Distress Terminations: It Isn't Just for Bankruptcy
I happen to be working a distress termination of a single employer defined benefit plan for a company that is not in bankruptcy or insolvent and it struck me that in the current economy, there might be more employers that will have to deal with this issue.
There are four statutory tests for determining "distress" for the purposes of distress terminations: (1) liquidation in bankruptcy or insolvency proceedings, (2) reorganization in bankruptcy or insolvency proceedings, (3) inability to pay debts when due to continue in business unless a distress termination occurs, and (4) unreasonably burdensome pension costs due solely to a decline in employment. While options 1 and 2 are considered the most common, options 3 and 4 may become more commonplace.
There are a couple of interesting hurdles to options 3 and 4 in a distress termination. First, the determination is made by the PBGC, in its discretion, based on information provided by the plan sponsor. The second hurdle is that the distress tests must be applied to the members of the control group of the sponsor, not just the sponsor itself. That means that a troubled subsidiary may not be able to terminate its own plan if the parent is not equally distressed.
When an underfunded plan terminates in a distress termination, the plan effectively goes into receivership. The PBGC becomes the trustee of the plan, takes control of any plan assets, and assumes responsibility for liabilities under the plan. The PBGC makes payments for benefit liabilities promised under the plan with assets received from two sources: assets in the plan before termination, and assets recovered from employers. The balance, if any, of guaranteed benefits owed to beneficiaries is paid from the PBGC's revolving funds. Following a distress termination, the plan's contributing sponsor and every member of that sponsor's controlled group is liable to the PBGC for the excess of the value of the plan's liabilities as of the date of plan termination over the fair market value of the plan's assets on the date of termination. The liability is joint and several, meaning that each member of the controlled group can be held responsible for the entire liability.
Not surprisingly, the PBGC is not particularly receptive to distress terminations and will carefully scrutinize applications for termination where the sponsor is not in bankruptcy. But if the choice is between bankruptcy and terminating the pension plan, sponsors should consider whether distress termination is a viable option to keep the company itself in operation.
