Options for Unaffordable Pensions: Out-of-Bankruptcy Distress Terminations

As economic and business conditions change, plan sponsors are sometimes no longer able to afford their pension obligations. A distress termination may be a viable option for financially challenged employers that need pension funding relief but want to avoid bankruptcy. Although the process is time-consuming and comes with some risks, it also provides the sponsor with a potential avenue for negotiating reduced or delayed pension payments.  

What is a distress termination?

The Pension Benefit Guaranty Corporation (PBGC) has the authority to permit a plan sponsor to terminate its underfunded pension plan outside of bankruptcy through a distress termination when the sponsor, and each member of its controlled group excepting certain de minimis entities, will be unable to pay its debts when due and continue in business unless the plan is terminated. This is generally determined through a “but for” test, meaning the company needs to prove to PBGC that, but for the pension, the company could stay in business. PBGC generally reviews applications to ensure that the company has a viable business plan going forward and has taken all reasonable steps to either reduce costs or find alternative methods of funding the pension.

PBGC can also grant a distress termination where a company makes a showing that unreasonably high pension costs are due solely to declining covered employment under all single-employer pension plans for which the entity is a contributing sponsor. However, that test is often difficult to meet as pensions become unaffordable for a variety of reasons, which may include, but not be solely as a result of, a work force decline.

What are the benefits of a distress termination?

The distress termination process allows a plan sponsor to work with PBGC to resolve pension liabilities without resorting to bankruptcy, which can be a costly, inefficient and risky process. Typically, PBGC and a plan sponsor enter into an agreement to settle the liabilities related to the termination, and PBGC has a considerable amount of latitude when negotiating. Settlements often include a mix of short-term payments with longer-term, secured obligations—e.g., secured notes. PBGC also is typically willing to work with lenders to ensure that the company still has access to credit and does not breach its covenants. The ultimate goal is to reach an agreement that allows the company to continue as a going concern while providing PBGC with resources to pay guaranteed pension benefits.  

How do you apply for a distress termination?

To initiate a distress termination, a plan administrator must apply to PBGC. The administrator first selects a date of plan termination, and, as of that date, the plan must reduce the benefits of those in pay status to PBGC-guaranteed levels. The administrator then files a Notice of Plan Termination with “affected parties,” including participants, beneficiaries and PBGC. 

In its notice to PBGC, the plan administrator must provide information, including tax returns, audited financial statements, projections and a summary of any restructuring efforts taken prior to applying for the termination. The administrator is also required to submit plan-related information to PBGC such as the plan document, actuarial valuation reports and participant information. 

If PBGC determines that a plan qualifies for a distress termination, PBGC will take over as trustee and begin making benefit payments. The plan sponsor and all controlled group members become jointly and severally liable to PBGC for the plan’s underfunding, as well as any unpaid minimum required contributions, unpaid variable-rate and flat-rate premiums and termination premiums ($1,250 per participant per year for three years). Importantly, the plan’s underfunding is calculated using PBGC’s conservative termination assumptions, which generally results in a considerably larger liability for the plan sponsor.  PBGC typically resolves all of the liabilities through a negotiated settlement with the plan sponsor.

What are the risks associated with a distress termination?

An out-of-bankruptcy distress termination may be appropriate for some, but plan sponsors should be aware that the process can take a considerable amount of time. Success is also largely dependent on PBGC’s willingness to enter into a settlement that is affordable for the company. If PBGC and the sponsor are unsuccessful in negotiating a settlement, the plan sponsor may be responsible for accelerated funding obligations, and liens may arise. Finally, the settlement of termination liability with PBGC does not necessarily settle all plan-related obligations, so the sponsor may need to have additional discussions with the Internal Revenue Service (IRS) to resolve, for example, funding-related excise taxes. 

Michael Kreps (mkreps@groom.com) and Mark Carolan (mcarolan@groom.com) practice at Groom Law Group, Chartered, where they counsel employers on pension plan funding and restructuring, as well as other issues.