day after the end of the cure period (in the case of a payment failure default) or one day after the date of the loan acceleration or notice of default. 29 C.F.R. 4043.34(d)(2). However, the 30-day clock starts to run long before it is known whether the event will have to be reported. Thus, for loan defaults, the real deadline for reporting once it is known that a report is required may be essentially immediate rather than within the usual 30 days. -25-